This time last year, the word “sequestration” had defense companies and their shareholders waiting for the sky to fall and crush earnings. But as it turned out, defense contractors not only weathered that storm, they even boosted profits.
That was last year, however, and it could be tougher for defense stocks to emerge from the next round of automatic budget cuts unscathed if Congress doesn’t act to repeal them.
The Pentagon sounded the alarm on Tuesday that sequestration cuts for weapon systems are set to kick in between fiscal 2016 and 2019; those cuts could gut military readiness and have grave implications for national security:
“With the addition of projected sequestration-level cuts for FY 2016 through 2021, reductions to planned defense spending for the ten-year period from FY 2012 to 2021 will exceed $1 trillion. If sequestration-level cuts persist, our forces will assume substantial additional risks in certain missions and will continue to face significant readiness and modernization challenges. These impacts would leave our military unbalanced and eventually too small to meet the needs of our strategy fully.”
If Congress fails to repeal sequestration cuts that will automatically take effect between FY 2016 and FY 2019, these five major defense stocks stand to take a significant hit:
Lockheed Martin (LMT)
Lockheed Martin (LMT) — the largest defense pure-play — managed to overcome sequestration and sagging Pentagon spending the last time around, posting earnings per share of $9.58 for 2013 on a top line of $45.4 billion. LMT’s profitability last year was driven by aggressive moves to moves to cut overhead costs. But this time around, the Pentagon’s top contractor might not be so fortunate.
In order to reach sequestration spending levels, DOD will have to cut 17 F-Lightning II Joint Strike Fighters, which cost between $153 million and $200 million each. Fifteen of the fighters are conventional F-35As; two are F-35Cs that are modified for aircraft carrier landings.
General Dynamics (GD)
General Dynamics (GD) ended 2013 with an EPS of $7.03 on a top line of $31.2 billion, thanks to a combination of frugality and blockbuster performance in its Gulfstream commercial aircraft business. The new sequestration poses a significant threat to Pentagon shipbuilding contracts, some of which are shared with Huntington Ingalls Industries (HII).
The report reveals sequestration could result in one less Virginia Class attack submarine and three fewer advanced Arleigh Burke DDG-51 destroyers. While that doesn’t seem like much, those four naval vessels account for more than $3 billion. Additionally, GD would lose out on $681 million worth of Stryker double-v hull armored vehicles.