The Truth About Trump, The F-35 And Cutting Costs

| About: Lockheed Martin (LMT)

Summary

Cost reductions have been more or less linear since LRIP-5.

$600 million in cost reduction coincides with what could reasonably be expected.

Negotiations between indeed seem to be harsh.

Defense and Trump probably are not the happiest couple. The 45th president of the United States has repeatedly criticized the Lockheed Martin (NYSE:LMT) F-35 program as well as the potential costs of the new Air Force One with Boeing (NYSE:BA). The goal for Trump is easy, getting the best deal possible on each and every deal that the United States makes.

In the latest of these episodes the President has claimed to reduce by $600 million. I think that the President's contributions to cutting costs have been closer to 0 than to 1. In this article, I explain why.

Pricing

So, the F-35 as many know is not one aircraft, but 3 separate aircraft. Each of these aircraft has different capabilities and a different pricing.

Table 1: Pricing LRIP 9 Batch

Contracts and sales prices are currently being awarded per batch and the LRIP-9 batch represents the ninth batch of low rate initial production. This batch was for 57 aircraft and can be valued at $6.3B. The A unilateral contract basically told Lockheed Martin that no more than $6.1B would be paid for these aircraft. The LRIP-9 contract puts the value per aircraft at $107 million vs. the $110 million that Lockheed would like to have received for the batch on a per unit basis.

Cost curve and cost cutting

Trump said the following about the LRIP-10 batch:

We cut approximately $600 million off the F-35 fighter, and that only amounts to 90 planes out of close to 3,000 planes. They were having a lot of difficulty. There was no movement and I was able to get $600 million approximately off those planes. So, I think that was a great achievement.

Figure 1: Unit costs F-35A (Source: AeroAnalysis)

Figure 1 clearly shows that with or without Trump's interference the price for the F-35A already has come down quite a bit. The compounded rate signals that the unit costs have come down by roughly 12% each batch. Over the past batches this behavior has become more linear signaling a $6-$7 million decline over each batch. The trendline suggests that the price would come down to $92.1 million.

The linear part of the graph, however, is more telling indicating costs to come down to $95-$96 million per aircraft.

LRIP 10

The LRIP 10 batch will cover 90 aircraft. A quick calculation using the F-35A unit costs shows that if we look at the linear behavior of the costs cutting, the price was already supposed to come down by $450-$540 million. Now, the order mix does not solely consist out of F-35s of the A-variant, but also includes Bs and Cs which are expected to all see a significant cost reduction.

Lieutenant General Chris Bogdan, director of the F-35 joint program office, said the following about savings in the next batch:

I fully anticipate that when we do settle LRIP 10 you will see all three variants, the A, the B, and the C come down in price significantly. Somewhere on the order of 6 to 7 percent per airplane, per variant.

If we do the math we obtain the following results:

*Dollar value in millions.

What you can see here is that the savings of roughly $600 million as Trump stated coincide with the guidance of 6%-7% by Lieutenant General Chris Bogdan.

Conclusion

Trump has been in contact with Lockheed as the President-Elect in late 2016 and so it is hard to say he has not played a role at all, but I think it is safe to say his impact here has been minor. The unit cost development over the past LRIP batches suggests that LRIP-10 would indeed be cheaper by roughly 6%. So Trump is not responsible for that cut in costs, it was already there and the linear part that we see in Figure 1 for LRIP-5 up to LRIP-9 clearly shows that.

I think that there is one thing that Trump is right about and that is there was difficulty and no movement. The previous batch ended in a unilateral contract, which Lockheed Martin was not pleased with and it also shows that negotiations are tough. At those times, a President such as Trump might come in handy to slam down prices.

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Disclosure: I am/we are long BA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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