Defense Cuts? What Defense Cuts?

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On Capitol Hill, all talk these days involves cutting defense spending. But as reports this week, not all cuts run equally deep. As Boeing taught the U.S. Navy last year, by offering a 10% discount on several dozen F-18 fighter jets, sometimes you've got to spend money to save money.

Now, General Dynamics (NYSE: GD  ) and Lockheed Martin (NYSE: LMT  ) are reaping the benefits of a similar strategy. As you may recall from back in November, the two contractors gave Pentagon acquisitions specialists a happy surprise when they submitted their latest bids on the Navy's Littoral Combat Ship project. For the same price the Navy expected to pay to acquire 15 LCSes, the contractors would happily provide them with 20 instead.

Buying in bulk: It's not just for warehouse retailers anymore
The Pentagon's no dummy. Presented with a bargain, it jumped, ordering a full run of 10 LCSes from each contractor. What's more, as conflicts flare among littoral (coastal) states around the globe, including Tunisia, Egypt, Libya, and Somalia, the Pentagon is wasting no time buying littoral warships. Just three months after instructing General D, partner Austal USA, and Lockheed to begin work on the first two ships from the new order, this week, it ordered up two more.

And wouldn't you know it? The strategy seems to be working. In the Dec. 29 contract, Pengaton purchasers promised to pay a fixed price of $437 million to buy "LCS 5" from Lockheed, and $432 million for "LCS 6" from General D. The two latest buys, however, come at the bargain-basement prices of $377 million and $369 million, respectively.

What's it mean to investors?
For multibillion-dollar businesses like these, a few hundred mil won't move the needle much. But the companies are giving Pentagon buyers every incentive to keep buying. As manufacturing operations scale, they promise to bring the cost of Lockheed's vessel down to the point where it averages $362 million apiece (and $352 million for General D's LCS variant.)

When all's said and done, this should work out to roughly $3.6 billion in incremental revenue for the General, and $3.5 billion for Lockheed, as they work through the Pentagon's order book. And the best news of all? Once these ships are built, the Pentagon will still need another 19 LCSes to reach its targeted fleet strength of 55 vessels.

$3.6 billion here, $3.5 billion there … if the Pentagon "cuts spending" much more, Lockheed and General Dynamics shareholders will retire as millionaires.

Want to keep a closer eye on developments at your defense contracting stocks?

The Fool owns shares of General Dynamics and Lockheed Martin, but Fool contributor Rich Smith does not own shares of any company named above. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

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10/28/2016 4:01 PM
GD $151.50 Up +1.37 +0.91%
General Dynamics CAPS Rating: ****
LMT $248.00 Down -0.53 -0.21%
Lockheed Martin CAPS Rating: ****