9 APR 2009
by Rick Whittington

The military budget is going up slightly, but big contractors like Lockhead ad Rayheon won’t get the spoils.

A major shift in America’s defense posture is underway. No simple lane change, the FY10 military budget sets the stage for long-lasting change. The new president is true to his word, and is already heartily endorsed by Sen. John McCain. Defense Secretary Robert Gates’ media blitz, sought by veterans of Iraq and Afghanistan to show them the money, funds today’s ground operations at the expense of the tradition: no more keeping all the balls in the air; just fund what you’re using now. The vested interests (read: defense companies and their Congressional supporters) are already headed off at the pass. They might as well grin.

Boeing ( BA – news - people ) military–half the company–is hurt the most, with Lockheed and Northrop ( NOC – news - people ) also hit hard. General Dynamics ( GD – news - people ), Raytheon ( RTN – news - people ) and L-3 Communications ( LLL – news - people ) are only a bit hobbled. The winners? The U.S. tax payer who will see far less money spent on the military in future years. In a big deficit era, who can argue with that? If we had to own one of the defense names, we’d pick General Dynamics first, Raytheon second. Lockheed, Northrop and L-3 should be avoided. Boeing is a commercial play.

Defense dollars are being redirected from weapons to ground troops and civil service procurement people to speed new weapons to the field, with the emphasis upon counter-insurgency in forlorn trouble spots, cyberdefense, plentiful low-tech over costly whiz-bang, unmanned aerial vehicles and small ships able to send to trouble spots. The losers: legacy defense contractors supplying aircraft carriers, high-tech surface warfare, fighter aircraft, air transports and strategic missile defense. Confident we remain years ahead militarily, China and Russia are now the focus of economic cooperation, no longer military competition or deterrence.

Diplomatic initiatives to Turkey, Iran and a Muslim world at large, and this is a truly revolutionary redirection of America’s military. The base budget is increasing 2% this year, but contractor monies shrink as personnel costs mushroom. The Quadrennial Defense Review, due for release before summer, and the defense budget (for FY11) to be unveiled next February will cement in this change–fewer new generation weapons means even bigger hits to company top and bottom lines in FY11, 12 and 13.

Lockheed (Sell)–Super-tech F-22 production ends at 187 aircraft; $4.4 billion more to up F-35 funding to $11.2 billion and increasing FY10 to 30 aircraft from 14, but lowering the buy over five years by several dozen aircraft to 513–but maintaining the long-range Department of Defense inventory objective of 2,443–you figure this one out! The $26 billion Transformational Satellite program being competed canceled, also the $13 billion Presidential helicopter, but adding an additional Littoral Combat Ship for which Lockheed will compete, with Theater High Altitude Air Defense and the Navy’s SM-3 (adding $700 million) anti-ballistic missile defense, equipping 6 more DDG-51s with Aegis combat systems (adding $200 million).

Boeing (Buy)–Ending the Air Force’s C-17s at 205 aircraft; also the F-22 for which BA is major co-supplier of about one-third of each aircraft; conducting new competition for the aerial tanker this summer (a plus because OMB wanted this deferred five years), canceling Future Combat Systems armored vehicles and CSAR-X (search/rescue helicopter), stopping production and installation of missiles for the ground-based mid-range missile defense program while returning the program to R&D–same with the aerial laser antiballistic missile aircraft, while canceling a satellite contract for which Boeing is competing. Commercial Airplanes, which we are bullish for, will soon strongly predominate BA’s activity as defense subsides.

Northrop (Sell)–Stopping DDG-1000 canceled but DDG-51 resumed, slower aircraft carrier and other advanced combat ship development and production, while Kinetic Energy Interceptor anti-missile defense kept in protracted R&D–at least for now.

Raytheon (Hold)–Canceling ground-based mid-course missile defense warheads and likely slowing R&D but keeping Aegis air-defense cruiser and Standard Missile air defense funding, while upping Cyberwarfare/defense, and some battlefield intelligence gathering.

A private company, General Atomics, makes the Predator sequel Reaper–a very big budget winner. Hellfire air-to-ground missiles, used by Predators and Reapers, are produced by Boeing and Lockheed.