* Core performance flat for second year running
* Program cuts from 2009 beginning to be felt
* Some firms may feel impact of tighter '12 defense budget
By David Alexander
WASHINGTON, July 26 With military spending
stagnant and the Obama administration looking at billions of
dollars in cuts, the U.S. defense industry faces
belt-tightening and consolidation over the next few years as
companies begin to feel the pain, analysts say.
Core performance among the top 105 defense contractors was
flat for the second year in a row in 2010, Deloitte consulting
firm reported last week, and new business booked by the
companies was not enough to replace the revenue collected from
completed contracts, suggesting another stagnant year in 2011.
"That's an indicator of the status of the industry, which
is treading water at this point," said Tom Captain, Deloitte's
vice chairman for aerospace and defense.
Loren Thompson, a defense analyst at the Lexington
Institute think tank, said the industry was fairly healthy
following a decade of growth in U.S. defense budgets. But
program cuts two years ago -- like the termination of the Air
Force's F-22 fighter and the Navy's future cruiser -- were
beginning to affect the bottom lines of some firms, he said.
"Most of the cuts that are being made to work forces are
pre-emptive rather than a reaction to major budget reductions,"
Thompson said. "However, the industry senses that tough times
have begun and expects ... conditions to progressively
deteriorate for some time to come."
Defense contractors may begin to feel the bite in 2012.
President Barack Obama is asking for $689 billion in defense
spending for the 2012 fiscal year, about $35 billion less than
2011 -- the first significant reduction in years. Congress may
cut the military budget back even more as lawmakers wrestle
with record budget deficits.
"We are now at the point where 2012 is becoming the year of
defense funding contraction," said analyst Jim McAleese, of
McAleese & Associates.
FIRMS ANTICIPATE DECLINE
While Obama has asked for an increase of more than $20
billion for the Pentagon's base budget, that amount is more
than offset by the $41 billion decline in war funding due to
the U.S. withdrawal from Iraq.
Some defense firms have already begun to anticipate the
decline. Lockheed Martin (LMT.N) announced a voluntary layoff
program for about 6,500 employees last week, a move that
followed a series of cutbacks over the past year.
McAleese said Lockheed's action appeared aimed at reducing
general and administration costs and trimming overhead, steps
designed to make the firm more cost-competitive as well as
contributing directly to the bottom line.
"The Lockheed thing is good corporate governance," McAleese
said, adding there was no sign yet of an industrywide trend
toward reductions. "Lockheed is getting out ahead of everybody
Lockheed, the Pentagon's No. 1 defense supplier by sales,
topped Wall Street quarterly profit estimates in results
reported on Tuesday as sales rose in its fighter jet and
military plane division. [ID:nN1E76O14N]
McAleese said that due to the nature of defense contracts
for big weapons platforms like Lockheed's F-35 Joint Strike
Fighter -- the military's most expensive military hardware
purchase -- the company was unlikely to feel the effects of any
budget tightening for a year or two.
Purchases of hardware like aircraft carriers, strike
fighters, transport planes and refueling aircraft are all
"long-term in nature, so in any one given year it's very hard
for a recession or decrease in funding to have a ...
catastrophic effect on the industry," Captain said.
Signs of a defense budget cuts are likely to show up first
in the business activity of service firms, McAleese said,
because the Pentagon contracts for services within the year the
funding is appropriated.
Service firms doing business with the U.S. Army are likely
to be hit first, he added, because the Army will be hardest
squeezed by reduced funding for the wars in Iraq and
Budget cutbacks will inevitably hurt second- and third-tier
defense firms, leading to pressure for consolidation as some
less-profitable companies seek to exit the market and others
look to gain scale to remain competitive.
"The stronger ones, the ones that have a more diversified
customer base, the ones that are highly cost efficient and the
ones that already have scale are the ones that are going to ...
survive," Captain said.
Analysts said defense firms seeking ways to grow despite
tighter Pentagon budgets would look increasingly to foreign
markets or expanding areas of the U.S. military budget.
"You'll see quite a bit of effort being made in countries
outside of the traditional Western alliance where sales of
military weapons platforms are increasing," Captain said.
"That's in the UAE, Saudi Arabia and India, in particular, and
to some extent Japan and Brazil. India, for example, is going
to be spending $80 billion over the next five years."
Defense companies also will be looking at new growth areas,
such as cybersecurity, unmanned vehicles, mission software and
intelligence, surveillance and reconnaissance.
(Editing by Peter Cooney)