Profiting from War: Analyzing American Defense Contractors Post-Sequester

As the American military prepares to end its conventional presence in Afghanistan, crises across the world prevent American military from shifting back to peacetime mode. With the rise of the Islamic State and the continued presence of global terrorism, coupled with the crisis in Ukraine, global humanitarian issues, and the administration’s pivot towards South Asia, the need for a strong American military persists into the 21st century.

But American budgetary cuts in the 2011 Budget Control Act have stood in the way of a perpetually increasing Department of Defense’s (DoD) budget. The 2008 Recession has forced policymakers to make difficult choices and defense spending, insulated from much of the partisan rhetoric after the September 11th attacks, now appears an attractive target for fiscal hawks. While the 2013 fiscal cliff deal postponed some of those cuts, a noticeable political coalition has started to form, uniting fiscally conservative Libertarians with anti-war and pacifist Democrats in search of defense cutbacks. This new coalition could radically redefine American military presence across the world, as many see an extended US presence abroad as an expensive distraction from more pressing policy woes. If some of the proposed austerity measures become law, we could see foreign military bases shutter, deployments shrink, and advanced weapons development halt. As this new reality sets in, defense contractors should see their revenues lower and their stock prices decline.

The reality of defense spending, however, is complicated. Since procurement of military equipment takes years, severing pre-existing contracts and relationships is both politically and professionally unpopular. According to the Center for Strategic and International Studies, the Defense Department has awarded over $314 billion to defense contractors in fiscal year 2013. Lockheed Martin, the largest contractor, accounting for 9.5 percent of all defense contracts, received over $44 billion from the DoD in 2013. This year, its profits grew from between $5.25 and $5.40 billion in 2013 to over $5.475. With the exception of Boeing, the top five contractors, Lockheed Martin, General Dynamics, Raytheon, and Northrop Grumman have seen their stock prices rise over 25 percent in the past year. In comparison, the Dow Jones Industrial Average has risen 9.37 percent, the Nasdaq 13.71 percent, and the S&P 500 12.62 percent. Although many factors contribute to stock prices, the defense industry stands out as Wall Street bets big on continued American military operations across the world.

Yet defense spending cuts have hit military contractors and in particular, research and development. Since passage of the sequester in the Budget Control Act, overall defense spending declined from $702 billion to $646 billion and contract obligations declined from $373 billion to $314 billion—a 16 percent cut, or double the overall blow to defense spending. While reductions fell across the board, research and development suffered a 21 percent hit. In total, the defense cuts in the sequester totaled $37.2 billion for fiscal year 2013 and $34 billion for fiscal year 2014, although future amounts could vary with future legislation.

Increasingly, defense contractors are looking to foreign nations to export their cutting edge technology. For example, Israel, which over the summer fought a war against Hamas, relies on American military assistance and military equipment. Raytheon has partnered with Rafael in Israel to produce missiles for the Iron Dome defense system to the tune of $149.3 million, and Israel just announced its purchase of another squadron of Lockheed Martin F-35 fighters after its first order worth $2.75 billion. This increased growth has likely fueled the rise in stock prices, and as conflicts in the Middle East have increased in intensity, the prospect of additional military exports appears more likely. As policymakers debate the extent of American involvement across the world, foreign leaders appear poised to jump at the opportunity to purchase state of the art American equipment.

The defense industry must confront its desire for ever-greater profits with its national priority to provide for the American defense industry. As American policymakers search for cuts in the budget, defense contractors have formulated creative methods to deal with the prospect of decreased defense spending. By exploring export opportunities and minimizing wasteful programs, defense contractors have survived the recent round of limited austerity. The American military remains the most powerful fighting force in the world, but as geopolitical realities combine with budgetary distress, American defense contractors face an uncertain future where they must innovate and demonstrate the worth of their programs to both appropriators and their shareholders.