Could More Drone Contracts Offset DoD Budget Cuts?

The controversy behind drone attacks is not stopping the Pentagon from using unmanned vehicles, which will benefit the defense contractors that make them such as Raytheon RTN and Lockheed Martin LMT. With Leon Panetta slated to announce a 30% increase in military spending on armed unmanned aircraft, demand for drones is set to remain solid even as the military looks to cut corners elsewhere. Growth in the drone market has been met with criticism and protests, but that hasn't stopped spending on the unmanned planes to increase rapidly as the military looks for strategies that require less troops on the ground. With Barack Obama's push for smaller special operations instead of large and costly wars, military spending on drones was bound to increase. The announcement will give some relief to defense contractors, who have been threatened with shrinking military budgets for some time. With Leon Panetta set to cut the Pentagon's budget by $487 billion, subcontractors were the first in line to feel the pain. Now, those same companies will need to restructure their operations to benefit from growth areas in military research. Raytheon has gone in that direction. For example, last year the company announced the Small Tactical Munition, a 13-pound bomb whose laser guidance and GPS systems allow it to hit stationary and moving targets. Meanwhile, the company streamlined operations and focused on international markets to prepare for lower spending at home. The diversification worked. Contracts with Saudi Arabia and Taiwan yielded $1.34 billion in 2011 alone. Another well-known player in the drone market is Lockheed Martin, whose RQ-170 Sentinel was used in the raid on Osama bin Laden. The company's Desert Hawk series of unmanned aircraft remains a popular choice for American and British militaries. However, the loss of an RQ-170 in Iran was a serious blow to the integrity of Locheed Martin's intellectual property, and fears of reverse engineering may make the U.S. government consider alternatives when assigning drone contracts in the future. This may translate to a boon for Raytheon, who has already begun expanding into both cyberwarfare and drone technologies after the company's Applied Signal Technology and Intelligence, Surveillance, and Reconnaissance programs saw greater demand. These arms of the company develop technologies that help governments use drones in special ops and defend against enemy drones. The focus on these parts of the company's operations explain how it was able to increase earnings by 17% despite a 6.4% fall in net sales to just $6.44 billion. Raytheon may choose to expand by acquiring smaller companies focusing on unmanned vehicle research and development. It is in a stronger position to do this, thanks to an increased cash flow and a jump in working capital, which rose 118% from the previous year. However, the company may be uneasy about going shopping when governments around the world seem more strapped for cash than ever, and when military contractors are becoming increasingly unpopular. With Lockheed Martin and Raytheon beating analyst estimates in their most recent earnings releases, the companies delivered consistent growth even as the bubble in military spending bursts. With continued investment in growth niches like unmanned military aircraft, they could sustain their performance, but they will face a struggle as the U.S. government scales back and other nations face an age of austerity.