Flat defense spending might be the best-case scenario for the defense industry. Still, as Capital Alpha’s Byron Callan wrote in an April 8 note to investors, “defense should be a relative safe haven in 2020.”
In the meantime, the heads of Navy and Air Force acquisition spoke to reporters Thursday about COVID-related disruptions to their weapons supply chain.
“We will have slips across the board,” said Will Roper, head of Air Force acquisition. “What I’m proud of is that nothing has come off the rails.”
Some companies, like Boeing, are resuming lines that were put on hold. Still, social distancing and increased cleaning in factories is limiting production.
“We will have slower deliveries than normal because of the [increased] spacing and we will also see those requests for adjustment because of the heightened operating costs during COVID-19 and allowed expenses on our current contracts,” Roper said.
The aerospace industry has been hit particularly hard over the past month as commercial air travel grinds to a near halt. The case is the same for Navy suppliers.
“We’re going to see delay and disruption, I think, in some varying waves,” said Navy acquisition chief James “Hondo” Geurts. “That’s not going to be the same everywhere.
“I think the other thing that will be a little bit challenging is the supplier impacts three and four and five levels down are going to come and hit us at different times,” Geurts said. “Right now, we’re, I think, a little bit living on the benefit of on-hand stock…At some point that on-hand stock if the downstream production supply isn’t being generated, that will start running out.”
He said the Navy needs a better understanding of industrial supply chains “and likely some targeted investments” where supplies are limited or foreign.
Aside from production delays, the Pentagon has cash on hand right now. Guerts noted that Pentagon acquisition officials have been working to flow that money through major prime contractors down to smaller suppliers so they’re “ready to roll” once coronavirus is in the rearview mirror.
Still, plenty of other factors could affect defense spending in fiscal 2021 and beyond.
How long will this last? It’s the question everyone ponders every day amid work-from-home and social distancing orders. Last week, Rep. Adam Smith, D-Wash., chairman of the House Armed Services Committee, acknowledged that the 2021 National Defense Authorization Act might not pass by Oct. 1, the first day of the fiscal year.
What will the Pentagon (and defense industry) get in future stimulus packages? Geurts suggested that future congressionally approved stimulus packages could include money for projects to help defense companies that rely on commercial aerospace business. The International Air Transport Association predicted this week that “airline passenger revenues drop by $314 billion in 2020, a 55% decline compared to 2019.”
Roper said he needs “funding immediately, so I can start working with industry on adjustment to programs…and I know exactly that number. I need that now in order to make sure programs are going to be whole and able to deliver for the mission on the other side of COVID-19.” Roper also said the Air Force needs stimulus funding so it can be “more strategic in how we’re postured in the future.” Specifically, that money could make the military’s hypersonic weapon and microelectronics supply chains more robust.
“The thing we have to have is funding,” Roper said. “A crisis is putting pressure on the industrial base. Congress has to act now because we can’t wait for these smaller suppliers [to go out of business]. If Congress does and we get funding, we will be able to stabilize our defense industrial base and keep program slippages to the minimum.”
Since the airlines are flying less, their demand for new planes and maintaining the planes they own is declining. So Geurts is looking for ways the Navy might be able to buy spare parts earlier than planned or have maintenance work done sooner by contractors like Boeing, Pratt & Whitney or General Electric. “Conversations are ongoing,” he said. “We’ve had some early identification of opportunities and we’re going to continue to look hard at that across all the program teams.”
Foreign military sales: No matter what the U.S. does, foreign military sales might not be the backstop for industry sales that it was when the U.S. defense budget took a hit nearly a decade ago. Since March 1, the State Department has approved nine foreign arms deals valued at more than $3.8 billion. (Israel’s $2.4 billion purchase of Boeing KC-46 tankers accounts for nearly two-thirds of the total.) Over the same period last year, State approved eight foreign arms deals valued at nearly $10 billion.
The 2020 election: With former Vice President Joe Biden now the Democrats’ presumptive nominee, a change in administration would certainly lead to a shift in federal spending priorities. Even if President Trump is reelected, the U.S. will inevitably need to dig out of a huge economic hole, likely meaning a focus on domestic investment.
What happens with China: With the coronavirus originating there and top U.S. officials' constant criticism of Beijing for not being transparent about the deadly virus, tensions between Washington and its great power competitor could continue fueling investments in cybersecurity, spacecraft, and fast-flying hypersonic weapons. “While we see this as a lower probability scenario, a bullish case for defense in the 2020s could emerge if U.S.-China relations deteriorate further to the point that both countries step up their defense spending,” Callan wrote on April 12. “China also has cards to play with Russia and Iran that could further shape U.S. spending.” China’s economic growth is expected to slow dramatically in 2020, according to the International Monetary Fund.
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Q1 Earnings Start Next Week
We’ll hear from Lockheed Martin first on April 21 and then from Boeing, Northrop Grumman, General Dynamics, and Textron the week of April 27. Textron actually slipped its earnings call one week because of coronavirus. The reports and calls with Wall Street analysts should provide a good glimpse into how coronavirus is affecting defense companies.
How Are Companies Responding to COVID-19?
The American Enterprise Institute has a new tool for tracking U.S. companies’ response to the pandemic, be it 3D-printing personal protective gear or assembling ventilators. “This tracker seeks to highlight American companies that, in the face of uncertainty and risk, are rapidly changing their existing production lines to manufacture new products in response to COVID-19, echoing the way typewriter companies, for example, changed their production lines to manufacture weapons during World War II.” You can view what hundreds of companies are doing, here.
Shipbuilder Staggers Shifts
Huntington Ingalls’ Newport News Shipbuilding is modifying its work shift schedules to allow for more social distancing and to better clean high-traffic areas. The new shifts will run from 6 a.m. to 2:30 p.m. and 6 p.m. to 2:30 a.m. for “production workers and other employees who directly support production and provide waterfront support services, such as some employees who work in waterfront engineering, production control, the clinic, and construction project and inspection departments,” the company said in a Wednesday statement. Newport News Shipbuilding builds the Navy’s aircraft carriers and large parts of Navy submarines. “Because more than 70% of employees work on first shift, transitioning to two eight-hour shifts will balance the number of employees working at a time, enhancing social distancing efforts.”
Boeing Deliveries Drop
The planemaker’s commercial and defense deliveries were down sharply in the first quarter over last year’s Q1 numbers, the result of coronavirus shutting some manufacturing plants and the continued pause in 737 Max production. Compared to the first quarter of 2019, commercial airplanes deliveries were down 66% and defense & space deliveries down 35%.
The first F-15QA for the Qatari air force flew for the first time this week at Boeing’s St. Louis manufacturing plant. The company billed the latest version of the venerable fighter jet as “the most advanced version of the jet ever manufactured.” That is, of course, until the new U.S. Air Force F-15EX comes along.
South African Defense Firm Making COVID PPE
Paramount Group is among a group of firms making the “intubox,” a device that protects healthcare workers from a patient’s respiratory droplets — especially during intubation. “Paramount Group has pledged its support for the country by making available its resources, from aircraft for the delivery of medical supplies, to its manufacturing facilities and highly skilled engineers and technicians, for the production of medical equipment,” the company said in a statement.
Testing Begins on F-15 EW
An F-15E Strike Eagle, suspended from the ceiling in a hangar at Edwards Air Force Base in California, is being zapped with electronic frequencies that would be used in enemy air defense weapons as part of the testing of the news Eagle Passive/Active Warning and Survivability System. “The EPAWSS is designed to provide indication, type and position of ground-based RF threats as well as bearing of airborne threats with the situational awareness needed to avoid, engage or negate the threat. The EPAWSS defends against RF and IR threat systems detecting or acquiring accurate targeting information prior to threat engagement thus complicating and/or negating an enemy threat targeting solution. The system counters threats through its suite of components with electro optical and RF techniques.” More, here, including a picture of the 23-ton fighter jet hanging in the hangar.
Want to own a 1981 Bell AH-1 Cobra attack helicopter? For $2.2 million, one could be yours. The helicopter, which according to a JetLease posting. The Palm Beach, Florida, private aviation leasing company also lists a former Canadian Air Force CF-5D fighter jet for $1.5 million, a Lockheed C-130E for $15 million and several Sikorsky Black Hawk helicopters starting at $3.25 million.
A 64-year-old defense contractor accidentally ejected himself from a French air force Rafale fighter jet during an incentive ride in March 2019. A malfunction prevented the pilot from automatically ejecting with the passenger. The pilot landed the plane safely. More photos of the incident here.