Military Budget Cuts Hit These Contractors

While President Obama's speech highlighted the need for spending to keep America on the road to recovery, there were plenty of cuts peppered throughout his proposed $3.8 trillion budget. In total, the plan would help reduce the nation's debt by $4 trillion over 10 years. The Pentagon was not spared, as the president proposed $487 billion in spending cuts to the Pentagon over the next decade. As a result, military subcontractors Lockheed Martin LMT, Boeing BA, and Northrop Grumman NOC will see smaller orders from the American government. For example, the budget includes an order to buy 29 F-35 Joint Strike Fighters from Lockheed Martin, two less than this year's order. That represents a loss of $1.6 billion in revenue for the military contractor, which is nearly 10 percent of the $18 billion in weapons cuts in Obama's new budget. Despite the loss, the news was better than expected for many investors, and shares in LMT recovered from a steep drop as the market reacted to the news. The total order to Lockheed Martin for 2013 includes $9.17 billion for new military aircraft, which translates to nearly 20 percent of the company's revenue for 2011, demonstrating the company's dependence on military contracts. This has been a source for concern for a while, as military budgets are eyed by politicians both on the left and the right looking to cut the nation's deficit without raising taxes. However, recent retraction from mainstream Republicans, who have looked for alternative ways to save money, has helped the stock to rally in recent weeks despite analyst scepticism, and it is currently up over 6.4 percent since the beginning of February. Lockheed Martin has also been helped by lower than expected pension costs, although some analysts still fear that a growing pension obligation, which recently hit the company's profits, will challenge the company in the long term at a time when it is facing steeper defense cuts. Alongside those military cuts is a ray of hope for the defence contractor. While the Pentagon may require less fighter jets, it listed unmanned systems, cyber defense, ballistic missle defence, and sateilltes as "high-priority initiatives" as more surgical special ops continue to replace largescale military operations. Since the Pentagon also plans to hand Lockheed Martin and Boeing $8 billion for defense satellites as part of a push to spend $40.1 billion on space operations through 2017, there is plenty of good news for contractors in the lower but more strategic defense spending. Lockheed Martin also needs to worry that it will not benefit from higher spending on unmanned aircraft as its competitors. Its loss of a drone in Iran last December meant a major compromise to the company's intellectual property. Meanwhile, Boeing and Northrop Grumman will not see their revenues jump from drone sales to the Pentagon anytime soon. Although currently major drone suppliers for the Air Force and Navy, the companies will lose $10 billion combined due to lower demand from the American military. The Pentagon is cutting $5.2 billion in purchases of Boeing's P-8 Poseidon as well as $2.5 billion in cuts on Northrop's Global Hawk Drones and $2.3 billion in cuts on the company's Defense Weather Satellite System. For now, the military contractors are seeing their stocks flat as investors digest the news. Looking ahead, they will need to find new sources of revenue if they want to offset slackening demand from the American military. With a large portion of the nearly half a trillion in military spending cuts subcontractors over the next decade, there is a big hole to fill.