In accordance with previous public utterances from President Trump, SecDef Jim Mattis has ordered acting DepSecDef Bob Work "to oversee a review of the F35 program to determine opportunities to reduce the cost of the F35 program while meeting requirements." In parallel, Work is to oversee a review that compares the Navy's version of the JSF, the F35C, to the current F/A-18E/F and to any potential improvements to that aircraft that could be made (Advanced Super Hornet).
We believe that when the review is complete this spring, the Pentagon will accelerate its planned F35 production ramp and buy substantially more F35s over the next five years than currently planned. This increase will be reflected in April when we expect to see a supplemental request of $15-$40B for the FY 2017 budget and the request for a much more robust FY 2018 budget.
The announcement of a review precipitated an immediate but temporary -$6.21 (2.4%) reaction in LMT trading on Friday, half of which was recovered just as quickly.
That there is going to be a review cannot be a surprise. The President said it was going to happen. The takeaway here is that Mattis' guidance to execute the President's desire is actually quite narrow. He orders two reviews:
- The first part of the review will focus on how to reduce costs to the F35 program while meeting requirements. There is no mention of challenging the requirement for the aircraft, just how to buy it cheaper. There is no question about the future need for the F35A or F35B. This is exactly what Mattis testified to in his Senate confirmation. In her two conversations with President Trump on this issue, LMT CEO Marilyn Hewson almost certainly told him of the 60% in unit cost reduction that has already occurred over the first 10 lots of production aircraft and the further 15% planned to come out over the next three lots when the F35A will cost $85M, about what a fourth generation aircraft will cost at that time. She has also been quite vocal that the key to further cost reduction are block buys and multiyear contracts and an accelerated ramp that will enable prime LMT to lock in better prices from suppliers through economies of scale.
- The second part of the review is to assess the F/A18E/F as a potential competitor to the F35C.
- Of the 2,443 aircraft total US buy, only 340 are F35Cs so the review is focusing on only 14% of the planned US market for the JSF. International customers are planning to buy an additional 600 to 1000 of the aircraft but none wants to buy the heavier, carrier-ready F35C. This means that the second part of the review is looking at about ~10% of the total market for the aircraft.
- We know how this is going to come out. This assessment is going over some well trodden ground: DepSecDef Work led almost the exact same assessment for the Dept of the Navy in 2011 when he was UnderSecNav. That study concluded that while there was potential for a high/low mix among the four fighter squadrons (10-12 acft each) in each of the Navy's ten carrier air wings, US carriers would be ineffective in high-end combat scenarios after 2024 without some fifth generation (F35C) squadrons aboard. We believe the review will conclude that the Advanced Super Hornet can complement the F35C but cannot replace it. Thus even if the Advanced Super Hornet (which is still mostly a powerpoint capability) performs and costs as advertised, the Navy must still buy at least ~260 of its currently planned 340 F35Cs and sooner rather than later.
The review is very good news for Boeing Defense (BA). The iconic St Louis line that had been delivering 48 F/A-18s per year for decades was due to shut down in FY 2014. Boeing kept St Louis alive for five more years by means of Congressional adds of F/A-18s, a greatly expanded EW requirement for the EA-18G Growler, and critical international sales of F1-5s to Saudi Arabia. Now, in the face of what looks to be a ballooning defense budget that can afford both an F35C and more F/A-18E/Fs, St Louis has new life. We expect the Navy to push for a multiyear contract of 24-30 F/A-18E/Fs per year under a five year multiyear contract that would run through FY 2022.
