FY24 Defense Budget Proposal - Here's Why Morgan Stanley Is Bullish On Defense Spending

Morgan Stanley analyst Kristine T Liwag, on the eve of the President’s FY24 budget request on March 9, spoke with a host of Defense and Government Services companies to know the pulse.

The multiple management teams and industry experts suggested they expect to see about 3% - 5% growth in the topline above FY23 enacted levels.

With $858 billion enacted in FY23, about 3-5% growth would place the topline request in FY24 in the range of $884 billion – 901 billion.

The experts anticipated a “skinny budget” release on March 9 with little detail available below the headline defense budget number. The budget details around specific programs are anticipated to trickle out a week or two after the March 9 release.

The experts do not expect any big surprises to materialize in the FY24 budget.

While programmatic details will trail the topline release, Lockheed Martin Corp LMT expects the Pentagon to request about 80 F-35s, which helps underpin its 156 aircraft delivery target in 2025 and beyond.

Political momentum around the push for deep defense cuts in FY24 appears to be waning, though management teams and outside defense experts noted the possibility of a series of Continuing Resolution extensions in FY24, given the current political divide.

Primes operating under fixed-price structures or those that priced fixed-price options before macro pressures were fully accounted for are now facing margin pressure on those programs.

Spotlight on B-21 L RIP: Northrop Grumman Corp NOC in its 2022 earnings, indicated that macroeconomic and inflationary risks related to the B-21 program have rendered it possible that one or more of its 5 Low-rate Initial Production (LRIP) options could be performed at a loss of up to $1.2 billion.

The B-21 LRIP options were priced in 2015, and higher-than-anticipated labor cost is the primary driver of margin pressure on the LRIP portion of the program.

In terms of remedies, the government could technically re-open the LRIP contract, though there is little precedent for doing so, and the possibility is remote.

Army Still Important: With the ongoing conflict in Ukraine, the Pentagon sees new value in Army systems.

Morgan Stanley was impressed by the extent of Textron Inc TXT investment in FVL capability and saw the potential for the US Navy and Marine Corps to leverage FLRAA technology for future systems.

Takeaways: First, although clear challenges remain, corporates sounded slightly constructive on supply chain pressures. Second, defense budget experts do not expect rhetoric around fiscal austerity to impact the FY24 defense budget.