Companies in the U.S. defense industry are expected to post double-digit earnings growth in 2006's first quarter, according to the average of estimates from analysts polled by Thomson First Call.

"The companies continued to benefit from a strong market for commercial aircraft in the quarter, with major growth coming from international airline customers, along with a healthy domestic demand for business jets," MarketWatch noted within its mid-April coverage of the estimates.

The recently released Quadrennial Defense Review (QDR), a Congressionally mandated report that lays out the threats to U.S. security and the capabilities the military needs to address them, did not indicate any significant shift in strategic threats or major changes to large weapons programs.

According to Standard & Poor credit analyst Christopher DeNicolo, higher revenues, earnings and cash flows, along with divestitures of "noncore assets," have positively affected the total level of funding. "Defense budgets have risen significantly since the late 1990s and, although growth is likely to slow after 2007, the total level of funding is still significant," DeNicolo said. Companies have been able to reduce debt, pursue targeted strategic acquisitions, or return cash to shareholders through moderate share repurchase programs and increased dividends in recent years.

Meanwhile, a Daily Press article in February observed that "the hot tickets in the defense industry are information technology, communication and high-tech equipment designed to assist soldiers in the field." This growing tech trend has thus helped drive recent acquisitions of defense IT firms. Companies that have innovative products or are viewed as "acquisition candidates" — have the potential to be acquired — are expected to prosper. Smaller companies, the article noted, have been especially impressive.

In fact, some analysts see the small-/mid-cap defense technology companies outperforming large caps throughout the entire cycle of upturns and downturns in defense spending. Acquisitions drive that, too, and in turn are driven by U.S. government procurement polcies.

Said the Daily Press:

Driven by ever-escalating defense budgets, stocks in the sector have soared since 1992. President Bush's $439.3 billion defense budget for fiscal 2007 includes $84.2 billion in weapons purchases, up 8 percent from the 2006 request. But his budget defers decisions on large cuts to major weapons systems. It is unlikely the Pentagon could afford all the weapons systems currently in the budget without receiving a significant boost in spending over the next five years.

For defense contracting, at least, needs for both the war in Iraq and long-term programs to modernize the military — particularly for the U.S. Army — fueled a slower but steady growth.

The recent QDR and President Bush's fiscal 2007 defense budget request point to "a continuing favorable environment for U.S. defense contractors," according to Standard & Poor's Ratings Services report, "Strong Funding Levels Keep U.S. Defense Contractors Prosperous," published mid March.

Standard & Poor's report also noted that although its rating outlooks for defense contractors are "overwhelmingly stable," ratings actions in the past year have been "mostly positive," as three of the top five U.S. defense contractors have seen upgrades.

Contracting jobs "took a rap in the wake of Hurricane Katrina," but federal agencies plan to announce public-private competitions for more than 26,500 positions by the close of this fiscal year, said GovExec in mid April. In fiscal 2005, fewer than 5,000 positions were announced.

And according to an April-released Office of Management and Budget (OMB) report on competitive sourcing, the list-leading Defense Department has 10,338 full-time positions planned for competitions — a significant increase over last year's 1,301 positions announced. The Army Corps of Engineers was second on the report's list, with 2,000 posts to be opened to contractors, compared with a mere 80 in 2005.

The intended 2006 competitions represent more than a five-fold increase over the 4,876 full-time positions that were opened to competition in 2005, GovExec noted.

Overall, the U.S. defense industry is making gains, slowly but steadily. Contracting jobs are opening up. And defense companies relevant to the important day-to-day needs of soldiers in the field — those in IT, communication and high-tech equipment — are in the defense industry's sweet spot, particularly the small- and mid-size businesses.

References

U.S. defense industry seen posting 1Q double-digit gains
by Ann Keeton
MarketWatch, Apr. 17, 2006

Tech firms are big guns in the defense sector
by Andrew Leckey
Daily Press, Feb. 12, 2006

Strong Funding Levels Keep U.S. Defense Firms Prosperous, S&P Report Says
Standard & Poors (via Defense-Aerospace.com), March 20, 2006

Crisis of Contracting
by William G.T. Tuttle, Susan Livingstone and Robert Welch
GovExec, April 1, 2006

Competitive Sourcing: Report on Competitive Sourcing Results Fiscal Year 2005
Executive Office of the President, Office of Management and Budget, April 2006

Number of federal jobs opened to contractors to jump this year
by Jenny Mandel
GovExec, April 20, 2006

Additional Resources

The US Defense Industry's Small-Mid Size Sweet Spot
Defense Industry Daily, Feb. 21, 2006

Analysis - US arms industry eager to gain foothold in India
by Andrea Shalal-Esa
Reuters, April 10, 2006