In a normal cycle, the Pentagon would be releasing its budget request for FY 2020 next Monday, 4 Feb. While it appears that the official release will be delayed somewhat by the impact of the shutdown (think: printers), there are clear signals about what to expect. As we start the big week for defense primes' Q4 earnings reports (29 Jan: LMT, LLL: 30 Jan; BA, GD, OSK; 31 Jan: NOC, RTN) we take a look at what they may expect to see when the Pentagon's request comes out.
Topline. The President has oscillated within a range of $50B on the level of FY 2020 discretionary spending for "defense" (050 funding includes DoE). $733B has been the level used by the Pentagon and other agencies since last spring (FY 2019 = $716B). In a brief nod to the burgeoning deficit in December he said he would come in at $700B. A week later he openly stated that he would submit a $750B plan in order to end up at $733B. We believe that the budget request will come in at $733B ($701B for the Pentagon and $32B for DoE and other supporting agencies), i.e., as planned since last spring. Good news for defense primes: maintains FY19 level plus inflation costs.
Paying for it. A $733B request exceeds the Budget Control Act 2020 caps on "defense" by at least $103B. The Pentagon plan had been to request an increase or removal altogether of the Budget Control Act caps for FY 2020 and request only a small OCO of ~$20B for true "war" spending. We believe that the Administration will try to keep the caps in place and request the difference between the defense BCA caps and $733B in OCO funds ~ $125B (FY 2019 = $69B). Bad news for defense primes: House will reject obvious effort to increase defense spending without concomitant non-defense increase. Lengthy budget drama will ensue.
Potential Major Program Changes To Look For:
- F-35: US demand is flattening which is long term negative for LMT, NOC, BAE, et al. USAF is apparently capping planned buys at 48 per year vice growing to 60-80 in the mid 2020s as long forecast. USMC and USN demand to remain at 40-44 B and C models per year with shift to more Cs and less Bs than previously planned. Foreign sales increasing with gains in Japan and Germany to offset possible loss of Turkey orders.
- F-15: Huge win for BA as USAF surprisingly decides to add $1.2B in FY 20 and ~$1.8B per year thereafter to buy more than 100 F-15EX, an update of legacy, fourth generation aircraft. With US support FMS sales will also grow.
- Army. Army leadership this week announced that they planned to cancel or reduce planned funding from 186 programs in order to move more than $25B over five years into 31 programs that directly support their six long term priorities. In general, money is being moved out of procurement and O&M into R&D = lower near term margins, more risk for primes.
- Long Range Fires. LMT and RTN stand to gain as Precision Strike Missile and Land Based Anti Ship Missiles are prioritized.
- Next Gen Vehicle. GD and BAE are competing to build 500 Mobile Protected Firepower vehicles and with long shot RTN for design/build of hundreds/thousands of Bradley replacements. GD's Abrams tank upgrade plans are safe but other legacy vehicle upgrades by GD, BAE and others will likely be trimmed to pay for priorities.
- Future Vertical Lift. LMT (Sikorsky) and TXT are the main competitors for design of Future Attack Recon Acft (Cap Set 1) and for the medium lift (Cap Set 3) variant. The Improved Turbine Engine Program (ITEP) to reengine Blackhawks and Apaches, which is set to be conferred on either GE or UTX/HON at any moment, will remain funded. However, other legacy aircraft procurements and upgrades such as CH-47 (BA) and UH-60 (LMT) will be reduced. OSK's JLTV program is secure enough but may end up losing some quantities to pay some of the bills.
- Air and Missile Defense. LMT, RTN and NOC will see boosts in Indirect Fire Protection and Lower Tier Air Missile Defense programs.
- Shipbuilding. Positive: GD and HII will see 10 ships requested as planne. HII in particular will benefit from the Navy's decision to block-buy the next two nuclear aircraft carriers providing good potential for margin improvement and giving them nearly $40B in backlog. Negative: Navy is still not able to fund its desired program of ~ 12 ships/year and remains dependent on $2-3B in Congressional adds which it has been receiving over the past budget cycles. That "help" is going to be increasingly hard to sustain.
- Space. HASC Chairman Adam Smith has publicly questioned Ground Based Strategic Deterrent (GBSD), the ICBM replacement program, bad news for competitors BA and NOC. Ballistic Missile Defense spending will increase, good news for BA which manages the national level program and RTN, NOC and LMT who make various components of the program. At the same time, the Pentagon is clearly moving away from the big bus satellites built by the primes and moving towards a service model based on LEO satellites and the disruptive models of Space X, Planet Labs, etc.
