by G. Jack Urso
The following article was written for a
competitive intelligence industry newsletter – June 17, 2010
There’s been a lot of speculation about the 2010 U.S. defense budget.
Despite a $21 billion increase, many news reports have focused on the loss of
big-ticket items, such as the cap on F-22 Raptor production. Additionally, the
Future Combat Systems (FCS) vehicle program has been scrapped, as the design
would have rendered the vehicles practically useless for combat operations in
Afghanistan and Iraq.
Less reported, however, is the fact that the increase in the defense
budget will result in an increase in the force structure and a shift in support
services expenditures. While a $21
billion increase implies new investing opportunities, there are still potential
financial landmines to avoid.
 |
| Source: Congressional Research Service Report Defense: FY2011 Authorization and Appropriations, November 23, 2010. |
Implications
Bob Nugent, Vice President of Advisory Services for AMI International,
which provides naval intelligence reports to navies, shipbuilders, and naval
equipment manufacturers, reviewed the 2010 defense budget and discussed its
implications for the financial investor.
“The DoD (Department of Defense) is making a concerted effort to reorient
the direction of the budget towards lower-intensity programs and capabilities
as opposed to big ticket items,” reported Nugent. “The other part of the reorientation is going
towards manpower because both the Marine Corp and the Army have increased their
force structure significantly in response to what’s going on in Afghanistan and
Iraq. So, a larger portion of the
defense budget will also go toward personnel accounts.”
One effect this shift will have is an impact on the military vehicle
market, which enjoyed growth over the past decade. While the military will
always need to get around, sales of military vehicles are expected to fall off
a bit, as indicated by the loss of the FCS program.
“We’re seeing a larger portion of the money going towards things like
rifles, vehicles, personnel gear, and tactical communications, as opposed to
fighter planes and big cruisers,” Nugent stated.
According to Josh Cohen, Defense and Aerospace Analyst with Fletcher/CSI,
a competitive intelligence and business consulting firm, “For defense
companies, diversifying their manufacturing capabilities can help weather the
storm of DoD project and budget cuts, which are not likely to slow anytime
soon.”
Cuts like a Knife
One wildly publicized part of the budget concerns the production of the
F-22 Raptor. Although production of the F-22 has been capped at 187 aircraft,
four more than approved under the Bush administration in 2005, planned
production has continued to drop over the past two decades. The cap means that
the F-22 program will lose 13,000 jobs by 2011.
The conventional wisdom notes that the increase in F-35 production will
add 44,000 jobs, more than making up the jobs lost in the F-22 program (both
are manufactured by Lockheed Martin). So, problem solved. No worries, right?
Well, earnest investor, don’t fire those financial afterburners just yet!
“There may be some shift in resources between the F-22 and F-35, but the
F-35 is a troubled program,” reports Nugent. “It’s not really in a position to
replace the jobs lost by the budget process for the F-22. The defense cuts do
paint a pretty grim picture for that industrial infrastructure. So, there’s
significant concern on this issue.”
There are industrial infrastructure concerns that will be affected by the
future trends in the defense budget, not only in fighter planes and aerospace,
but shipping as well. As the government reduces production of high-end, big-ticket
military hardware, highly skilled workers, with thousands of dollars invested
in their training and education, may no longer find work that utilizes their
highly-specialized skills.
“Very skilled and irreplaceable human resources are going to go away and
nobody’s coming in their wake,” Nugent grimly noted.
Logistics
 |
| Branch allocations for the 2010 U.S. defense budget. |
An army marches on its stomach, as Napoleon once said, so support
services are essential components of any modern military force structure.
Extended operations in Afghanistan and Iraq have underscored this need, which
for a modern army entails more than just food and equipment.
The 2010 defense budget reduces “support service contractors” from the
current 39-percent of the workforce down to a pre-2001 level of 26-percent.
However, that doesn’t mean the military is cutting back on support the troops
in the field, in fact, just the opposite.
Bob Nugent explains: “In the last ten years, large numbers of civilian
contractors have taken up those jobs that in past have been filled by people in
uniform. What they’re talking about
doing now is shifting it into a mix of government people as opposed to just
civilians. There’ll be civilians, but they’ll be government service civilians,
working for the U.S. government.”
This in turn may affect the portfolio of companies which have been
providing civilians to perform those services.
“With budgets being cut and competition increasing, those defense and
aerospace firms with a keen awareness of their competition’s activities, and
the ability to meet the government’s unique requirements, will likely end up
winning more contracts,” said Cohen.
Housing
One confusing statistic in the 2010 defense budget is the fact that while
military construction is going up 19-percent, family housing is going down
about 20-percent. Is the military actually cutting housing during a time of
extended overseas operations?
“I think the decrease in family housing is a little misleading because
what a lot of the services have done in the last ten years has been to
privatize military housing,” commented Nugent.
“The Navy, the Army, and the Air Force are contracting it out, so I’d
want to peel back that number on military housing and see how much of that is
actually represented by spending on their own properties as opposed to money
going to outsource people that are handling construction and maintenance of
military housing. So, that’s been a trend in the last ten years.”
One area of dramatic outsourcing by the military has been in counseling,
education, and related base facilities. While the government has been
assimilating some of those responsibilities into its force structure in recent
years, Nugent feels it’s a trend that will reverse itself.
“I think the military is very happy to have somebody else be their
housing managers, their recreation managers, what have you, as opposed to
putting government civilians back in those jobs,” Nugent said. “If there’s an
area where I see the trend isn’t very pronounced, or the reversal of the trend
isn’t going to be as pronounced, it’s in an area like support services and
family housing.”
Trends Analysis
Analyzing a trend requires a bit more research than scanning the
headlines and listening to the latest network talking heads. Certainly, there
are cuts in big ticket items, but Unmanned Aerial Vehicles (UAVs) are in high
demand and the budget line for the Littoral Combat Ship has increased. Defense electronics will be a growth area, as
well as small arms, personnel equipment, and communications gear.
While some support services, such as housing, will continue the trend of
being outsourced to civilian contractors, other aspects will be folded into
government service, and some others will see a mix of government and civilian
workers.
Cohen, of Fletcher/CSI, noted, “We see a lot of requests to look into
markets that are not specifically military orientated, such as IR sensors,
civilian armored vehicles, remote undersea vehicles, and testing equipment for
communications and radar systems. This
is definitely a trend, but businesses with little to no experience working with
the government need guidance in determining what contracts to bid for and what
technology to invest in.”
Investing in the defense industry is not a passive activity. It reflects
not just the direction of the defense budget, but the country as well. It’s
more than asking whether we’ll be building ships and planes tomorrow. It also means asking whether anyone will be
around to build the hardware we’ll need tomorrow if we don’t invest in those
programs today.
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