A year after coming into office, Canada's Liberal government finally moved closer to keeping Prime Minister Trudeau's campaign promise to cancel its planned buy of 65 F-35As (LMT/UTX). While not completely shutting the door on the fifth generation fighter, the Canadian government announced that it would acquire 18 fourth generation F/A-18E/Fs (BA/GE) as an interim step towards a final procurement decision to replace its 35-year-old fleet of 77 CF-18s five years from now. 18 F/A-18E/Fs will probably cost ~$1.5B.
The "interim step" aspect of the announcement is curious because of the condition of the Canadian fleet and the fact that there is no guarantee that BA's F/A-18E/F production line will be open five years from now (see below). Not announced but almost certainly, the Canadian government will have to develop a near term Service Life Extension Program (SLEP) to keep its CF-18 fleet going until a final decision is made.
Given the controversy over the selection of the F-35 ever since it was made in 2010 and the clear election results of October 2015, a negative decision towards the F-35 has long been anticipated by LMT and other aerospace observers. The announcement is, however, less than half a loaf for BA given the size of the Canadian fleet. Canada originally bought 138 CF-18s from BA in the 1980's and the fleet has been attrited over that time to its current size of 77.
Throughout the recent controversy on the Canadian selection of the F-35, LMT has been quite clear with the Canadian government that its F-35 subcontracts with Canadian aerospace industry are contingent on Canada's acquisition of the jet. Canada has been one of nine international "partners" and has contributed/invested $150M in F-35 RDT&E since 2002 in anticipation of ~$8B in production subcontracts and sustainment business over the life of the program. Approximately $800M in contracts have already been awarded in that timeframe. Magellan Aerospace (TSE: MAL), for example, has a 20-year Memo of Agreement valued at $1.2B to produce 1000 horizontal tail assemblies. Given its previously stated intentions to do so, LMT will almost certainly punish the Liberal government by revisiting these agreements and sending its F-35 business to countries that are acquiring the jet. We are not aware of "pot sweeteners" offered by BA for selecting its aircraft.
The Canadian buy of 18 F/A-18E/Fs follows recent White House approval of the sale of 40 of the jets to Kuwait. The US Navy requested only 3 F/A-18E/Fs in its FY 2017 OCO budget and has stated its intent to buy 14 in FY 2018. Given these international sales, a multiyear contract that would allow larger sales to the USN at a reasonable unit price is much more likely. We expect that Congress will fund at least 14 F/A-18E/Fs when it finally approves the FY 2017 DoD budget next March and will include at least that many again in 2018. All told, we believe that BA can count on 75 to 100 orders over the next three years. We think it likely that BA's St Louis F/A-18E/F production line can remain viable through 2020.
