Edison Investment Research

FY18 US Defense Budget

Not as radical a departure from Obama as the headlines suggest

President Trump released his first full US Defense Budget yesterday. It requests a base budget of $574bn for FY18, and $65bn in Overseas Contingency Operations funding (OCO), making a total request of $639bn (as shown in the chart below). This would be a 3% increase year on year, and it is 3% higher than Obama requested for FY18. Whilst I acknowledge that the market environment looks better for the defence industry under the Republicans compared to the Democrats, I think the headlines this morning are focusing on the bullish rhetoric rather than understanding the nuances of the numbers. This budget is positive for the overall trajectory of defence spending and there is clearly going to be a focus on providing good equipment for troops, However, most of the uplift is consumed by higher troop costs and the Budget Control Act means there is uncertainty over whether this budget will ever come to fruition. In today’s blog I examine what I consider to be the three key questions; what has changed in this budget from Obama’s plans? Where will the extra money be spent? And how likely is it that the proposed budget is enacted by Congress?

US base defence budget and Overseas Contingency Operations funding ($m) FY01 – FY22 (Source: FY17 DoD Green Book & FY18 Budget materials)

US strikes budget deal to end six month long Continuing Resolution

Trump secures 3% uplift for defence, half of what he requested

The Republicans and Democrats reached a compromise over the weekend to avoid a government shut down in the US. They have agreed at $1.6trn omnibus spending bill for 2017, with $593bn for defence. The US is currently in Continuing Resolution (CR) which as Ultra Electronics noted last week has led to lower levels of government spending in the first half of 2017. The House is expected to vote on the Consolidated Appropriations Act of 2017 today, followed by the Senate on Friday, putting it on track for enactment before Friday’s midnight budget deadline.

China to build UAVs in Saudi Arabia

UK’s biggest defence export market looks east

Saudi Arabia has signed a strategic partnership with the China Aerospace Science and Technology Corporation (CASC) in order to establish the manufacturing of Chinese Unmanned Aerial Vehicles (UAVs) in Saudi Arabia. This announcement is significant for two reasons; first it shows that Chinese defence companies are now competing with their western peers, and second it will challenge the UK Government to become comfortable with Chinese made military hardware operating alongside UK built military aircraft.

US budget battles

End of 2017 Continuing Resolution looks likely as focus turns to Trump’s first budget

We are firmly in budget season. On this side of the pond Mr Hammond had his moment in the spotlight, but I was watching the news from the US because a few hours later the US House of Representatives approved the $584bn 2017 Defense Spending bill. This sets in motion the process to end the current Continuing Resolution (CR) that is only established until 28 April. The previous day, President Trump outlined his intent to spend $54bn (+3%) more than the Obama administration had planned to on defence in 2018. So what do we know so far and what can we expect?

Boeing comes to Sheffield

The US aerospace giant is spreading its wings into Europe

Last week, Boeing announced it would be opening its first ever manufacturing facility in Europe. Where will it be I hear you ask? Sheffield. I imagine that isn’t what you were expecting. I certainly wasn’t. The decision is significant for two reasons; what it says about Boeing’s relationship with Europe, and what it says about UK industrial capability.

Trump soldiers on

General H.R McMaster is appointed as US National Security Advisor

There is a certain irony that the US host of the Apprentice was left scrabbling around for someone to fill the post of US National Security Advisor (NSA). However, after what appears to have been a fraught week of negotiating, President Trump has appointed General H.R.McMaster, a current Army Officer, who gained notoriety for his criticism of military leadership during the Vietnam War.

Court room dramas

Embraer & Brazil vs. Bombardier & Canada – round 2

Embraer and the Brazilian Government vs. Bombardier and the Canadian Government looks set to be the next aerospace courtroom drama. This follows hot on the heels of the aerospace giants Airbus and Boeing slogging it out in the courts over government’s providing financial support for new aircraft programmes, known commonly as ‘Launchaid’ (see Andy’s December blog). 2017 will see the aerospace minnow’s take to the stand in a replay of their previous drama, as Embraer has again complained to the World Trade Organisation about Canada’s support of Bombardier.

Russian Roulette

General Flynn resigns as US National Security Advisor over links to Russia

In my blog last December I described President Trump’s new security team of General Flynn and General Mattis as a ‘fiery and intriguing cocktail’. After less than a month in office, Gen Flynn has indeed set the sparks flying over his liaisons with Russian officials, and on Monday evening handed in his resignation. So what happened and where does this leave President Trump’s foreign policy now?

“You like me and I like you”

Trump promises to “load up” the US military

With Valentine’s Day next week, it seems fitting that President Trump has made public his love affair with the US military. He opened his first speech to service personnel on Monday with the words “you like me and I like you”, referencing the support he received from military voters during the election. He then promised to “load them up with beautiful new planes and beautiful new equipment.” Words which sent US defence stocks soaring. So is this really music to the defence industry’s ears?

2017…the year of the rooster, Trump and flying cars

What does the year have in store for Aerospace & Defence stocks?

The Aerospace & Defence sector has two distinct sides to it, with civil aerospace and defence often proffering very different investment narratives. Historically, terrorism and political instability have tended to cause the two sides of the sector to diverge, with defence valuations surging and civil valuations falling. This happened most notably after 9/11 in 2001. At the end of 2016 though, a year defined by terror attacks and political turmoil, the situation was quite different. Defence stocks were the stand out performers during last year, driven initially by the fact global defence spending is now growing, having been in decline from 2011 – 2015, and more latterly by Donald Trump’s US election victory. However, civil stocks have also performed well. Although there have been a high number of terror attacks during 2016, improved airport security measures have forced terrorists to seek new targets and so aerospace stocks have been largely unaffected, and in fact have continued to benefit from the structural growth of passengers numbers which continues to drive output growth. So what does 2017 have in store for aerospace and defence?

Cyber wars

Will Russia’s attempt to influence the US election change global cybersecurity policy?

The news this week that Russia tried to influence the outcome of the US election is likely to have elevated cybersecurity up Mr Trump’s ‘to do’ list for when he takes office next week. The report from the Intelligence Agencies stated that “Russia’s effort the influence the election represented a significant escalation in directness, level of activity and scope of effort compare to previous operations.” Cyber is not a new topic, and has been a buzz word in the defence industry over the past five years as companies sought exposure to what has been seen as a growth market. However, cyber is still a very small percentage of revenues for the defence primes and the market has been very fragmented. In today’s blog, I ponder what impact Russia’s meddling in the election will have on cybersecurity.

Trump wants to defeat ISIS and eliminate budget caps

Leaked memo outlines the President Elect’s defence priorities

A leaked Pentagon memo has given us a fascinating insight into President Elect Trump’s approach to US Foreign Policy. It suggests that Mr Trump is going to take a very different approach to handling Russia compared the current administration. His top four priorities are reported to be; defeating ISIS, eliminating budget caps, developing a new cyber strategy and finding greater efficiencies in the US Department of Defense (DoD). You will note that controversially Russia does not feature in this list. In today’s blog we examine what this new approach could mean for the defence industry.

Trump’s new security team

Gen Flynn and Gen Mattis make a fiery and intriguing cocktail

I have resisted commenting on Mr Trump’s election victory until now, because I wanted to let the dust settle and see whom he appointed as National Security Advisor and Defense Secretary. With General (Rtd) Michael Flynn and General (Rtd) James Mattis now confirmed respectively (pending Congressional approval for Mattis), today I take a look at what these appointments signal for foreign policy, and therefore the defence industry, during Mr Trump’s tenure as President of the United States.

Who’s the daddy?

Airbus, Boeing, the WTO or the lawyers

As the latest round of chest beating by Boeing and Airbus dies away until the next round of appeals, I really start to wonder why the finger pointing and name calling persists. It seems to me that only one group of people are directly benefiting from the “discussion”, and I do not mean Joe public.

F-35 funding in chaos

DoD and Lockheed Martin still struggling to agree contract terms

Earlier in the year I highlighted that there were serious problems with F-35 contract negotiations (Lockheed Martin names and shames the US DoD). Last week’s announcement that Lockheed is to receive $1.3bn of ‘stop gap’ funding to continue production of LRIP 10 whilst negotiations drag on, together with the unexpected and unilateral contract announcement for LRIP 9 earlier in November, indicate that the situation has got worse not better in the past four months. So what does the future hold for the programme, particularly under Donald Trump as President?

China shows its air power

Stealth fighters take to the skies at Zhuhai air show

On Tuesday, China showcased its long awaited J-20 stealth fighter jet for the first time in public at the Zhuhai air show. Yet again an impeccably timed show of force with the US Presidential Election next week. The first test flight of the aircraft in 2011 coincided with the then US Defense Secretary Robert Gates’ visit to Beijing. With other new military aircraft expected to be unveiled throughout the week we look at the changing shape of China’s military arsenal, and question how does Chinese defence spending affect Western budgets.

It pays to be civil in the long run

Backlog execution should enable improved investor returns

By the end of September, Boeing and Airbus had surpassed an aggregate of 1,000 aircraft deliveries as previously announced product introductions and rate increases continue to drive up demand across the aerospace supply chain. By the year end the two companies are expected to deliver an aggregate of around 1425 aircraft, slightly higher than in 2015.

Consolidation in the Cyber market

Who will benefit from the super nomal levels of forecast growth?

The global Cyber attack last Friday is the latest stark reminder of how the defence and security market is changing. Attacks do not have to be physical in order to cause harm. Cyber attacks have the potential to be fatal or economically disastrous in just the same way as conventional warfare. As President Obama said on Monday “One of the biggest challenges for the next President, and the President after that is going to be how do we continue to get all the benefits of cyberspace but protect our finances, protect our privacy”. In a world where growth is hard to come by, new forecasts see the Cyber Security market growing 12-15% year on year until 2021. But is it clear what the products of the future will look like? And can we discern which protagonists will win market share?

The ‘special’ relationship?

Carter and Trump's speeches raise big questions about US and UK defence

Events of the past week have raised some fascinating questions about the ‘special relationship’ between the United States and the United Kingdom. Firstly we saw Ash Carter (US Secretary of Defense) hold Theresa May and Michael Fallon’s feet to the fire to ensure the UK supports the US in its role as global policeman, and continues to spend 2% of GDP on defence. Subsequently Donald Trump set out his plans to increase the size of the US military without any explanation of how he would fund it. So what do these two acts of showmanship actually mean for the defence landscape?

New tanker and fighter jet ready for take off

F-35 declared combat ready and KC-46 ready to enter production

August may traditionally be the month of days spent by the beach and long summer evenings, but it seems life has been somewhat busier at Lockheed Martin and Boeing in August 2016. Last month saw the companies achieve major milestones for the F-35A and KC-46 tanker respectively.  The F-35A has now reached Initial Operating Capability (IOC) and the KC-46 has been approved to enter production. These are significant achievements because the products have both had eventful development phases and both aircraft should be important drivers of profitability going forward, at not only the prime manufacturers but for suppliers as well, notably BAE Systems with its significant programme share.

What does the future hold for NATO?

Trump and Corbyn refuse to support Article 5

9/11 was the first time that NATO’s article five – an attack on one member state is an attack all – had been invoked. It sent a powerful message about the strength of the alliance. Every member of NATO, no matter how small, provided assistance to the United States during the campaign in Afghanistan.  Fifteen years on and the alliance is arguably in its weakest position since its formation in 1949. Politicians in six major member nations have questioned the point of NATO and only five of the twenty-eight states spent the guideline 2% of GDP on defence. Could this be ‘make or break’ for NATO? And if so what could this mean for the defence industry?

Have you heard of GKN?

Making things work for more than a quarter of a millennium

Watching a BBC documentary of a behind the scenes look at the opening ceremony of the 2012 Olympic games reminded me of how the industrial revolution was a centre piece of the performance, creating the illusion of the Olympic rings being forged from steel. Had it happened back in the latter part of the 18th century as new processes changed Britain for ever, those rings may well have been forged in iron by one of the UK’s greatest global brands. GKN’s forebears have been making things happen for over 250 years and the company Guest, Keen & Nettlefolds was formed via merger in 1902. The company is one of our leading global manufacturers, and yet it is hardly a household name.

The rain fell mainly on the planes

Farnborough Airshow 2016 rant, sorry round up

When considering my view on the Farnborough International Airshow 2016 it is tempting to focus on the chaos of the first couple of days at the show. Monday’s washout was spectacular, and when we were eventually cleared from the site at around 5.30pm there was hardly anybody left. Even the ice cream van had gone home!

Trumping Clinton on defence spending

A look at the potential impact of Donald Trump as President on US defence spending

“I’m gonna build a military that’s gonna be much stronger than it is right now. It’s gonna be so strong, nobody’s gonna mess with us. But you know what? We can do it for a lot less.” (Donald Trump)

Donald Trump is somewhat of an enigma when it comes to his military strategy. On the one hand he seems to have the US defence primes in his crosshairs. He frequently criticises politicians and defence contractors for colluding to build costly and unnecessary weapons systems, and he is determined to reduce the procurement budget. On the other hand he has spoken of wanting to increase troop numbers, buy new equipment and bolster the US military presence around the globe, particularly in the Middle East and China.

Civil wars abating

Farnborough Airshow Preview 2016

Next Monday sees the start of the week long Farnborough Airshow which typically heralds a flurry of news in the sector. We expect the main talking points to be:

- A lack of headline grabbing aircraft orders

- Will Airbus and / or Boeing commit to a new aircraft?

- Airbus’ production issues to come under scrutiny

- F-35B to be the highlight of the flying display

- A focus on innovation

- Will Farnborough survive in a post Brexit UK