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Big defence contractors spared from U.S. spending cuts

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Austerity is, in principle, a bad thing for the big weapons makers that serve the U.S. military. So far, though, austerity has mostly stayed at the level of principle.

Lockheed Martin Corp. reported financial results on Tuesday that might make one forget that sequestration – the indiscriminate spending cuts meant to trim a tenth from every line in the Pentagon's budget – went into effect in March. Revenue in the last quarter fell a bit but margins expanded and earnings per share rose 11 per cent. Profit targets for the year were bumped up. On Wednesday, General Dynamics Corp. reported flat revenue and earnings – a better result than Wall Street had projected – and gave its earnings targets an upward nudge. Also on Wednesday, Northrop Grumman Corp. reported flat sales and earnings up 9 per cent. It inched targets up, too.

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Budget strains did show up here and there. Products with shorter delivery cycles, such as information technology and consulting, are being hit. Lockheed's and Northrup's information systems segments both saw sales drop. The wind-down of the war in Afghanistan may be having an effect too. General Dynamics's combat systems division, which makes tanks and vehicles, saw revenue fall by a quarter. But most products with long cycles – aircraft, ships – are doing fine.

Over the past six months or so the three companies' shares have risen in lockstep and their valuations have reached roughly 12 times forward earnings – post-crisis highs. It is an open question, however, how much of that has to do with the fact that austerity turns out, in the military's case, to be a slow process and how much of it has to do with the shrinking risk premiums for equities in general. It is at the very least possible that the fate of investors in military contractors depends less on the Department of Defence than on the Federal Reserve.

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