No end in sight for aero, defense boom

A U.S. Air Force F-16 CJ Fighting Falcon from the 20th Fighter Wing flies over the Pentagon during a North American Aerospace Defense (Norad) mission, September 24, 2003. Picture taken September 24. FOR EDITORIAL USE ONLY

NEW YORK (Reuters) - Wall Street may be fretting that the U.S. economy is slowing down, but the aerospace and defense industries are hard pressed to figure out when their party will end.

Defense spending is at record highs, boosted by operations in Iraq, while a surge in leisure and business travel is pumping demand for commercial airliners and business jets.

Even long-suffering airlines are raising ticket prices after five years, racking up billions of dollars of losses.

"This is the first simultaneous civil and military upturn in several decades. If you are a contractor, you are doing great," said Richard Aboulafia, an analyst at the Teal Group. "Every sector of the industry: jetliners, fighters, business jets, helicopters are doing really well, by all indicators."

Top defense contractors Lockheed Martin Corp. (LMT.N), Boeing Co. (BA.N), Raytheon Co. (RTN.N), and General Dynamics Corp. (GD.N), have all risen sharply this year, pushing the Standard & Poor's Aerospace and Defense index .GSPAERO up 26 percent over the past 12 months. That has easily outpaced the 10 percent rise in the S&P 500.

The Amex Airline index .XAL, after two years of losses, is up 14 percent so far this year, ahead of an 11 percent rise in the S&P 500.

The question now is: when will the explosive growth start to fade? Next week Reuters hosts 20 leading CEOs, analysts and government arms buyers at the annual Reuters Aerospace and Defense Summit in Washington, D.C., to try to answer that question, and others.

REGIME CHANGE

For defense firms, the main issue is whether a Democrat-controlled Congress will clampdown on Pentagon spending or clear the way for further increases.

"The Democrats are unlikely to want to appear weak on defense, so they're not going to call for big cutbacks on defense spending," said Cowen & Co. analyst Cai von Rumohr, in an interview this week with Reuters Television.

That said, big programs like cargo planes for the U.S. Army and Air Force, or refueling tankers for the Air Force, may get nudged backward to save money for repairing equipment worn out in Iraq.

"Clearly the cost of war in Iraq exceeded everyone's estimates last year, so we still have a relatively tight budget and yet we have a number of potential new programs," said von Rumohr. "Are they really going to fund all these programs this year or is it more likely that some of those are going to move to the right?" he said, using the industry slang for delaying a project.

War in Iraq and Afghanistan and other operations have cost $437 billion since September 11, 2001, according to the nonpartisan Congressional Research Service.

The resignation of Defense Secretary Donald Rumsfeld -- the chief architect of the Iraq war -- may actually prompt a rise in spending, as Congress admits the war is costing much more than expected.

"There's an argument to be made that the (budget) flood-gates will open with Rumsfeld out of the way," said Aboulafia.

"Budgeting for the equipment needed to rescue a ground-down, hollow military force ... would have contradicted the administration's 'mission accomplished' message," he said.

Now Rumsfeld is gone, Aboulafia said, Democrats may address the cost of Iraq in a more rational way, but still maintain spending on bigger, longer-term programs.

SOARING AWAY

The surging demand for travel has finally pushed the aircraft construction and travel businesses over the recession caused by the September 11 attacks.

Boeing, which took a record 1,002 plane orders last year, is on track to match that figure this year, while Textron Inc.'s (TXT.N) Cessna and General Dynamics' Gulfstream are leading players in a multi-year business-jet boom.

"When does the party ever end?" asked Aboulafia. "Everyone's looking for some kind of peak in sight, but the line keeps going up. There's no real sign of a U.S. downturn."

More travelers means airlines like AMR Corp.'s AMR.N American Airlines and Continental Airlines CAL.N are flying fuller planes and charging more for tickets.

But with two major airlines in bankruptcy -- Northwest Airlines Corp. NWACQ.PK and Delta Air Lines Inc. DALRQ.PK -- and a general admission that there are too many U.S. airlines competing with each other, most agree the industry is set for consolidation. Still, nobody is sure when that consolidation will start.

Ray Neidl, airlines analyst at Calyon Securities, reckons there's no more than a 40 percent chance that regulators would approve US Airways Group Inc. (LCC.N) $8.5 billion offer to buy Delta, launched two weeks ago, even if Delta agreed to it.

"The industry needs to consolidate, but I'm not sure if the regulators and politicians are ready for it," said Neidl.

(Additional reporting by Frederick Katayama)