Defense contractors gain reprieve on cuts without long-term fix

DEFENSE CONTRACTORS INCLUDING GENERAL DYNAMICS Electric Boat were saved from potential spending cuts when Congress approved a budget deal, but the reprieve may prove short-lived.
Posted 1/2/13

WASHINGTON - Defense contractors led by Lockheed Martin Corp., General Dynamics Corp. and Raytheon Co. gained a reprieve from U.S. spending cuts that may prove short-lived.

The companies’ shares rose in the immediate aftermath of a budget deal by President Barack Obama and lawmakers that put off by two months the automatic reductions in military and domestic programs that had been scheduled to take effect today.

After that, “the arrow of cuts is more directly pointed at defense spending” than earlier, Byron Callan, a defense industry analyst at Capital Alpha Partners LLC in Washington, said today in a phone interview.

The House of Representatives last night cleared a bill raising taxes on top income earners and extending expanded unemployment benefits. It also delayed until March 1 the automatic defense budget cuts of about $500 billion over 10 years. Obama said he would sign the bill.

Lockheed rose 54 cents, or less than 1 percent, to $92.79 at 1:36 p.m. in New York trading. General Dynamics gained 1.9 percent to $70.60, and Raytheon increased 1.4 percent to $58.35. The broader Standard & Poor’s 500 Index rose 1.8 percent.

The two-month delay would cost about $24 billion that would be offset by a blend of additional revenue and spending reductions, half of which would come from defense.

If the automatic cuts aren’t averted by March, the Pentagon would have that much less time to impose the $55 billion in reductions mandated for the current fiscal year that ends in September, Callan said.

Revenue outlook

Even if a new deal is reached, “it’s possible an additional $100 billion to $200 billion of reductions” will be imposed on defense spending as part of such an agreement, Christopher DeNicolo, a credit analyst with Standard & Poor’s in New York, wrote in a note to investors today.

Those additional cuts, along with the $487 billion reduction in planned defense spending over 10 years that the Pentagon already agreed to impose, will mean “flat to declining revenues and earnings for most U.S. defense contractors for the next several years,” DeNicolo said.

Amid contractors’ relief that lawmakers “‘avoided the cliff,’ all they did was push it down the road,” said Stan Soloway, chief executive officer of the Professional Services Council, an Arlington, Virginia-based group that represents contractors such as SAIC Inc. and CACI International Inc.

“It does not erase any of the instability and uncertainty that has been vexing every federal agency” and contractors that support them, Soloway said in a phone interview.

‘Long-term solution’

While lawmakers made headway on taxes, “we’re very concerned that they could not agree to a long-term solution to sequestration,” said Dan Stohr a spokesman for the Aerospace Industries Association, an Arlington, Virginia-based trade group that represents Lockheed, Raytheon, Boeing Co. and other defense contractors.

The association last month called on lawmakers to separate sequestration from negotiations over taxes and spending, rolling back the automatic cuts as the first order of business.

Defense company executives announcing their 2012 year-end results later this month may not be able to offer clear forecasts for 2013 because of the uncertainty, Callan, the analyst, said.

The Pentagon has yet to analyze what yesterday’s agreement “means for our current budget,” Defense Department spokesman George Little told reporters today. “There probably will be some impact,” in fiscal 2013, “but we don’t know precisely what that number is” given that the Pentagon will have only six or seven months of the fiscal year to apportion the cuts if sequestration occurs.

Asked how much of the agreed-to $24 billion in short-term cuts the Pentagon would be required to absorb this fiscal year, Little said no precise figure was available.

Many of the Pentagon’s 800,000 civilian employees still “might face some kind of furlough” if automatic budget cuts go into effect, Little said.

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