Fed Shutdown May Put Defense Stocks in a Funk

by Susan J. Aluise | April 7, 2011 11:18 am

Top defense contractors are bracing for turbulence if Congress fails to reach a deal to fund the federal government by a midnight Friday deadline.

While shares of many of the top 10 U.S. defense contractors, including Lockheed Martin (NYSE:LMT[1]), Northrop Grumman (NYSE:NOC[2]), Boeing (NYSE:BA[3]), and Raytheon (NYSE:RTN[4]), holding steady on Thursday, it could be the calm before the storm. Federal government contracts generated more than $65.5 billion in revenue for the top 10 U.S. defense companies in 2010.

That means any government shutdown that lasts for more than a few days is likely to throw a monkey wrench into the contractors’ second-quarter revenue.

Congress must reach a budget deal by midnight Friday or the federal government will run out of money. Democrats and Republicans have been unable to agree on how much money should be authorized to run the government between now and September. Republicans want to cut funding by $60 billion, but in recent days have floated a $40 billion compromise. Democrats have drawn the line at $33 billion in cuts.

If the Defense Department experiences a funding lapse, it can’t sign contracts for anything that wasn’t previously authorized. And it can’t pay contractors for anything — not even for those previously approved goods and services — until Congress OKs a spending plan. 

Here’s how real the challenge is. Most uniformed military personnel would still have to work through a government shutdown.  But if the government closes and a deal is not done by April 15, personnel – including those in combat operations — would only be paid through this Friday.  If the government is still shuttered on April 29, service members would miss a check for that pay period, too.

Bottom Line: The odds right now of getting Congressional Democrats and Republicans to cut a budget deal by Friday’s deadline are about 50-50.  So defense contractors – and investors – need to be prepared for the next move in the game.

If the government is shuttered for an extended period of time, defense contractors will not be getting paid and may need to temporarily stop supplying DOD.  They also may need to furlough employees.

While defense contractors should get their money after all the dust settles and the government funding is restored, investors shouldn’t be surprised if companies’ with a hefty share of business in the defense sector miss earnings estimates over the next couple of quarters.

If Congress can’t find common ground on the budget, the best shot for defense shots might be a one-week spending proposal that would buy more negotiating time, while funding defense spending for another six months.

However, since Democrats don’t like that proposal, it’s likely to be DOA in the Senate.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks mentioned here.

Endnotes:
  1. LMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=LMT
  2. NOC: http://studio-5.financialcontent.com/investplace/quote?Symbol=NOC
  3. BA: http://studio-5.financialcontent.com/investplace/quote?Symbol=BA
  4. RTN: http://studio-5.financialcontent.com/investplace/quote?Symbol=RTN

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