Less than a year ago, the defense industry was feeling a little let down.
President Trump’s election created sky-high hopes, even a kind of euphoria, for a military spending hike the likes of which had not been seen in a generation. The president campaigned on that and, newly sworn in, stoked the anticipation with talk of a historic buildup.
Those industry hopes were deflated in May when Trump finally released his first budget request, and its modest increases did not meet the hype.
But the industry’s outlook has brightened over the past eight months, and for good reason.
Defense stocks have surged. Republicans pulled off landmark reform that slashed the tax rate for contractors and other corporations. And Trump’s lower-than-expected budget request? It still appears likely to yield a significant boost for the defense industry this year.
“Normally, I would say ‘cautiously optimistic.’ I think we are going to drop the ‘cautiously’ on this one. We are optimistic,” said Dan Stohr, spokesman for the Aerospace Industries Association, which represents more than 300 aerospace companies. “There are a lot of things that are breaking the right way, if they are sustained.”
As investors flocked, U.S. defense stocks climbed 27 percent in value last year, which is above the S&P 500 average of about 20 percent and a sign the state of top prime contractors is “strong,” according to an analysis compiled by McAleese and Associates, a government contracts consulting firm based in Virginia.
Boeing, one of the big five U.S. defense contractors that builds fighter jets, helicopters, and missile defense systems, drove a 70 percent surge in stock value in the aerospace industry, McAleese reported. The defense giant along with Lockheed Martin, Northrop Grumman, and other contractors are expected to release their newest earnings reports at the end of this month.
A strong showing on Wall Street is not unexpected as global tensions remain unnervingly high.
North Korea’s burgeoning nuclear program has raised fears of war and spiked interest in missile defense systems at home and abroad, while Russian saber-rattling and Chinese investments in cutting-edge defense technologies all promise to keep interests in defense high.
Those factors could now merge with a “tailwind” from the coming defense budget to lift the industry higher, said James McAleese, founder of his namesake consulting firm.
“The defense companies are showing strong sales growth,” McAleese said. “They are already returning to growth even before they start to see the benefits of the significant Trump jump in the 2018 [defense] budget request and potentially the 2019 budget request.”
Congress is more than three months late in passing a defense appropriations bill for the 2018 fiscal year, which ends on Sept. 30.
Defense hawks in Congress managed to get widespread support for a National Defense Authorization Act calling for more aircraft, ships, and troops than what the president requested. But the $700 billion NDAA only sets policy and provides no actual money to the Pentagon. Analysts believe lawmakers, despite a heated budget fight over immigration reform, will eventually settle on a deal to fund at least the 10 percent increase in base defense spending.
“In a perfect world, the department would get the full 10 percent increase in 2018, which would be a $50 billion increase from $524 billion [last year] to $574 billion in the base, and potentially some additional up-side congressional plus-ups perhaps up to an additional $15 billion on top of that,” McAleese said.
Despite the earlier disappointment, a $50 billion hike could be a boon to defense contractors.
The so-called “tailwind” infusion would begin later this year as the Pentagon hustles to spend an estimated $192 billion in operations and maintenance money, McAleese said. The money could go to a wide array of readiness needs, including fixing aircraft and ships, munitions for training, spare parts, and increasing shipyard workforces.
Any O&M funding must be spent by the end of this fiscal year, or it will disappear, while other budget money such as the procurement of big-ticket weapons systems has longer deadlines. Rep. Mac Thornberry, R-Texas, the Armed Services chairman, is looking into giving the Pentagon more flexibility to spend the O&M money after Sept. 30 because the late budget might create a time crunch.
The industry’s financial fortunes also will depend on the 2019 defense budget, which the Pentagon said last year would make good on Trump’s promise for a historic buildup.
Indications have so far pointed to more money for the military — another positive sign for defense contractors — but signals have been more mixed on how big of a hike may be coming.
House Speaker Paul Ryan, flanked by GOP leaders, stepped in front of the cameras last week as the chamber returned from the holiday break and underscored the party’s goal of rebuilding the armed forces.
“That is going to be one of our primary focuses this year, is getting the men and the women in the military the resources that they need — and getting Gen. [Jim] Mattis the budget he needs — to begin the hard work of rebuilding our military,” Ryan said.
Meanwhile, Trump’s new budget request is expected to be unveiled at the beginning of February, meaning Defense Secretary Jim Mattis has likely finalized or is finalizing the Pentagon’s portion.
Mattis has pushed for 3-5 percent real growth in his budget. The lower increase would allow the military to either add troops or modernize its forces, the higher figure would allow both. A 5 percent increase — and perhaps more — could be needed to kick off the kind of buildup Trump sold on the campaign trail, such as a 350-ship Navy, an increase of about 65,000 soldiers, and more Air Force combat squadrons.
McAleese said Mattis’ “body language is comfortable, that something positive appears to be happening” on the budget front. But Deputy Defense Secretary Pat Shanahan told reporters last month that the budget set to be unveiled in February would offer a “step up,” and the 2020 budget is planned to be the “masterpiece.”
“People were thinking about FY19 to really be that first big year of the Trump buildup,” said Roman Schweizer, an aerospace and defense policy analyst at Cowen, a Washington, D.C., research group. “It sounds like Deputy Secretary Shanahan and others have tried to kind of walk that expectation back a little bit.”
Mattis will have to settle any final increase in defense spending, whether it is 3 or 5 percent, with Mick Mulvaney, the director of the White House’s Office of Management and Budget and a fiscal hawk. Schweizer said the increase would also have to come on top of the 2 percent rate of inflation to have the desired effect for the Pentagon, which actually means a growth of 5-7 percent.
“I don’t know if that’s possible in the Mulvaney view of what the federal budget looks like,” Schweizer said.
Despite the ever-present uncertainty surrounding the budget, there remains general optimism among the industry that spending is on an upward trend, he said.
A year of renewed growth is leading into what could be a surge in new spending both this year and the coming year. Stohr, of AIA, said the industry just wants Washington to maintain increases as a priority.
“They just have to follow through,” Stohr said. “We’re hopeful, but there is a lot of work that has to be done.”