Following Boeing's (BA) lead off on Tuesday more major defense and aerospace contractors began reporting their most recent quarters with mixed results. Pressure on costs, reductions in defense spending and charges took their toll on performance. Lockheed Martin (LMT) and Raytheon (RTN), which along with Northrop Grumman (NOC), General Dynamics (GD) and Boeing make up the biggest five defense contractors, had different quarters but the same prediction for 2012.
Lockheed Martin
Lockheed had begun cutting its costs and overhead over a year ago. This involved reducing the size of the workforce by especially eliminating middle management and support positions as well as negotiating favorable union contracts. This was in management eyes a way to get ahead of Pentagon demands for lower prices and the potential cuts coming in the future. Lockheed also faces pressure from Congress and the Defense Department to control costs on the F-35 Joint Strike Fighter, which is the most expensive defense program in history.
For the 4th Quarter, though, Lockheed struggled. Revenue was down about 4 percent to just over $12 billion, which was a decline of $554 million form the previous year. Net income fell 58 cents per share and profit 17 cents. The company is also projecting revenue of about $45 billion for 2012, which will be flat.
Lockheed did make some progress by paying pension costs in advance to reduce future costs, continued its $4 dividend and also its stock buy back provision. It plans to cushion the expected decline in U.S. defense spending with a focus on international sales while continuing its cost cutting moves.
Raytheon
Raytheon, on the other hand, was able to increase earnings with a similar revenue decline. It was up 32 cents a share compared with the same quarter last year to $1.58. Revenue was down $400 million to $6.5 billion, which was below analysts' expectations of $6.7 billion.
The company is predicting $25 billion or less in revenue or earnings of about $5.45 a share. The company too is going to continue to plan to "capitalize on global market opportunities" while adjusting to realities with the U.S. defense budget. The company's backlog is now 37 percent international contracts.
Future Defense Budget
Both companies, and the whole defense industry, may face a more difficult 2013 than 2012. The 2012 defense budget is set and many major contracts awarded. The Pentagon released its plans for the next five years on Thursday and the plans reflect an 9 percent cut with some decisions affecting both companies.
First, the Army will not continue the Joint Air-to-Ground Missile (JAGM) program. Both Lockheed and Raytheon were bidding to be the prime contractor on this missile and if it had gone into production revenue would have been six billion dollars or more over the next several years. The JAGM would have replaced the Hellfire and Maverick missiles currently in use, both of which are supported by Raytheon. Lockheed may have lost a significant revenue enhancer.
Second, current programs like Lockheed's Joint Strike Fighter (JSF) will see cuts to annual production buys reducing near-term revenue. The U.S. and its allies will still need to buy the aircraft but are shifting the costs to future years, which will aid Lockheed in the long run but not in 2013 and out.
These types of cuts will most likely cause declines in revenue for all defense contractors in the next five years. Maintaining what they have now may be difficult. This will lead to further rounds of staff reductions, cost cutting and more attempts to enter a crowded international market.
Until some of these plans sort out defense stocks will most likely trade flat mirroring revenue and earnings.
Congress could disagree with the Obama Administration's budget plans and continue some programs and funding above what is being proposed, which would provide some cushion. The chances are, though, that while some funding may be kept there will still be a real decline.
Defense is potentially entering a period like the 1990s that saw major drops in spending, revenue and consolidation in the industry. It will be an interesting few years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
