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The large defense industrials began reporting their most recent quarterly earnings reports this week. Despite the threat of sequestration and the potential for large cuts to planned U.S. defense spending overall the companies have had good quarters and most expect the year to meet or exceed their initial forecasts.

So far four major components of this sector have reported: Lockheed Martin (LMT), Boeing (BA), General Dynamics (GD) and Northrop Grumman (NOC). They will be followed by Raytheon (RTN) on the 26th to round out the five biggest U.S. defense contractors.

Boeing is apart from the others because of its large commercial aircraft production business which as in the past allows it to cushion declines in military spending and programs. The company reported that its second quarter earnings were almost a billion dollars to $1.27 a share. This was an increase of 2 cents year-to-year on a 21 percent increase in revenue to $20 billion. Earning estimates were a consensus 13 cents lower on revenues of just over $19 billion. This was driven by the commercial aircraft side which saw a 34 percent increase compared to defense's 7 percent.

Boeing is starting to see the effects of steady 787 deliveries along with the new 747-800 freighter. These two programs had multi-year delays but are starting to hit their stride. At the same time the company is starting up the KC-46A tanker program which is offsetting the ending of the C-17 transport production which unless it has more overseas sales will stop production in a few years.

Boeing has upped its estimate of full year results to $4.40 to $4.60 a share, well above last quarter's $4.15 to $4.35. Most analysts had expected defense to decline but as we wrote in April there were some significant short term improvement in military programs that may carry through the next few years as the defense budget is worked out.

Lockheed Martin also saw a good quarter building on its last one with earnings up 5 percent to $2.38 a share. Lockheed beat estimates by almost fifty cents following up on last quarter's 32 cents. The company had earnings grow over 11 percent year-to-year on a 3 percent increase in sales. Lockheed has continued to cut its costs through new contracts with its workers and the elimination of overhead.

They recently settled the strike by production workers in Fort Worth, TX home of the biggest defense program in history, the F-35 Joint Strike Fighter, with the new contract lowering pension and healthcare costs. Lockheed also fully funded its pension contribution whose costs have been a serious negative for it and the other large defense contractors. Lockheed also raised its estimate of profit for this year to $4.025-4.125 billion slightly from the earlier $3.9-40.0 billion.

Northrop Grumman, too, reported a rise in earnings to $1.88 a share. This is an increase of 7 cents year-to-year and well above estimates of only $1.61. This was done despite a decline in overall profit by $40 million. Revenue also declined by $29 million to $6.27 billion. Even so the company believes its full year earnings will be up ten to thirty cents to $7.05-$7.25 from an earlier prediction.

Part of this good performance was due to Northrop's aggressive stock repurchase plan. In the quarter almost 5 million shares were bought back and another $1.1 billion have been authorized. The company also sees reduced pension issues with a change in Federal law allowing contributions to be deferred.

General Dynamics, though, did not follow this trend with reduced earnings for the quarter and lower estimate for the full year. Per share the company reported $1.77 which while 3 cents above estimates were 2 cents lower year-to-year. Revenue was up $100 million leading to earnings of $634 million or down $32 million. This performance has led to a reduced outlook for the year of $7.00 - $7.10 a share down ten cents.

Of these stocks GD has done the worst over the last year compared to the market performing at -10%. It closed at $62.00 on Wednesday. Boeing and Northrop have basically tracked with the market with prices at $74.03 and $63.93 respectively. Lockheed closed at $87.68 and has outperformed by 10% since last July. All also pay decent dividends with Lockheed being the highest at $4.00. Northrop and GD pay just over $2.00 and Boeing at $1.76.

Hanging over all of this is the threat of sequestration caused by the failure of Congress and the Obama Administration to reach a budget deal last year. This will require automatic cuts of about $500 billion to the defense budget over ten years. If these cuts are implemented then all of these contractors will see current programs as well as future opportunities reduced as the different Armed Services seek out ways to lower spending.

That does not mean the cuts will take place. The House has already passed its version of the 2013 spending bill for the Pentagon and they have maintained levels at the 2012 rate. While this is not the substantial increase seen over the last decade primarily due to the fighting in Iraq and Afghanistan it does spare a great deal of the reductions. Of course this means the House and the Senate depending on how they treat the defense budget will need to cut other parts of the overall Federal budget unless they decide to ignore sequestration entirely.

Areas that might see the biggest hits is shipbuilding affecting Northrop and GD and delays in replacing or modernizing equipment used in Iraq and Afghanistan. Overall aircraft programs would continue but face reductions in annual quantities stretching out the receipt of funds by Lockheed and Boeing.

Currently the Defense Department continues to execute the budget that they have. Major contract awards continue such as one for almost a billion dollars to Raytheon for development of new anti-missile interceptors. The Services will still execute these throughout the next several months until the budget is actually reduced by Congress. This means that for the next few quarters the contractors should maintain planned revenue and expenditures.

Source: Defense Industrials Mostly Outperforming Expectations