After warnings that U.S. budget cuts would devastate the defense industry, three top weapons makers this week announced second-quarter profits that beat analysts’ estimates.
The automatic spending reductions haven’t hurt the leading government contractors including Lockheed Martin Corp. (LMT:US), Northrop Grumman Corp. and General Dynamics (GD:US) Corp. Lockheed and Northrop raised their profit outlooks for the full year.
The companies, whose shares have outpaced the Standard & Poor’s 500 Index this year, boosted net income by cutting jobs, divesting poorly performing units and using cash reserves to buy back shares. The Pentagon has shielded big weapons programs such as the F-35 jet, the military’s most expensive weapons system, from the cuts that started taking effect March 1.
“We’ve seen less impact from sequestration, writ large, than we expected to through this part of the year,” Bruce Tanner, Lockheed’s chief financial officer, told analysts yesterday. “The Pentagon has done a fairly masterful job kind of deflecting” cuts to weapons programs.
The biggest defense companies so far have escaped the full force of $37 billion in military cuts mandated to occur by Sept. 30. The Pentagon faces another $52 billion in reductions from planned spending for the next fiscal year, if Congress and President Barack Obama don’t reach agreement on reducing the U.S. budget deficit.
Even if sequestration remains in effect next year, the weapons makers are unlikely to be hit with significant reductions, said Rick Whittington, an New York-based analyst with Drexel Hamilton LLC.
“I don’t think either party wants to go to the polls next year reducing the number of ships or airplanes or satellites,” he said in a phone interview. “The odds of worst-case sequestration are diminishing.”
Defense Secretary Chuck Hagel has said cuts to next year’s budget would cause the Pentagon to buy fewer ships, planes and satellites.
Amid the reductions, spending on large programs such as the Lockheed F-35 Joint Strike Fighter probably will be preserved, the Pentagon’s top weapons buyer said in an interview this month.
‘Like a Hurricane’
The Defense Department’s commitment to the jet is unlikely to change “under any of the budgets we are looking at, including sequestration,” Frank Kendall said in a July 12 interview.
Kendall used a weather metaphor to describe the minimal damage to defense contractors.
“There were people who thought that when sequestration was triggered it would arrive like a hurricane or a thunderstorm,” Kendall said. “It arrived more like a rain that just started to fall and just keeps falling and the water’s rising.”
The situation in 2014 will probably be similar to this year, Lockheed’s Tanner told analysts yesterday. The company’s units that depend on shorter-duration orders are more likely to be affected, he said.
“The pain probably will not be as bad as the howling,” George Ferguson, a defense analyst at Bloomberg Industries, said in an interview. “All of these contractors work on programs the Pentagon is going to move to protect.”
The Defense Department probably will reduce the size of the Army and Marine Corps, scale back on operations and seek savings in health care to protect weapons programs, Ferguson said.
The Aerospace Industries Association, an Arlington, Virginia-based trade group that represents contractors, was among those that last year predicted severe outcomes for the industry as a result of the automatic budget cuts.
Marion Blakey, the group’s president, said the budget cuts would lead to “an unemployment Armageddon.”
In a phone interview today, Blakey said the job cuts estimate was made last year when few details were known about how the budget cuts would be implemented. “And we are only five months into this, and it could take another 12 to 18 months to see the kind of job losses we forecast,” she said.
Lockheed said yesterday that the automatic cuts probably won’t slice revenue by the $825 million anticipated in April. Its net income jumped 10 percent to $859 million in the quarter from a year earlier.
The Bethesda, Maryland-based contractor said it expected to book about $7.5 billion for the quarter ending Sept. 30, including orders for another lot of F-35 jets, missile defense programs and international sales.
Northrop (NOC:US) rose 1.7 percent today to close at a record $90.30 in New York trading after raising its sales and profit outlook and reporting second-quarter earnings that exceeded analysts’ predictions.
General Dynamics gained 1.5 percent to close at $85.31, the highest level since September 2008, after it said the quarter’s profit was better than what analysts had estimated. It also maintained its forecast for the year. The company said its second-quarter orders included $2.8 billion from the Navy for construction of four DDG-51 destroyers.
Northrop shares have climbed the most of the three defense contractors this year, advancing 34 percent, compared with a 19 percent rise in the S&P 500.
There are signs of the slowdown in defense spending. Each company’s order backlog declined as Pentagon contract awards slipped. Lockheed’s backlog, for example, fell 8.7 percent to $75.1 billion, from $82.3 billion at the end of 2012.
In June, the Pentagon said sequestration will affect 2,500 programs, projects and budget activities with each losing some funds from planned spending.
Boeing Co. (BA:US), the No. 2 weapons maker, is looking to blunt U.S. budget cuts by boosting foreign sales, said W. James McNerney Jr., Boeing’s chairman and chief executive officer, during the Chicago-based company’s earnings conference call today. Those sales accounted for 23 percent of the defense unit’s $8.2 billion second-quarter revenue and 37 percent of its $71 billion backlog.
“We remain cautious,” he said. “We think there’s more to come on sequestration.”
Boeing’s defense unit is closely minding operating margins and preparing “for some pretty draconian scenarios” as it awaits details on Pentagon spending, McNerney said. “We are not out of the woods, at all. We are just entering the woods.”
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