The defense contracting industry is entering uncertain times. It is facing near term, moderate defense cuts in the 2013 budget and the potential for much worse if the "sequester" cuts mandated by the failed supercommittee in Congress go forward. These if implement would reduce their potential revenue, and earnings, by tens of billions of dollars as well as the wholesale ending of major programs.
The industry is fighting back with the Aerospace Industries Association (AIA) releasing a report highlighting the contribution their industries primarily fueled by defense spending make to the U.S. economy as a whole. The Defense Department leadership has also through its testimony to Congress made clear that the "sequester" reductions would end the U.S. military as it is currently known.
The report from the AIA highlights how many jobs would be lost and the reduction in tax revenue the individual states will face in a bid to garner support for their industry. Overall it is an attempt to put pressure on Congress to reduce planned spending reductions and keep their funding flowing.
Even so the companies need to continue to make adjustments to reassure investors and maintain their stock prices. This can be done in various ways including stock buybacks. General Dynamics (GD) chose to raise their dividend last week 4 cents to 51 a quarter or an annual amount of over $2.00. This makes their dividend yield closer to three percent and moves it closer to the two top companies, Lockheed Martin (LMT) and Northrop Grumman (NOC). Their dividend is now just higher then Northrop's and over half of what Lockheed, at $4 a year, pays out.
The company also reorganized its executive branch with the appointment of Phebe Novakovic to new positions entitled Chief Operating Office (COO) and President. She will report directly to the Chairman and CEO. Previously the company had four main Vice Presidents heading up their business divisions under the chairman. Ms. Novakovic was in charge of the marine unit responsible for building and supporting ships primarily for the U.S. Navy. She has held this role for almost two years. Prior to that position she headed up other parts of the company and investor relations.
This move indicates that the company feels it needs some overall coordination and guidance for all divisions. This will help facilitate any possible reorganizations or restructuring. If the massive cuts proposed go through all of the industry would have to make major adjustments in their business lines and organizations to offset them.
The stock price despite these two announcements has remained trading flatly. After the dividend increase it jumped to just over $72 but closed this weekend at $71.78. It has made a decent recovery since last October when it was below $55 a share but has not been able to get above $80 which it last was in 2008. PE remains a fairly decent 10.4 and EPS is almost $7.00. The company has predicted this will remain level in 2012 but analysts had been predicting more.
Like most defense contractors despite little growth in revenue last year it did increase earnings. The majority of defense contractors of all sizes had a similar year. Further declines in revenue should be expected as the Pentagon and Congress work out what they want to spend and buy.
GD's focus on ground vehicles and ships may see some major cuts as programs are either reduced in quantities or purchases are spread out over more years. Other then aviation these are the big ticket items in the defense budget and cuts to GD's business there may have to be made up with investments in Unmanned Aerial Vehicles (UAV), intelligence and cybersecurity programs. GD especially will hope its Gulfstream and Jet Aviation Unit which support the civil aviation market begin to do better. That growth will be reliant on an overall recovery in the world economy.
The fact that the company has made these changes reflects a realization of the current market. GD remains a better bet then some of the other defense contractors. Smaller ones more reliant on one or two programs face a bigger challenge. The stock, like Lockheed's, has become primarily a dividend only buy. Further growth in the price beyond the recent $15.00 or more run up seems unlikely. Further emphasis on cost cutting and growth in civil aviation may help profits and earnings but revenue will most likely show little increase over the next few years.
Ms. Novakovic who is rumored to eventually become the next Chairman of the company has some challenges ahead as does the whole industry.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.