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)

Global Xpress has lift off

4th and final satellite launched

Inmarsat’s high profile but somewhat beleaguered Global Express (GX) programme is now almost fully operational. The fourth and final satellite, I-5 F4, was successfully sent into orbit on 15 May. This is significant for the Aerospace and Defence industry because the Global Xpress network provides new bandwidth capacity for secure mobile communications from ships, aircraft and vehicles.

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 launches its first indigenous aircraft carrier

A show of force which will force the West to take notice

China celebrated the launch of its first domestically built aircraft carrier yesterday (Wednesday 26th April). Known as Type 001A, the ship is as yet unnamed and is the largest ever warship to be built by China. The televised launch comes at a time when tensions are running high in the region’s waters after the US deployed warships and a submarine to the Korean peninsula.

The MOD is open for business again

‘Accelerator’ project intended to encourage innovation but may also encourage acquisitions

Historically, defence technologies used to lead development of civilian technologies. However, military research and development (R&D) budgets have been constrained over the past five years so we have seen civilian technologies leading the way, particularly in the communications sphere. I was therefore encouraged to read about the UK MOD’s new ‘Accelerator’ programme, which funds novel, high-risk and high-potential benefit research to develop new capabilities for UK defence and security.

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.

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.

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 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.

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.

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?

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?

Safran and Zodiac - do opposites attract?

A look at two very different French Aerospace companies

Safran and Zodiac are both French, both exposed to the structural growth of the civil aerospace industry, and both have world class products. But it is there the similarities end. Over the past five years, Safran has proved itself to be a well-run company with strong project execution. Zodiac’s management and execution has been found sorely wanting as it struggles to keep pace with the production ramp ups at Airbus and Boeing. Last week saw Zodiac’s ninth profit warning in two years, but interestingly over the past couple of months there has been a resurgence in market rumours that Safran is potentially interested in acquiring the company. Why are the two companies such a different investment proposition, and do they really have a future together?

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?

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?

A New Year’s resolution for Cobham?

CEO and CFO to move on from the struggling Aerospace & Defence company

Three years ago I, and many others, expected Cobham to be given a fresh lease of life by its new CEO Bob Murphy and CFO Simon Nicholls who joined the company in 2012 and 2013 respectively. Mr Murphy was the first American to take the helm of a business whose largest customer is the US Department of Defence (DoD), and Mr Nicholls was the highly respected CFO of Senior, where he had a reputation for cost cutting and attention to detail. Whilst Cobham has made some progress under their stewardship, the past three years have also been turbulent for the company. Here we stand in 2016; a year which has seen the company profit warn, require a £500m rights issue and the CFO resign. To cap it off, it was announced last Wednesday that Mr Murphy is to leave the company in order to ‘pursue other opportunities’, ending months of speculation over whether he would remain as CEO. So what has gone wrong and what does this change in management mean for the company?

The rise of the activists

A look at the impact of activist investors on the Aerospace and Defence sector

Last week it emerged that the activist investor, Elliott Capital Advisors, now holds a 5% stake in Meggitt. This makes Meggitt the third European Aerospace & Defence company to have such an investor on its shareholder register and it led me to ponder what is driving these activists? Why the interest in Aerospace and Defence? And what are they trying to achieve?

Common sense in UK defence?

The UK MOD is to buy its new fleet of Apaches directly from Boeing

In my blog last week I highlighted the calamitous processes, and often illogical decisions that characterise defence procurement. However, the announcement during the Farnborough Air Show that the MOD will buy 50 AH-64E Apache Guardian helicopters from Boeing may well be turn out to be one of the Ministry of Defence’s (MOD) most sensible decisions yet.

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.

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?

What do amazon drones and BMX bikes have in common?

How civilian technologies are leading the defence industry

What do Amazon drones and BMX bikes have in common? The answer – the use of cutting edge ‘sense and avoidance’ technology, developed by the civil aerospace industry. Traditionally in the A&D sector, pioneering technologies were developed by the defence industry (funded at least in part by Government customers) and then used in the civil aerospace industry. However, as Governments looks to rein their spending, companies are developing new technologies for civil applications, which will then in time be used in the military sphere. The use of ‘sense and avoid’ technology by Amazon to step up its drone tests, and by British BMX cyclists in preparation for next week’s Olympics are timely examples of this.

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.

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!

Full speed ahead for Successor

UK's nuclear deterrent looks assured with May as PM

On Wednesday evening, Theresa May was asked to write her orders for how the military should react in the event of nuclear war. Not exactly the easiest first few hours in a new job and probably cause for a sleepless night. However, the executives at the top of the UK defence industry will probably have slept a little more soundly as the future of Trident finally looks secure under her leadership.

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

Can aerospace & defence weather Brexit

Impact of lower GDP growth on the aerospace & defence industry

I am a firm believer that GDP growth is the most important driver behind the health of the aerospace & defence sector. A strong economy increases people’s propensity to travel, and defence budgets are set as a percentage of GDP. I acknowledge that the two sides of the sector are both affected by a number of other factors (the oil price, new technologies, geopolitical tensions, etc) and both industries are global. However, the Treasury’s projection that in two years’ time UK GDP will be 3.6% lower than if we had remained in the EU forces me to pause for thought as to the possible impact of Brexit on the sector over the long term.