Commentary on Defense Budget News

The latest issue of the SPADE investor newsletter contains some good commentary about the latest U.S. defense budget news. Highlights:

Defense firms are more diversified than they were back in the 90's when the last major cuts happened.

Firms have also been repositioning for the new defense environment by acquiring or expanding into commercial and non-defense adjacent markets -- markets that often have higher margins and hence increased profitability as compared to defense weapons systems. Commercial aircraft, helicopters; air, sea, and land robotics, and IT services; to name but a few.

and

Individual programs typically account for less than 5% of overall revenues; so cuts may impact a firm but not cause its collapse. Most of the firms in the SPADE Defense Index report that they receive less than 5% of their revenues from the war effort.

Why it's different this time:

The 1990s “peace dividend” followed the Cold War and the early 70s decline was post-Vietnam, etc. While enemies in the world remained (ie. Soviet Union in the late-1940s to early-1950s, post WWII) the immediate threat was less than the one we just faced. Today, that is not true. Terrorism still exists. Iraq, North Korea, and others are developing and flexing their nuclear muscles.

There could be less reliance on US defense budget in the global market:

Increased marketing to global customers is being pushed by the White House who supported marketing aerospace products overseas and making long overdue changes to export licensing procedures. This is highlighted by the recent $60 billion deal to sell defense products to Saudi Arabia. Dozens of other multi-billion dollar deals have also been announced, approved by Congress, or are in process.

Analysis of U.S. Defense Budget

The Feb issue of the SPADE Investor newsletter has a good general analysis of the new U.S. defense budget. Overall the budget looks as strong as ever and should be received by the sector as highly positive for increased competition and generally increased spending.

Highlights (all stats come from SPADE Index):

• Core defense budget (which excludes overseas CONOPS) will grow around $15B annually for the next 5 years
• 2010 supplemental is $33B and 2011 has $159B for overseas operations
• Time & materials and labor hour contracts will decrease 17% through 2011
• SOCOM gets a 6% increase in spending (plus 2800 new personnel)
• DA will add a 12th active duty brigade (a combat aviation brigade) in 2010 and another in 2015
• M&A firm Houlihan Lokey says the 60 transactions completed in 2009 is likely to rise. 50 of those deals were sub-$100M. A confirmed shift from large "exquisite weapons programs" will surely fuel continued M&A as big firms continue to diversify into growth areas like cyberwarfare, UAV, and overall more technical services.

Much more coverage in the full issue, including mention of Sikorsky developing an unmanned Blackhawk, as well as earnings report coverage of all the majors and more.

Defense Industry Indexes and Funds

We mentioned the SPADE Defense Index on a previous post and thought we'd share other indexes or funds that one could use for tracking performance in the aerospace & defense industry.

• ITA: iShares Dow Jones US Aerospace & Defense
• FSDAX: Fidelity Select Defense & Aerospace Fund
• ^DXS: SPADE Defense Index
• PPA: Powershare Aerospace & Defense ETF (linked to SPADE Index)  
• DJUSDN: Dow Jones US Defense Index

We'll add a ticker list to the site later to keep track of these together. 

Latest Commentary from SPADE Investor Newsletter

Scott Sacknoff's commentary in the exceptional SPADE Investor newsletter (free, btw) is always worth checking out. Go to the SPADE Defense Index site and sign up to receive by email.

For those that do not know, the SPADE Defense index [ticker: DXS] "provides a an investment benchmark for companies involved with defense, homeland security, and space." It's also linked to a licensed ETF from Powershares under the symbol PPA (NYSE). 

Highlights from the latest March newsletter:

• Index is down BIG in Februrary, "with Boeing, Lockheed Martin,and General Dynamics all losing more than 20% of their value." But Price to Earnings growth ratios for many companies the sector are less than 1, "a level historically associated with undervalued firms."
• Further, the much talked about spending cuts could end up being good news. "Declines in a big program may be offset with gains in several smaller ones."

I won't ruin it, though. For more information on what firms might be looking undervalued and which areas will benefit from spending that gets cut from the big boys, go here and download the full newsletter.