Budget deal likely to deliver hefty business to defense companies

The recent budget deal has handed U.S. defense companies an extra $75 billion over the next two years as the Pentagon boosts spending on aircraft, missiles, tanks and maintaining older equipment.

The Pentagon proposal unveiled Monday alongside the White House budget request for fiscal 2019—which starts on Oct. 1—includes spending more than $470 billion over the next two years on buying weapons and military research, a 20% increase from the Obama administration’s final plan in fiscal 2017.

“I had to actually go practice how to say the word ‘growth’ a few times before this call,” Mike Petters, chief executive of Huntington Ingalls Industries Inc., told analysts after the Navy shipbuilder reported quarterly earnings on Thursday.

Even Boeing Co’s defense arm, which has shrunk in recent years, forecasts rising military sales, and its combat aircraft and missile-defense systems are among the biggest beneficiaries of the new Pentagon budget, which still has to be vetted and approved by lawmakers.

The federal budget deal hammered out last week raised the statutory cap on military spending over the next two years and paved the way for the release of President Donald Trump’s first stand-alone defense budget. This followed a series of White House-commissioned strategic reviews that officials said emphasized tackling the threat of potential adversaries such as Russia and China, rather than fighting terrorism.

The increase in planned spending on everything from bullets and missiles to F-35 combat jets has eased investor concerns about any abrupt end to the two-year bull run in shares of companies including Lockheed Martin Corp , Northrop Grumman Corp. and Raytheon Co , analysts say.

A basket of U.S. defense stocks rose 27% in 2017, according to Vertical Research Partners, and have continued to outperform the market this year, even with valuations near historic highs. The industry is returning to growth after five years of declining domestic sales, raising optimism among investors that higher profits will follow.

Companies can also plan with more certainty as they and the military have operated under a series of temporary budgets for much of the past nine years.

“As important as the increase in the dollar amount is the predictability,” said Michèle Flournoy, a former Pentagon policy chief.

The budget for tanks and armored vehicles is up by an average of 59% over the next two years compared with 2017, benefiting companies including Abrams tank maker General Dynamics Corp and BAE Systems PLC, which makes armored cars. Jim McAleese at consultant McAleese and Associates, notes the factories producing them are concentrated in Ohio and Pennsylvania, battleground states in upcoming midterm elections.

Another big winner is the space budget, up by almost 50% in a reflection of U.S. concerns about vulnerable satellites and losing access to the GPS. Northrop Grumman Corp, Boeing and Lockheed Martin Corp. all stand to benefit.

Spending on military aircraft and on ships and submarines would rise by 8% and 9%, respectively, boosting all of the main prime contractors and their suppliers. However, some analysts are concerned spending could taper off in the early 2020s, just as big bills to modernize U.S. nuclear forces fall due. Building new submarines, bombers and intercontinental ballistic missiles is forecast to cost an average of $17 billion a year from 2021 through 2043, said Bob Work, a former deputy defense secretary.

“There is a big chance that 2018 and 2019 are the high point of the defense build up,” Mr. Work said.

Still, defense company executives said they are more confident in their outlooks, helped in part by strong exports.

Raytheon CEO Tom Kennedy said at a recent investor conference that budgets are also rising in Europe and Asia, as well as the Middle East, big markets for its Patriot missile defense system.

Tax reform also has spurred additional investment as the industry starts a return to job growth. Raytheon is adding 2,000 jobs over the next five years at its missiles plant in Tucson, Ariz., and Lockheed announced plans this week to add 1,800 workers over the next three years, mainly at plants in Alabama, Florida and Texas. It is already hiring 1,800 staff to support increased production of the F-35 jet.