THIS FISCAL YEAR (2020): Pentagon outlays, the best indicator for quarterly defense industry revenues, continue to accelerate.
- Pentagon outlays for FY 2020 investment (Procurement + RDT&E) through 30 April are running $16B (+13%) ahead of the same period in FY 2019.
- Expect +10% y/y increase in 2020 investment outlays vice forecasted 8.7%.
- The acceleration reflects the concerted Administration policy to get projects on contract and push money out and down the supply chain in the face of the COVID-19 crisis.
- Investment outlays have grown at a 10.5% CAGR since Trump took office in 2017. DoD Investment outlays are estimated to peak in FY 2021 and will be the second highest in US history in constant dollars, exceeding the Reagan buildup by ~8%.
NEXT FISCAL YEAR (2021): The Pentagon's FY21 topline will be flat with FY20
- The topline request of at least $740.5B is a done deal. Regardless of COVID-19 and an obscene $3.7 Trillion Federal budget deficit in 2020, this is an election year and this ceiling number was agreed in the two year deal that enabled approval of the FY 2020 budget. Defense spending is also stimulative = jobs.
- While the topline looks set, there has been a lot of discussion on content. For the most part, Congress wants to stay the course of FY20 for most programs in this election year and is pushing back on many of the Administration's proposed changes.
- It is virtually certain that Congress will add a second VA-class submarine (HII, GD) as no one is happy with the Navy's shipbuilding plan.
- There will likely still be some F-35s (LMT) added to the request for 79 aircraft although not on the scale of past years (+19 for total of 96 in FY20) given Lockheed's reduction of production goal for this calendar year.
- ICBM replacement (NOC) (known as Ground Based Strategic Deterrent) will be a hot House-driven policy discussion but we think any real threat to this nascent program is a year away.
- Senate authorizers will mark by June 10 and the House at the end of June with a conference certain to be required later this summer. Appropriators are typically further behind and we think it likely that there will be a Continuing Resolution with a final appropriation in a lame duck session after the election.
THE NEXT FISCAL YEAR (2022): Reductions are coming beginning in FY 2022 and accelerating in FY 2023.
- Elections have consequences and anxiety is high in the Pentagon concerning the FY 2022 topline and a real sense of dread/panic for FY 2023.
- We expect OCO funding, which has been running at ~$69B per year, to be drastically reduced beginning in FY 2022, regardless of the election winner.
- There is genuine bipartisan dislike for the funds' use as a means to increase baseline budget authority ("slush fund"). The President seems intent on withdrawing from AFG before the election.
- Cuts to OCO will pressurize baseline investment accounts because many of the currently OCO-financed O&M bills are "must pay bills" which must find a home in the base with or without OCO support.
- PresBud 21 shows only a $20B placeholder for OCO in FY 2022 vice the current $69B but increases the baseline by the difference, minimizing impact on the overall topline. This increase to the base to accommodate OCO cuts will be a point of contention particularly with a new Administration.
- The chart compares the PB21 proposal to adjust the base upward to accommodate a large OCO cut vs. absorbing the reduction, i.e., including $20B for OCO but then only increasing the FY21 base by 2% for inflation.
- FY 2022 will see tough skirmishing but FY 2023 has the potential to be a real inflection point down. Even if Democrats were to sweep this November, history indicates that while it is possible for a new Administration to make some adjustments in the near term, big changes to the budget profile come in the fiscal year following inauguration, i.e , FY 2023. That proposal will be published in February 2022. We also believe that the Federal deficit and the risk of inflation could be so ominous by February 2022, that even if Trump and/or Republican Senate were to survive this November, both parties will be looking very hard at the defense topline by then.
