Will You Have to Play Defense Because of Defense?
Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As part of the negotiations that allowed the debt ceiling to be raised and in the midst of the downgrading of the U.S. government's credit rating by Standard & Poors during the summer of 2011, Congress included a so-called sequestration in the Budget Control Act of 2011. This basically means that without intervention there will be across-the-board, automatic spending "reductions" beginning in early 2013 for both defense and social programs. Many national security, political and economic pundits are sounding alarms.
According to the Aerospace Industries Association (AIA), sequestration of the defense budget could lead to the loss of up to two million jobs, increasing the unemployment rate, and could reduce economic activity by $215 billion, decreasing GDP by about 1.5%. Since the economy is presently sputtering along at less than 2% annual growth it could completely stall out. It is one aspect of the upcoming fiscal cliff that many people are concerned about. Another contributor is the expiration of the Bush-era tax cuts.
Should investors also be concerned?
Automatic cuts may not even occur. Since the sequestration affects many policies besides defense and both sides of the political spectrum have a vested interest, the government may act and somewhat more orderly cuts will occur.
However, if the process is allowed to go forward on autopilot, major defense contractors like General Electric (NYSE: GE), United Technologies (NYSE: UTX), Boeing (NYSE: BA), Northrup Grumman (NYSE: NOC) and Lockheed Martin (NYSE: LMT) will be affected.
Since all are well diversified, it probably won't be a major catastrophe for them.
Northrup is well positioned in businesses that will not be affected. Unmanned aerospace vehicles, cybersecurity, intelligence and logistics are some of the areas that will grow. The company recently increased its earnings outlook to a range of $7.05 to $7.25 a share from its earlier forecast of $6.70 to $6.95. It appears that Northrup won't necessarily fall off the cliff.
Lockheed also sees growth in several non-defense related businesses such as information technology, energy, health-care technology and advanced materials that may offset some cuts in defense contracts. However, CEO Bob Stevens reportedly said that the company will issue layoff notices in early November as part of their interpretation of the Worker Adjustment and Retraining Notification Act (WARN) and the sequestration.
United Technologies, where I am employed as an engineer, recently acquired Goodrich Corp. and merged it into its aerospace operations. This will enhance opportunities in the worldwide commercial aerospace industry, which is projected to grow over the next five to ten years or more. Potential defense sales to European governments may also soften the blow of domestic cuts. Note that everything that I write about the company is obtained from publicly available information.
Boeing and GE are said to be preparing layoff lists, according to sources. Some areas of their businesses will be impacted.
Any cut in payments to major contractors will also be felt by smaller companies. About 70% to 75% of a typical large defense contract is actually funneled to second and third tier suppliers, which are mostly medium and small businesses. They may be impacted to a much larger degree as they are not as diversified. For example, JWF Industries in western Pennsylvania, a DOD subcontractor that employs 450 people and supplies parts for U.S. Army vehicles, will be seriously affected, according to management.
A trickle-down effect may also be seen by some cities and states. Northeastern Florida, home to several defense contractors and military bases, may lose up to $111 million a year in economic benefits as the result of the budget cuts.
So keep a keen eye out as to what Congress and the administration does before New Year's Eve and if you own stocks of defense contractors or suppliers or there is a major military presence in your town, you may want to reevaluate your portfolio and spending habits depending on what they do or don't do.
Contact your representative or senator.
Mathman6577 owns shares of and is employed by United Technologies. The Motley Fool owns shares of Lockheed Martin and Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.