What will defense firms do with their tax breaks?; Pentagon awards billions of dollars in orders; Shutdown countdown, redux; and more.

Just before most of Washington packed its bags for the year-end holiday, large companies received an early Christmas present: a big tax cut. It’s not yet clear how the various changes to the tax code, which are projected to increase the federal deficit by more than $1.4 trillion over a decade, will ultimately affect defense firms.

But in the short term, several large companies announced employee bonuses and internal investment. Boeing said it would put an additional $300 million toward charitable investments, workforce development, and facility upgrades. Telecommunication giants AT&T and Comcast pledged employee bonuses and infrastructure upgrades.

“For industrial products organizations in the manufacturing, aerospace and defense, chemical, and automotive sectors, the new provisions are significant and will likely impact their businesses for years to come,” writes PwC’s John Livingstone.

So what will defense corporations do as their tax rate falls from 35 to 21 percent?

There’s a “strong inference that most defense primes will use” the tax cuts to “immediately-return more cash to investors,” instead of boosting independent research and development spending, capital expenditures, or mergers and acquisition in 2018, Jim McAleese, who runs McAleese and Associates, wrote in a Jan. 2 note.

He predicted that Lockheed Martin, the world’s largest defense firm, will pre-fund required pension contributions, which are hefty: about $1.6 billion in 2018 and $1.7 billion in 2019.

Wall Street equity analysts seem to agree that defense firms will benefit from the tax overhaul, particularly firms with U.S.-based manufacturing. But they also don’t see firms’ tax rates falling precisely to 21 percent.

Lockheed said in a statement that the new tax law will “help level the playing field for U.S. manufacturers and strengthen the many small- and medium-sized businesses that make up our supply chain. These reforms will allow industry to compete effectively in the global market while encouraging continued investment in technology and advanced manufacturing in the United States.”

Byron Callan of Capital Alpha Partners wrote that “we don’t expect there to be a major shift in current capital allocation policies that have generally favored shareholders.” He also doesn’t “see lower tax rates significantly enhancing U.S. global defense competitiveness.”

We should find out more details about how CEOs are viewing this when firms report their 2017 fourth-quarter earnings later this month.


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Budget Clock Ticks Down, Again

Congress has less than 15 days to figure out how to fund the federal government for the remainder of fiscal 2018, pass another continuing resolution, or let it shut down. With one-quarter of the fiscal year already behind us, there is “little evidence of movement on any long-term funding agreement,” writes Matt Vallone, director of research & analysis at Avascent. Among the sticking points: immigration (DACA) and funding for Trump’s wall on the southern U.S. border with Mexico. “The possibility of a shutdown or another significant CR cannot be dismissed at this time,” Vallione writes. Meanwhile, Capital Alpha’s Callan likens the defense budget to pinball. “The defense ‘ball’ could stay in play throughout the year if it gets positive bumps from swift resolution of the FY18 budget, geopolitics, the U.S. midterm elections, and contractor execution,” he writes. “If the FY18 budget is not resolved in Jan.-Feb., or DC appears headed for gridlock based on the 2018 midterms, or there are now-unlikely geopolitical changes, or contractor execution becomes factor, there may be the equivalent of a low score and a need to put additional balls in play.”

2017 Defense Stock Wrap

It was a good year on Wall Street for aerospace and defense firms, which ended 2017 up “an impressive” 40 percent (the S&P rose “just” 20 percent), writes Vertical Research Partners A&D analyst Rob Stallard. The big winner was Boeing, whose 89 percent gain was also buoyed by strong commercial revenues, but other defense gainers included Orbital ATK (which is being purchased by Northrop Grumman) up 50 percent; Northrop and Raytheon, each up 32 percent; and General Dynamics, up 18 percent. Globally, defense shares were up 22 percent globally — but while U.S. defense stocks were up 27 percent, shares of EU-based firms fell 7 percent, dragged down by one of the biggest decliners of 2017: Leonardo, down 26 percent. (A big U.S. decliner was Engility, which lost 16 percent.) As for the federal IT sector? That rose 9 percent, Stallard writes, paced by Leidos’ 26-percent gain.

Big Purchase of Small Bombs

The U.S. Air Force (on behalf of Saudi Arabia, Japan, Israel, the Netherlands, South Korea and Singapore) placed a $193 million order for 6,000 Small Diameter Bombs from Boeing. About $100 million will be paid by the foreign countries.

Raytheon received a $634 million contract for AMRAAM missiles for Japan, Korea, Morocco, Poland, Indonesia, Romania, Spain, Turkey, Bahrain and Qatar.

Lockheed Martin secured a $110 million deal from the Air Force Research Lab to develop a networked, “low-cost” cruise missile called Gray Wolf. “Gray Wolf will operate in highly contested environments, and will be capable of collaborative, networked ‘swarming’ behaviors to address air-defense system threats,” the company said in a statement. The weapon is being designed for the F-16, F-15, F/A-18, B-1B, B-2, and B-52, Lockheed said.

Boeing’s Big Christmas Presents

Just before Washington shut down for the Christmas week, Boeing received a long-awaited $6 billion order for 36 F-15s from Qatar. The Gulf state is expected to get all of its planes by the end of 2022. Boeing also got a $288 million order from Japan for a KC-46 tanker. It’s the first foreign sale of the plane (which it still hasn’t delivered to its main customer, the U.S. Air Force). Japan already has four KC-767J tankers. Of note: 16 percent of the 767 (the aircraft the KC-46 is based on) is “made with Japan,” Boeing said.

Lockheed’s Big Christmas Present

That would be a $7 billion deal to upgrade and sustain the F-22 Raptor over the next 10 years.

Circle These Dates

  • Jan. 9: The three-day Surface Navy Association annual symposium kicks off. Expect to hear more about the 355-ship Navy.
  • Jan. 19: As noted above, that is the date the current continuing resolution that funds the government expires. If Congress does not pass another CR or full-year budget deal, the government shuts down.
  • The big defense firms begin reporting 2017 fourth quarter earnings beginning the week of Jan. 22. Expect to hear questions from investors about tax reform and the state of the U.S. defense budget.
  • Jan. 30: President Trump gives his first State of the Union address.

Making Moves

President Trump plans to nominate Will Roper — head of the Pentagon’s Strategic Capabilities Office (the shop that looks to make existing weapons more lethal) — to become assistant secretary of the Air Force for acquisition. The Air Force has not had a Senate-confirmed person in this position since Bill Laplante stepped down in 2015. Our Caroline Houck has a look at what Roper’s departure could mean for the future of the Strategic Capabilities Office.

The Senate confirmed former Lockheed Martin executive John Rood, as undersecretary of defense for policy. At Lockheed, Rood was senior vice president of Lockheed Martin International, a position, the company announced, he would be resigning from soon.