Defense contractors will face significant pressures thanks to the potential for 10% or greater cuts in the nation’s defense budget, as expected following the August 2 signing of the US Budget Control Act, says a new report by Moody’s Investors Service. Both larger prime contractors and smaller manufacturers will be affected over the next 10 years, says the report.
“Pressure on earnings and cash flow could eventually lead to ratings downgrades for some contractors, particularly those still dealing with substantially underfunded pension programs,” says Russell Solomon, a Moody’s senior vice president.
With industry margins already under pressure and at a modest average of just 10%, increased competition for a less robust market will pressure profits further, notes the report. Companies are likely to reduce payrolls and may be forced to undertake other restructuring-related activities as specific programs to be cut are identified.
Moody’s warns that big programs, particularly those behind schedule or over budget are vulnerable to quantity reductions, deferrals or in some cases, cancellation. The report highlights programs such as Lockheed Martin’s (Baa1, stable) $385 billion F-35 Joint Strike Fighter project, the Textron (Baa3, stable) partnership with Boeing (A2, negative) on the $55 billion V-22 Osprey tilt-rotor aircraft program, and Lockheed Martin’s split (with unrated Austal) $34 billion Littoral Combat Ship program as being exposed to potential cuts.
With concerns mounting over the larger players, the report also explores ripple effects throughout the supply chain on smaller — and weaker — companies and notes potential impact on service contractors in addition to outright program cuts.
Moody’s also points to cyber security and unmanned aviation as areas likely to be less affected by cuts and more likely to continue and in fact accelerate recent growth trends, noting that potential threats and constantly rising risks are only beginning to be understood and historical spending in these areas has been inadequate.
