As the U.S. leaves the fog of war, the defense industry enters the fog of deficits. No industry is as vulnerable to the budget ax than defense -- with or without the fiscal cliff. The Pentagon is already planning to cut $487 billion in spending over the next decade even without "sequestration," which would pile on another $500 billion in cuts over that same time frame.
Defense contractors have enjoyed unprecedented spending since the 9/11 attacks, and management knows that's subsiding. However, companies have seen this coming, and they've been preparing.
Here are three predictions for the coming year.
THE F-35 WILL BE FINE
Lockheed Martin's Joint Strike Fighter, the F-35, is the most expensive defense program in history. The total cost over the lifespan of the more than 2,400 jets the Pentagon plans to purchase could reach $1 trillion. That's with a 't'. The jet has been criticized for cost overruns and delays. Canada is reportedly reconsidering its decision to buy 65 F-35s.
But this may be one program that's too big to fail. The Pentagon continues to sign deals with Lockheed Martin to buy more of the jets, though at a lower price. If fewer jets are purchased overall, it drives up the cost of each individual aircraft, and if Lockheed is being paid less, it will squeeze profits.
However, there has been too much invested in the jets, there are too many jobs at stake, the nation's largest defense contractor has too much riding on it, and some members of the military says it's too risky to give up American domination of the skies. (See: China completes jet fighter test flights on its first aircraft carrier).
CASH WILL BE KING—TO BE SPENT ON MARKETING ABROAD
As spending in the U.S. winds down, UBS expects many defense companies will conserve cash by reducing share repurchases. At the same time, companies will focus on building up more international business to make up for slower bookings in the U.S.
IT'S A BIRD, IT'S A PLANE...IT'S BIG BROTHER
The use of drone strikes has proven how effective unmanned aircraft can be, but the occasional collateral damage has also drawn criticism. But as the wars in Afghanistan and Iraq draw down, look to see UAV manufacturers launch a drone war here at home. The FAA predicts there could be 30,000 drones flying domestically in U.S. skies by 2020, with everyone from Homeland Security to TMZ seeking permission to use them. This is an area currently dominated by General Atomics Aeronautical Systems, which makes the Predator, as well as Northrop Grumman, which makes the Globalhawk.The Teal Group says UAV s could be an $89 billion industry globally within a decade.
Every large defense contractor, plus some small ones, like AeroVironment's "Hummingbird," is hoping for a piece of the action once U.S. skies are opened up.