NOC Seeing the Pinch of the Bomber Win?

06/07/16 06:33PM EDT

In widely reported public remarks made at a sell-side research conference in NYC last Friday, CEO Wes Bush stated that he is "now biasing more of our capital toward the investments inside our company."  He also acknowledged that new development programs can come with lower profit margins without getting program specific. 

While Bush's remarks are being characterized as heeding Pentagon pressure for defense industry to increase its own R&D spending, we believe that they are actually a manifestation of some of the downside of NOC's $80B win to develop and build the B-21 Long Range Strike bomber.  

In our note of 2 March, "Good, Bad and Ugly for NOC on Bomber"  we identified the following perils:

  • Senator McCain, Senate Armed Services Committee chairman, has come out stridently against the cost-plus nature of the development contract awarded by the Air Force to NOC.  McCain is a dangerous enemy who similarly opposed the contract vehicle the USAF originally wanted to use with BA for the KC-46 tanker and that began the 8+ year delay now seen by that program, resulting in nearly $2B in charges by BA. 
  • While a change in the B-21 contract format at this point seems improbable, a cost cap imposed by Congress is almost a sure thing.  The device has become standard practice in Congress’ handling of Navy shipbuilding.  The point of the cap is to pressurize the Air Force so that it will pressurize NOC as if it were a fixed price contract. 
  • While the cost of the B-21 development is budgeted for $23.8B, that is almost certainly not what was actually awarded by the Air Force to NOC. Transparency in the contract amount is currently being debated in Congress but indications are that bids from both Northrop and Boeing were much lower than the Government’s independent cost estimate.   
  • With a cost cap on what must have been a very aggressive bid by NOC and a contract award that appears to be significantly less than what an independent cost estimate has said development will cost, NOC margins are likely to be greatly pressurized in order to keep the B-21 program on track.
  • NOC’s firm fixed price production bid also carries risk since it must have been based on NOC’s view of the design and development of the B-21. Given the higher independent cost estimate and budget requests, the government obviously has a different view of the risk and costs of NOC’s design than estimated by NOC.  Changes in the design during the development phase for whatever reason are bound to result in changes in the production cost.  
  • With all of this pressure to perform on the B-21 and still maintain company margins, NOC is going to be challenged to be competitive on new programs.  For example, NOC has been working for some time on a clean sheet design bid for this fall’s $8B Air Force T-X trainer competition (LMT, RTN and BA are the other bidders). 
© 2024 Hedgeye Risk Management, LLC. The information contained herein is the property of Hedgeye, which reserves all rights thereto. Redistribution of any part of this information is prohibited without the express written consent of Hedgeye. Hedgeye is not responsible for any errors in or omissions to this information, or for any consequences that may result from the use of this information.