The Division of Defense has submitted its fiscal 2020 spending budget proposal to Congress. The $718 billion request represents a five% enhance more than fiscal 2019. Having said that, the $247 billion in investment funding (procurement and analysis, improvement, test, and evaluation, or RDT&E) is much more pertinent for defense organizations and is slated to rise only two% year more than year. In spite of this lackluster development, the spending budget is in line with our expectations, and we’re not moving our fair worth estimates for the contractors we cover.
We see 4 takeaways for investors:
- Congress might enhance procurement, so investment development could come in larger.
- Boeing (BA) is a winner thanks to the F-15EX, which could be worth $14 billion.
- F-35 cuts are a concern for Lockheed Martin (LMT), but Congress might rectify this.
- The DOD is most likely to start out fiscal 2020 with a continuing resolution, but a spending budget agreement remains our base case.
In the fiscal 2020 spending budget, procurement funding dropped three% versus fiscal 2019, when RDT&E improved roughly 9%. The procurement decline coupled with the RDT&E enhance reflects not only the DOD’s gambit that Congress will plus-up procurement but also the complete incorporation of the National Defense Approach, which is focused on RDT&E for nuclear weapons, hypersonics, cyber, autonomy, directed power, space, and artificial intelligence. Developing improvement spending might also foreshadow additional stress on margins, as contractors garner much more expense-plus contracts and record fewer favorable estimate at completion adjustments. More than the midterm, we think the DOD might struggle with transitioning improvement applications to procurement.
The Trump administration is circumventing the Spending budget Manage Act caps by requesting $545 billion in the DOD base spending budget (cap compliant) and then stuffing $165 billion into overseas contingency operations and $9 billion into emergency specifications. We believe this method is dead on arrival in the Residence of Representatives. Nonetheless, we think one more spending budget agreement–possibly sometime in early calendar 2020 with the DOD operating below a continuing resolution–represents the most most likely outcome, but the procedure will be painful.
Procurement funding fell on the back of fewer F-35 buys and decrease C-130J funding, each of which are Lockheed applications. Army ground autos are seeing decrease procurement funding, but most of this spending reduce will not impact General Dynamics (GD), given that the cuts are focused on the JLTV (Oshkosh) and AMPV ( BAE Systems (BAESY)). Much more broadly, we believe the Army’s reprogramming of its spending budget to favor modernization more than legacy applications indicates organizations and company units with substantial Army exposure, like L3 Harris Technologies (LLL), Basic Dynamics, BAE Systems, Boeing’s helicopter company, and Lockheed’s Sikorsky company, face a much more volatile spending budget atmosphere going forward.
The Navy added one more Virginia-class submarine (Basic Dynamics and Huntington Ingalls Industries), raising the quantity to 3 for fiscal 2020. We’d note that the Navy’s arranging incorporates savings from an aircraft carrier retirement (the USS Harry S Truman CVN-75), a thing that might not get via Congress.
The Air Force is slated to account for about half of the enhance in RDT&E spending for fiscal 2020, with the B-21 bomber ( Northrop Grumman (NOC)) driving Air Force RDT&E larger. Northrop alluded to B-21 income leveling off in 2019 for the duration of its complete-year earnings get in touch with, so the fiscal 2020 spending budget enhance is superior news for calendar 2020. Turning to fighter aircraft, the fiscal 2020 spending budget request incorporates 78 F-35 buys, which represents 15 fewer aircraft on a year-more than-year basis. Each the Navy and Air Force program to trim their procurement quantities relative to final fiscal year. Having said that, we believe it is a distinct possibility that Congress will move to plus-up F-35 procurement. On the Boeing F-15EX, the DOD is budgeting a bit much more than $1 billion to obtain eight aircraft in fiscal 2020. This $1 billion incorporates industrial startup fees, so we’d caution investors against extrapolating any unit fees from this figure. Per DOD comments, Boeing might sooner or later provide 144 F-15EX fighters to the Air Force.
Lastly, we highlight that the DOD is arranging for $7.7 billion in efficiencies for fiscal 2020. Even though we haven’t gotten a appear at the Future Years Defense Plan however, we suspect there may possibly be an efficiency wedge incorporated in the lengthy-term program that incorporates savings the DOD expects to materialize. This would represent a threat, in our view, given that attaining these efficiencies across the DOD bureaucracy can frequently prove difficult.
Chris Higgins, CFA does not personal shares in any of the securities described above. Come across out about Morningstar’s editorial policies.