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Defense industry: What to expect from quarterly earnings

The big defense companies start reporting third-quarter earnings on Tuesday, and industry watchers expect only modest increases in earnings due to tighter Pentagon spending.

Patriot Missile
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Patriot Missile

Last week, the U.S. Treasury reported that weapons spending by the Defense Department fell 4 percent in fiscal 2015 ended Sept. 30. Analysts say the outlook for defense spending remains clouded given uncertainty on whether there will be a deal for the fiscal 2016 budget.

"We're going to continue to see what we've seen in more recent periods, which is relatively slow top line, stronger margins and good cash flow," said Sam Pearlstein, defense analyst at Wells Fargo Securities.

Lockheed Martin, the largest defense contractor, is seen beating Wall Street analysts' consensus earnings per-share estimates in the quarter, but the top line is expected to be flat with a year ago. Lockheed is likely to provide details on its conference call about the $9 billion acquisition of Sikorsky Aircraft Corp. from United Technologies, a deal now expected to close in the fourth quarter. Management may address questions about plans to offload the company's nonmilitary government information technology business.

"The way the quarters are, you really have to look at it on an annual basis for these companies — and there's obviously a lot of moving parts with pensions, too," said Peter Arment, a defense analyst at Sterne Agee CRT.

If past practice is any indication, Lockheed, Raytheon and Northrop Grumman will update their pension outlook for 2016 during their conference calls. Wells Fargo's Pearlstein said he believes the return on assets has been weaker due to the stock market, and that will become a headwind when looking at GAAP earnings-per-share outlook next year for those three companies.

Analysts say Lockheed and Boeing may be asked to discuss whether they are interested in selling the United Launch Alliance, a space-launch joint venture. Earnings from Lockheed are scheduled for Tuesday, and Boeing is set to report on Wednesday.

Raytheon, the maker of the Patriot missile system, is expected to report operationally strong third-quarter results and single-digit sales growth from its Integrated Defense Systems (IDS) and Missile Systems segments. The company's Space and Airborne Systems segment, which has posted lower sales for the past three quarters, is expected to see another slight decline.

"You could see some foreign orders this quarter from Raytheon, and ... good sales growth at their IDS division with margins improving," said Cai von Rumohr, defense analyst at Cowen & Co. "Patriot contracts will be building, and profitability should be getting better."

Raytheon's $1.9 billion acquisition of cybersecurity firm Websense earlier this year will result in some dilution to GAAP earnings, but analysts say that's already factored into current estimates. Raytheon is set to report on Thursday.

For Northrop, slightly weaker per-share earnings and lower sales growth is forecast for the latest quarter, according to consensus estimates from Thomson Reuters. Some analysts see a possibility that Northrop could report a modest beat in earnings for the September quarter, as it did in the prior quarter.

Northrop previously indicated that it was adopting new tax practices that shift taxable income into future periods, and that the move will result in a $45 million nonrecurring increase in unallocated corporate expenses in the third quarter.

Northrop Grumman and General Dynamics are scheduled to report third-quarter results on Oct. 28. General Dynamics is forecast to show modest earnings growth and slightly lower revenue in the quarter.