The only thing certain for the defense industry is that the cornucopia of government contracts will be shrinking. The Defense Department is already facing $400 billion of cuts requested by the White House. Any additional defense cuts triggered by the debt ceiling bill could slice away $600 billion more.
Defense contractors like General Dynamics (GD) and Northrop Grumman (NOC) should be very concerned. But Lockheed Martin (LMT) should be sweating bullets.
The immense cost of its F-35 Joint Strike Fighter contract has painted an unignorable target on Lockheed. No matter how hard Pentagon cost cutters look for trims in other places, they can't help but cast their gaze skyward.
The Costliest Cost-Effective Defense Program Ever
The projected lifetime operation and maintenance cost of the F-35 program is $1 trillion -- yes, that's a "t"-- which doesn't include purchasing the planes. That will be an additional $382 billion, please.
It's hard to believe, but the F-35 was conceived to be cost effective. The Air Force, Marines, and Navy were to get versions designed to meet each of their specific requirements. The Air Force needed an air defense fighter, the Marines needed a short takeoff and vertical landing version, and the Navy needed one built for carrier operations. Commonality of parts was supposed to provide economies of scale that would keep costs down.
Instead, the F-35 has turned into the costliest defense program ever.
It has been plagued by problems: The F-35 versions have missed their original combat-ready dates by wide margins. The Air Force has moved its date back to April 2016 (the original was June 2011). The Marine version was to be ready in December 2012, but that date is now off the table and no new one has been set. The Navy version, also delayed to 2016, had its first successful catapult test launch last week. Reports indicate that Navy officials aren't thrilled with their overweight version, and if costs continue to skyrocket, the department could go with Boeing's (BA) F/A-18E/F Super Hornet as a fallback plan.
The company executive in charge of the project blames delays on a needed redesign of the Marine version of the fighter, which froze all production, and says the Pentagon's cost projection methods have produced higher estimates. But no matter the positive face the company tries to put on the F-35 program, it is still in a precarious position.
The Senate Lifeboat Is Sailing Away
Lockheed Martin shouldn't look to the Senate for much public support. Last May, in a Senate Armed Services Committee hearing, Sen. John McCain called the F-35 program "a train wreck." Further, he accused the company of doing "an abysmal job."
That review can't be taken lightly by a company that gets 84% of its sales from the U.S. government, where the F-35 program takes center stage.
Lockheed's Plan B: Go Global
With hard budget decisions to be made all around, Lockheed and its F-35 contract won't be able to fly under the radar for long. So Lockheed is looking elsewhere to diversify its sales.
With the Soviet Union no longer our national bogeyman, the military-industrial complex needs an enemy worthy of defense expenditures. Who else is out there? Other than terrorist groups and North Korea, we're left with ... China.
Though China is not an immediate threat to our national security, countries within its direct sphere of influence are more skittish. Lockheed is counting on Pacific Rim countries like Japan, South Korea, Singapore, and Taiwan to make up for any possible cuts in F-35 orders by the U.S. or NATO.
Investors certainly hope that strategy gives the company a strong enough tailwind to keep it from crashing if the F-35 Joint Strike Fighter contract experiences heavy political turbulence.
Motley Fool contributor Dan Radovsky owns no shares of the mentioned companies. The Motley Fool owns shares of General Dynamics, Northrop Grumman, and Lockheed Martin.
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