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 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?

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.

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?

Do we need another Strategic Defence and Security Review?

UK Armed Forces have secretly begun preparing for another round of defence cuts

In last July’s blog ‘Can aerospace & defence weather Brexit?’  I wrote that the economic and political impact of the UK’s decision to leave the UK would require a new Strategic Defence and Security Review (SDSR). This has proved wrong thus far; Theresa May has maintained that the strategy remains intact and therefore the 2015 SDSR is extant and fit for purpose. However, press reports over Christmas that the UK Armed Forces have secretly begun preparing for another round of defence cuts suggest that my prediction may yet come true.

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.

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?

Is the last bastion of the UK Defence Industry at risk?

Urgent decisions are needed about UK shipbuilding

Naval Ships and Submarines are forecast to consume 40% of total UK defence equipment spending over the next decade, so you would think it is a safe assumption that shipbuilding is an excellent market for the likes of BAE Systems, Babcock and Rolls-Royce?  Last week’s report by the House of Commons Defence Committee suggests otherwise. MPs highlighted that decisions made over the next year about the Type 26 and Type 31 are critical in establishing whether skills can be maintained, budgets can be met and ships can be delivered on time.

One man’s gift is another man’s bribe

How has the 2010 Bribery Act impacted Aerospace & Defence?

The recent BBC Panorama entitled ‘How Rolls-Royce bribed its way around the world” prompted me to revisit the 2010 Bribery Act. Crucially I wanted to understand whether Rolls-Royce’s business activities prior to the Act becoming law in July 2011 could be looked at retrospectively? And what punishments does the SFO have in its arsenal? In answering these questions, it is interesting to look at how the Aerospace & Defence industry is adapting in order to operate within the law. 

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.

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?

Innovation in the defence industry

Is it industry or the the MOD that is too old to innovate?

There is uproar in the upper echelons of the defence industry. Last month Tony Douglas, CEO of the government’s Defence Equipment and Support group (DE&S) reportedly berated senior defence industry executives for all being over forty-five, implying that they are too old to be innovative. Ironically, in my previous blog ‘Brave new world for defence industry’ I highlighted that it is the Government’s cost cutting that is jeopardising long term innovation. So is Mr Douglas’ criticism fair? 

Brave new world for defence manufacturing

Hundreds of jobs at risk at GKN Yeovil

Last Friday GKN announced that it may have to “close or significantly downsize” its Yeovil site which employs 227 people. A statement from the company blamed the decision by Leonardo Helicopters to relocate all future A159 Wild Cat helicopter assembly away from the GKN Yeovil site to one of their own facilities. However, the story is more complicated than that and it raises the emotive debate of how much the Government is willing to invest in order to preserve the UK defence industry?

Heathrow vs. Gatwick?

The airport expansion debate rages on

Are we finally about to get an answer to the Heathrow vs. Gatwick airport expansion question? MPs are scheduled to debate the question of UK airport capacity next Tuesday (18 October) as the Prime Minister has indicated a desire to finally make a decision on an issue the Conservative Government has thus far managed to sweep under the carpet. Interestingly, the debate will be set against the backdrop of new research which shows that it is the road traffic in and around the airport that is the main contributor to emissions, not the aircraft themselves.

Are airlines weathering the impact of Brexit and terrorism?

Passenger traffic growth analysis

In my 27 July blog ‘The Summer of Hate’ I espoused that summer 2016 could be a defining moment for the aerospace industry. I questioned whether the new wave of terrorism on mainland Europe would lower our propensity to travel by air and therefore encourage more people to holiday closer to home. The IATA passenger data is now in for July so what does it show?

Do tanks have a future?

A look at how armour is evolving

Last month the British Army caused traffic chaos in London by driving a replica First World War tank and a modern Challenger tank around Trafalgar Square. This impressive, yet slightly anti-social display was to commemorate one hundred years of tank service. Seeing these two goliaths of warfare side by side, it struck me that whilst major technological advances have been made over the past century, a modern tank still looks remarkably similar to its predecessor. It made me question whether tanks one hundred years on will still look so similar? Or whether in fact modern warfare no longer needs tanks? These are questions that are likely to be preoccupying the military vehicle manufacturers such as General Dynamics, BAE Systems and Nexter.

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?

Does a smaller military present an opportunity for industry?

MOD statistics show significant troop shortfall

Last month’s UK Ministry of Defence (MOD) personnel statistics show the UK Armed Forces have a personnel deficit of 4.1%, and strikingly the number of trained soldiers in the Army is at its lowest since 1750. The doomsayers note that this recruitment crisis means the UK would struggle to respond to a major crisis. However, could this not provide an interesting opportunity for the defence industry to show how the right equipment means you do not need as many troops?

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?

Lockheed Martin names and shames the US DoD

Funding for the F-35 is "insufficient"

Lockheed Martin depends on the US Department of Defense (DoD) for c.80% of its revenues. Therefore for Lockheed Martin’s CEO Marillyn Hewson to name and shame the DoD as having overdue bills at Q2 results last week is not a decision she would have taken lightly. It caused me to wonder, what was Hewson trying to achieve?

The summer of hate

The impact of terrorism on the Aerospace & Defence sector

An article in the press today described the summer of 2016 as the “summer of hate”.  The relentless pace of the attacks has invoked terror into the minds of ordinary people and politicians have been forced to make frequent declarations of their determination to protect their citizens.  It therefore seems logical to me that the summer of 2016 will be one which shapes the near term future for Aerospace and Defence companies.

Inside the White House

A guide to the US budgetary process

Last week I wrote about what Donald Trump as President of the United States might mean for the US Defence Budget and I noted that in an election year, the President’s ability to alter the budget is quite limited. Today I look at why that is the case by unpicking the rather confusing and protracted US budget process.

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.