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Despite Iraq, US Military Suppliers Face Earnings Pressure

In the upcoming four-yearly review, Rumsfeld is under pressure to restrain Pentagon spending as the US government battles with a yawning budget deficit. Orders for big-ticket items such as fighter planes and ships could be in the firing line.

New York (AFP) Oct 30, 2005
Profits might be up, but leading US military contractors such as Boeing, Lockheed Martin and Northrop Grumman have reason to be nervous about government budget cuts, despite the Iraq war.

The top makers of hardware for the Department of Defense, including Raytheon, saw their share prices slip last week despite posting generally better earnings in the third quarter.

"The market is currently wrestling with DoD budget concerns for all defense contractors," CSFB analyst Rob Spingarn said.

Future US military spending will be shaped by a closely watched Pentagon policy report, called the Quadrennial Defense Review, which is expected to be released in the coming weeks.

Defense Secretary Donald Rumsfeld has called for a leaner and meaner US fighting force to gear up for the technological demands of future conflicts. But Iraq has also laid bare the need for large numbers of troops configured for more traditional work on the ground.

In the upcoming four-yearly review, Rumsfeld is under pressure to restrain Pentagon spending as the US government battles with a yawning budget deficit. Orders for big-ticket items such as fighter planes and ships could be in the firing line.

"Like peers, Lockheed Martin faces near-term headwind from DoD budget jitters," SG Cowen experts said.

Lockheed Martin, the largest Pentagon contractor by revenue, said last week that its third-quarter net earnings rose 39 percent.

Work on the next generation of fighters for the Air Force, space-related programmes and systems, and information-technology upgrades will drive earnings in the future, Lockheed chief financial officer Chris Kubasik said.

But in a conference call with analysts, Kubasik also stressed: "More than 40 percent of our revenue is non-Department of Defense."

Boeing also reported higher quarterly earnings, but revenue slipped 4.0 percent as the aviation giant's military sales slowed down and a machinists' strike shut down commercial-jet production for nearly a month.

Roman Szuper, credit analyst at Standard and Poor's, said that Boeing has diversified its business over time so that fluctuating Pentagon budgets do not have as much of an impact as they once would have.

But the company remains reliant on military sales for 60 percent of its turnover, and it suffered in the past quarter in particular from falling missile orders.

Along with the longer-term changes to the US military being debated at the Pentagon, the big defense contractors are also under cyclical pressure.

Under president Bill Clinton in the 1990s, said Paul Nisbet at JSA Research, "inventories were shrinking and equipment was getting old, so we had to replace airplanes (and) we were facing the necessity of speeding up our defense spending".

But now, the Pentagon is finding it harder to justify big spending on new military hardware, analysts said.

"Defense spending will slow down, but not in the next year or two," Szuper said.

One reason why spending is expected to hold up in the near-term is Iraq, where a bloody insurgency shows little sign of abating more than two years after US-led forces toppled the regime of Saddam Hussein.

"There's some money being spent in the replacement of weapons and munitions that are heavily used," Nisbet said, while also identifying a more prosaic reason why Iraq is proving expensive for the Pentagon.

"The sand is not good for the engines -- we have to repair aircraft, vehicles, helicopters as well," he said.

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