U.S. defense shares drop sharply after Obama victory

WASHINGTON Wed Nov 7, 2012 5:49pm EST

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WASHINGTON (Reuters) - U.S. weapons makers took a pounding in the stock market Wednesday as investors priced in leaner times after President Barack Obama's re-election.

Analysts had predicted gains for defense industry shares if Republican Mitt Romney had won the White House. He had pledged to boost military spending.

But Obama's victory will continue the downward trend in defense spending, as the government struggles to cut budget deficits and draws down the military presence in Afghanistan, analysts said.

Shares of Lockheed Martin Corp (LMT.N), Northrop Grumman Corp (NOC.N), General Dynamics Corp (GD.N), L-3 Communications (LLL.N) and Raytheon Co (RTN.N) were down between 5.8 percent and 4.5 percent in early trading. Boeing Co (BA.N) shares were down 2.6 percent. The Dow Jones industrial average was down 2.3 percent.

Some saw the trend continuing. "We expect a pullback in defense stocks over the coming days," analysts Peter Arment and Josh Sullivan said in a note to clients Wednesday.

Barclays analyst Carter Copeland said that although Obama's victory was "less bullish" for short-term stock prices, the election was unlikely to have a significant impact on the long-term outlook for U.S. defense budgets.

Some analysts said Obama's re-election may help Congress delay $500 billion in defense spending cuts, giving lawmakers time to find other ways to reduce the federal deficit.

Obama's pledge in his victory speech to reach across the aisle and work with Republicans on deficit reduction fueled hope among industry executives and defense experts that the indiscriminate $500 billion in cuts due to take effect on January 2 would be put off until the end of March when a temporary 2013 budget measure and Bush-era tax cuts expire.

The final compromise may still result in some additional defense budget cuts, analysts and industry executives said.

"This will be a nail-biter to the very end," defense consultant Jim McAleese told Reuters on Wednesday.

McAleese said the ultimate compromise over spending cuts would likely trim the administration's budget request for fiscal 2013 by $20 billion to $26 billion, nearly half the proposed annual cut of $55 billion under the pending sequestration.

"The election removes some uncertainty, though we think many investors had already anticipated that President Obama would be re-elected," said Rob Stallard with RBC Capital Markets.

"The focus now shifts to the fiscal cliff, and the associated sequester," he said, adding that reaching a deal "could still be a fraught process, given the lack of co-operation and willingness to compromise between the two parties over the last two years."

Stallard said defense stocks had largely rallied with the market this year but could see greater pressure "if the fiscal cliff deadline starts to loom and no progress is being made."

Richard Aboulafia, chief analyst with the Teal Group, said the market's reaction was bizarre, since the election outcome - and comments made by both Democrats and Republicans afterwards - made it much more likely that sequestration could be avoided.

"Given the utter defeat of the Tea Party, if they can get the (Grover) Norquist pledge (not to raise taxes) out of the way, and compromise on revenues, then sequestration can be removed from play and we can get back to strong defense budgets," Aboulafia said.

He said Wednesday's declines in share prices could have been driven by investors who were "looking for a rationale for volatility," since there was more money to be made on movement in share prices than stagnation.

Northrop Grumman closed down 4.6 percent at $66.70; L-3 Communications dropped nearly 4 percent to $74.40; Lockheed fell 3.9 percent to $91.15; General Dynamics lost 3.9 percent to $66.59 and Raytheon dipped 3.3 percent to $55.47. Boeing fell 2 percent to $70.11, its decline softened by restructuring news.

On Monday, Frank Kendall, the Pentagon's top arms buyer, said he expected U.S. lawmakers to agree in coming weeks to delay implementation of the automatic defense spending cuts. He said no one in Congress wanted the cuts to kick in on January 2 and Obama was determined to avert the reductions.

Lockheed Martin and other U.S. defense contractors have been warning for more than a year that uncertainty about future budget levels is depressing investment in facilities, hiring and mergers and acquisitions.

Lockheed, Northrop Grumman, Boeing, and Raytheon told investors last month that they were focused on cutting costs and drumming up foreign sales to maintain profits, amid a long cycle of budget challenges after more than a decade of growth.

But Kendall said the Pentagon is listening to industry concerns. He is due to unveil additional measures next week aimed at reducing cost overruns on weapons programs, including a bigger focus on promoting exports of U.S. technology, a move likely to be welcomed by industry.

The Pentagon this week announced $7.6 billion in potential sales of Lockheed missile defense systems to the United Arab Emirates and Qatar, and analysts see additional sales in this area on the horizon.

Lockheed, Boeing and Raytheon are likely to benefit from increased exports of U.S. defense equipment in coming years.

Lockheed's F-35 Joint Strike Fighter and Boeing's F-15 are competing for a huge South Korean fighter order that should be announced early next year.

Shipbuilders General Dynamics Corp (GD.N) and Huntington Ingalls Industries (HII.N) are also eyeing the possible sale of destroyers to Saudi Arabia, while Lockheed is promoting exports of its smaller coastal warship.

(Reporting By Andrea Shalal-Esa; Editing by Alwyn Scott, Kenneth Barry and David Gregorio)

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