Proposed Defense Budget For Fiscal 2016 Brings Cheer To Lockheed

President Obama has proposed a significant hike in the country’s defense budget for the fiscal year 2016, bringing cheer to major defense contractors such as Lockheed (NYSE:LMT) and Boeing (NYSE:BA). Over the past few years, as the government slashed its defense spending due to spending limits mandated by the Budget Control Act of 2011, overall contract volume fell for most defense contractors including Lockheed. However, if this latest defense budget proposal gets approved by Congress, then Lockheed could see its top line return to growth in the coming years.

We currently have a price estimate of $185 for Lockheed, which is slightly below its current market price.

See our complete analysis of Lockheed here

Proposed Budget Includes Large Hike In Weapons Procurement

The budget proposes an increase in the overall defense budget by about 4% to $585.2 billion in fiscal 2016, from $560.3 billion in the current fiscal year. However, the base defense budget in this overall budget has been proposed to grow at a much higher rate, as the allocation for overseas contingency operations (OCO) has been proposed to decline to $50.9 billion, from $64.2 billion. The decline in OCO was expected, as troops continue to withdraw from Afghanistan. After accounting for this decline in OCO, the base defense budget, which includes military personnel and procurement costs, has been proposed to grow by a whopping $38 billion or 7.7% in the fiscal year 2016. ^[1] A further breakdown of various items in the base defense budget shows that the military personnel budget is expected to rise by a modest 2%. So the real jump in the proposed base defense budget is being driven by weapons procurement, which has been proposed to grow by over 14%. ^[2] This sharp rise in weapons purchases would grow contract volume for defense companies. In line with this proposed defense budget, we are revising upward our forecast for contract spending by the Department of Defense (DoD).

If this budget is approved by Congress, the increase in weapons procurement will benefit Lockheed, which is the largest defense contractor of the U.S. government. Specifically, the defense budget for fiscal year 2016 proposes spending $10.6 billion on purchasing 57 F-35s. ^[2] Lockheed is the main contractor developing this fighter jet. The company produced and delivered 36 F-35s in 2014. ^[3] This should mean that Lockheed will be able to scale up production of the fighter jet in the next two years. Rising F-35 production volume will help grow Lockheed’s revenue and earnings. In addition, rising production volume will improve production efficiencies in the F-35 program, enabling Lockheed to lower the unit price of the F-35. Lower unit prices will in turn help bring more international orders, especially from countries that cut down their orders in the past due to the jet’s high price. Overall, the U.S. government’s rising budget allocation for the F-35 fighter jet will benefit Lockheed. Over the life of this program, the government is expected to buy over 2,400 F-35s.

In the coming weeks, Congress will debate this proposed budget. In our view, a higher defense budget could pass Congress, as the federal budget deficit has significantly declined over the last few years, from around $1.4 trillion in fiscal 2009 to under $500 billion in fiscal 2014. This lower budget deficit has provided the government more room to boost spending, including defense spending.

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1. Summary tables for the President’s 2016 budget proposal, February 2 2015, www.whitehouse.gov [↩]
2. DoD releases fiscal 2016 budget proposal, February 2 2015, www.defense.gov [↩] [↩]
3. Lockheed’s 2014 Q4 earnings transcript, January 27 2015, www.seekingalpha.com [↩]