Winners and Losers in the Defense Plan

Obama's Defense Secretary is proposing some major changes in Pentagon spending plans—but it was no "bloody Monday" for defense contractors

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Defense Secretary Robert M. Gates took the unusual step on Apr. 6 of announcing the Pentagon's spending priorities—and weapons program cuts—before the White House had actually submitted its proposed 2010 budget to Congress.

Wall Street had been expecting much worse for what had been categorized as "bloody Monday" for the defense industry. Instead, defense stocks rallied, with the Spade index, composed of 55 defense-related stocks, rising 3.6% even as the Secretary spoke. "For everything they took away, they added something else," says Scott Sacknoff, director of the index.

While the cuts were many, overall spending would still rise. Many defense shares had already fallen in anticipation of bad news. "I think they're all hit a bit," said Paul Nesbit, a defense industry analyst at JSA Research, of the big companies he follows. "But not as much as some people thought. Once that uncertainty was removed, they all took off."

More Federal Jobs

The announced 2010 budget would be $533.7 billion, up by $20.4 billion from 2009, not including an additional $130 billion for the wars in Iraq and Afghanistan. Gates said he would increase the budget to complete "the growth in the Army and Marines while halting reductions in the Air Force and the Navy. "

That means more federal jobs. Gates announced the Pentagon would be hiring 20,000 people, converting 11,000 contractors into government employees and hiring 9,000 new acquisition professionals by 2015. Much of the systems integration work, language translation, and technical support services that had been down by outsiders would be done in-house by the Pentagon. One loser there is Lockheed Martin (LMT), a big government services contractor.

Lockheed also took a direct hit to one of its fighter jet programs, the F-22 Raptor, which will stop at 187 planes at the end of this year. Another Lockheed jet, the F-35 joint strike fighter, got a boost, however, with Gates increasing the buy from the 14 aircraft bought in 2009 to 30 in 2010, with funding increases from $6.8 billion to $11.2 billion. The Pentagon will buy 513 F-35s over the next five years and, ultimately, 2,443 of the $80 million planes.

The surprises, says John Pike, a defense industry analyst with GlobalSecurity.org, were the cancellations of the F-22 and the indication by Gates that he would go ahead with the controversial airborne fuel tanker program, a battle won by Northrop Grumman (NOC) and its overseas partner EADS (EAD), but under protest by Boeing. Pike said he expected a continued fight to keep the F-22 by the many states involved in its production. Meanwhile, he notes, the Office of Management & Budget had recommended not continuing with the new tanker program. "The [existing] KC-135 was positioned as an Eisenhower-era plane—the struts need to be replaced, that's all," Pike says. "The only thing we get from a new tanker is new car smell in the cockpit."