US political chaos shuts Pentagon contractors out of military stocks boom

Financial Times carries an article about American defence companies underperforming European peers despite soaring demand as budget deadline looms, Caliber.Az reprints the article.

US defence contractors are missing out on a global military boom that has boosted their European counterparts’ share prices as legislative deadlock in Washington creates government spending uncertainty. Shares in the biggest military contractors to the Pentagon have shed most of their gains after Russia’s full-scale invasion of Ukraine two years ago. Lockheed Martin has lost 10 per cent in the past year and RTX, formerly known as Raytheon, has declined by 9 per cent.

By contrast, shares in Leonardo of Italy have jumped 91 per cent, while those of Germany’s Rheinmetall have rallied 78 per cent. The underperformance of the US groups’ stocks comes as spending at the Pentagon, as well as the rest of the US government, is frozen at last year’s levels because Congress has yet to pass the 2024 budget.

“I’ve never seen anything like this, the chaos,” said Byron Callan, managing director of research group Capital Alpha Partners. “It’s really a very chaotic environment in Washington right now.” Many US defence companies boast record order books; at the leading six groups the backlog was up 9 per cent to $508bn last year. Despite this, uncertainty over future government commitments has held back companies’ valuations, analysts said. Lawmakers have less than a month — until March 22nd — to pass the 2024 defence budget. Both congressional chambers passed a stop-gap budget that President Joe Biden is expected to sign soon in order to avoid a partial government shutdown.

The Pentagon is expected to unveil its 2025 budget request this week, but under the stop-gap measures it cannot start new procurement programmes and ongoing programmes will slow down. The undersecretaries of the Army, Navy and Air Force last week warned that ongoing military modernisation efforts would be harmed if Congress failed to pass a defence spending bill. “These are production rate increases, new starts — both in programmes for acquisition as well as military construction projects that we cannot start,” Army under secretary Gabe Camarillo told reporters.

The Biden administration’s additional spending package of nearly $60bn for Ukraine is also on hold. This includes $20bn to replenish US weapons stocks and $13.8bn to allow Kyiv to re-arm through the purchase of weapons and munitions from the US defence industrial base. “As much as the mantra, ‘the world is a more dangerous place’ is back — well, it’s not being heard in Congress,” said Callan.

US contractors lead the list of the world’s largest defence companies by revenue, according to the Stockholm International Peace Institute’s latest ranking. The US government is a significant part of their businesses, accounting for 86 per cent of Northrop Grumman’s revenues and nearly three quarters of Lockheed’s sales in 2023. The US defence sector faces further questions about its prospects if Donald Trump is re-elected as president in this year’s election in November. A weaker commitment to Nato could damp American defence exports while European governments, already under pressure to spend more on defence and bolster their own capabilities, would have to ensure more of their money goes to domestic contractors.

Callan said there was “still a question about the long-term growth and competitiveness of these [US] companies if Trump is re-elected”. US defence contractors are also struggling with labour shortages, inflationary pressures and fresh concerns over fixed-price contracts. Northrop Grumman said in January it would take a $1.2bn charge against the new B-21 Raider bomber that it is building for the US Air Force due to rising costs on the contract it won in 2015. The “monster” charge has “reawakened worries that the defence sector signed up for more risk than was prudent”, said Robert Stallard, analyst at Vertical Research Partners.

In many cases the contracts were signed “years ago, back when managements had no inkling that inflation was set to come back with a vengeance”, he added. Lockheed Martin and RTX are both dealing with losses on fixed-price contracts. Boeing’s defence business reported a loss of $1.8bn last year, following a $3.5bn loss in 2022. Nearly 60 per cent of its defence business derives from fixed-price contracts, according to Securities and Exchange Commission filings. Several executives have recently signalled they will no longer chase contracts that are at risk of cost overruns. Chris Kubasik, L3Harris chief executive, told analysts in January the company decided to forgo bidding on a fixed-price development programme late last year. “I will sacrifice revenue for earnings and cash every day of the year, and we will continue to do so until that changes,” he said.