It's been nearly a month since President Obama gave his State of the Union address, and hardly a day has gone by without at least one article lamenting the effect budget cuts will have on the U.S. military: reductions in force of 13% at the U.S. Marine Corps, 14% cutbacks at the Army, production delays for the F-35 stealth fighter, and a reduction of the strategic nuclear arsenal to boot.
Viewed in isolation, these moves seem tantamount to piecewise disarmament for the nation, and (this being an investing website, lets come right out and say it) potential disaster for investors in defense stocks. But is it really as bad as all that? Let's dig into some specifics, and find out what's really going on.
Cuts come one if by land ...
The big news for the Army (aside from reductions in force) is that the planned "recapitalization" of the Humvee fleet will be canceled, with funds diverted to develop the Joint Light Tactical Vehicle instead. This comes as quite a surprise. As recently as last summer, the JLTV program was seen as a dead man walking. Prototypes developed by contractors General Dynamics (NYS: GD) , Navistar (NYS: NAV) , and Lockheed Martin (NYS: LMT) have been plagued by weight concerns among others. Ford was so dubious that it declined an invitation to bid on JLTV, despite billions in defense revenues up for grabs.
Two if by sea...
The Navy gets to keep its 11-carrier fleet, but seven Ticonderoga-class Aegis cruisers (cutting-edge tech ... circa 1990) will be retired early. That's one third of the fleet. The Navy will postpone purchase of at least two littoral combat ships. So far, though, it's sticking with the long-range goal of buying 55 LCSs from General-D and Lockheed.
Meanwhile, below the waves, the Navy will postpone plans to replace the Ohio-class ballistic missile submarine and delay purchase of one additional Virginia-class nuclear attack submarine.
And more if by air ...
Perhaps the most wide-ranging cuts are to America's air forces. Boeing's (NYS: BA) decade-long battle for the right to build the KC-46 refueling tanker will pay off, since the Pentagon really has no choice but to upgrade its ancient fleet of flying gas stations. But planned purchases of the V-22 Osprey helicopter-plane hybrid will be cut 20% between 2013 and 2017, leaving just $1.75 billion budgeted for the birds.
In addition to transports and support craft, actual warplanes are also on the chopping block. The venerable A-10 "Warthog" is targeted for retirement. (This may or may not be part of a planned rollback of "tactical fighter jet" numbers by six squadrons.) Lockheed's F-35, meanwhile, is supposedly "safe" through at least the 2020s. But the Air Force will slow its purchase of the planes to give Lockheed more time to work out the kinks in the bird.
Filling the gap will be more robotic airplanes. Plans now call for increasing the numbers of General Atomics' armed Reaper drones sufficiently to permit the Air Force to run 85 sorties simultaneously. Makers of spy drones, however, won't be so lucky. Northrop Grumman (NYS: NOC) will see the "Block 30" edition of its Global Hawk terminated entirely. Conversely, Lockheed's U-2 spy plane, which the Global Hawk was set to replace, just got a new lease on life.
Viewed piece by piece, it sounds like a lot of cutting. But on the whole, the cuts being proposed by Defense Secretary Leon Panetta are actually pretty modest. The SecDef's proposed budget for 2013 amounts to an 8% reduction in near-term funding, swelling into $487 billion in cuts over the next decade. In the context of last year's $895 billion Pentagon funding request, though, it amounts to just a 5.4% reduction in annual spending.
That'll hurt, but it's really only a flesh wound in the grand scheme of things. What could really make this wound fester, though, is the risk that $487 billion in cuts turns out to be a lowball figure. As you may recall, when given the chance to make $1.2 trillion in cuts to government spending last year, Congress punted. It permitted something called "sequestration" to take effect and, without going too far into the weeds, what this means is that unless Congress passes targeted spending cuts this year, defense spending must be cut by a further $492 billion.
Over a 10-year span, that basically doubles the defense spending cuts to about 9.4%. Adding risk, even if Congress does act, additional cuts would almost certainly touch the defense budget as well as other departments. So we're looking at cuts ranging anywhere up to and including 9.4% ... but almost certainly more than the 5.4% we know about today.
The doomsayers are not right about the devastating effects of defense cuts ... at least, not yet. But give it a year, and I bet they'll be proved right eventually.
Is there any safe port in this storm? Possibly. Some companies, you see, are too crucial to national security for Congress to risk cutting their budgets. Read the Fool's new report on the defense industry, and we'll tell you about "Two Small Caps the Government Won't Let Go Broke."
At the time thisarticle was published Fool contributorRich Smithdoes not own shares of any company named above.The Motley Fool owns shares of General Dynamics, Ford Motor, Northrop Grumman, and Lockheed Martin.Motley Fool newsletter serviceshave recommended buying shares of Ford Motor and creating a synthetic long position in Ford Motor. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.
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