Will the Navy Scuttle Shipbuilders?

According to an article in Tuesday's Washington Post, the war on terrorism has taken a toll on the U.S. Navy -- but not in the usual way wars do. Recent shifts in defense policy toward retooling the armed forces to fight terrorism and perform long-term peacekeeping missions, and away from fighting two-front wars against a communist superpower, have caused the Navy to propose a scale-back of its orders for new warships. Specifically, whereas the Navy has placed orders for nine new warships in 2005, its 2006 funding request will envision a more than 50% drop in ship orders to just four warships.

The problem is that America's six remaining shipyards are already working at only about half their full capacity. Cutting ship orders by half will make it economically infeasible for all six shipyards to remain open. This means that, realistically, one or more of these shipyards is going to have to close -- and the shipyards' owners, Northrop Grumman (NYSE: NOC) and General Dynamics (NYSE: GD), will have to lay off hundreds of workers.

The implications of the shipbuilding scale-back and likely shipyard closures are legion: Workers and their families must now anticipate layoffs. The two naval defense contractors will hope that more efficient production can offset the reduced revenues from fewer orders. Politicians in the shipyards' home states will feel compelled to oppose any closings in this election year (Sen. Olympia Snowe of Maine, home of General Dynamics' Bath Iron Works, and Sen. John Warner of Virginia, home of Northrop's Newport News Shipbuilding, are already on record against the Navy's proposed cuts).

But Foolish investors should look beyond the obvious implications for the shipyards, the shipbuilders, and their employees. General Dynamics and Northrop will not be the only companies to lose revenue as warship orders fall. There are plenty of other defense contractors that, while they may not build the actual ships, do derive a lot of revenue from arming the ships and equipping them with sophisticated electronics gear -- and will consequently suffer from having fewer ships to arm and equip. Think General Electric (NYSE: GE) and the engines it builds to power Navy destroyers. Think Lockheed Martin (NYSE: LMT) and its sales of computer systems and missiles to the Navy. Raytheon (NYSE: RTN) and its Tomahawk cruise missiles. Titan (NYSE: TTN) and Britain's BAE Systems (AMEX: BAE), both of which supply naval communications systems. Each of these contractors is likely to share General Dynamics' and Northrop's pain in the coming years.

The Motley Fool has written often on America's defense contractors and once recommended General Dynamics in its Motley Fool Select newsletter, a predecessor to Hidden Gems. For a sampling of Foolish writing on this industry, consider:

• Roger Nusbaum's assessment of Northrop's latest earnings results.
• Bill Mann's review of General Dynamics' numbers.
• Brian Gorman's report on Boeing's win of a new sub-hunting contract.
• Jeff Hwang's review of two other Boeing contracts.

Fool contributor Rich Smith has no ownership interest in any of the companies mentioned in this article.