The U.S. Military Just Doubled Its Purchases of Tomahawk Missiles. Here's Why

And more importantly, here's how much Raytheon stands to earn on these missile sales.

Jul 26, 2014 at 10:20AM

Now this is interesting.

As China ratchets up tensions in the South and East China Seas, and Russia goes from sponsoring aircraft-shooting-down separatists in Ukraine, to -- apparently -- instructing its own military to begin artillery shelling of its neighbor, the United States Congress has just announced it is doubling its order for new Tomahawk cruise missiles from Raytheon (NYSE:RTN).

Tomahawk Launch
Raytheon's Tomahawk cruise missile is one of the Navy's most popular weapons systems. Photo: Raytheon.

Last week, Britain's defense ministry confirmed that it has ordered 65 new Tomahawks for its Navy. Meanwhile, here in the U.S., military news website reports that the new fiscal year 2015 defense bill is sailing through Congress, loaded with $82 million in additional spending allocated to nearly double purchases of Tomahawk cruise missiles in the coming fiscal year. Previously, the Pentagon had been expected to receive 100 of these missiles. Now, the number is rocketing to 196.

To date, Raytheon says it has delivered more than 3,000 of the most advanced Tomahawk variant, the "Block IV," to the U.S. Navy. Launched from a U.S. warship at sea, the highly accurate, GPS-enabled precision weapon is capable of striking targets as far as 1,000 miles away -- and has been used 2,300 times in combat over its history. The weapon's long range gives the U.S. Navy an extraordinary ability to affect events around the globe, even if its actual ships are nowhere near the theater of operations.

And this begs the question: Why does the Navy suddenly think it's going to need twice as many Tomahawks as it previously planned to purchase? Is the Navy planning to actually use these weapons somewhere soon?

Maybe yes, but probably no
So far as we know, no, the plan is not to actually use these Tomahawks in combat any time soon. Rather, what's happening here is simply that Congress and the Navy are looking down the road, and noticing that Raytheon's Block IV Tomahawks are rapidly approaching the target date for recertification.

Raytheon began producing the Block IV line of Tomahawks in 2004. These missiles have a projected "shelf life" of 30 years. But at the halfway mark in their lifespan, they must undergo recertification to ensure they'll still work as designed if they do eventually need to be used. For the oldest Block IV Tomahawks, that halfway mark arrives in 2019.

Preparatory to this recertification effort, the Pentagon plans to suspend Tomahawk purchases in 2016 for a period of three years. (Once production resumes, it will be with new upgrades to the missile that improve Tomahawk's "lethality, guidance and ability to find and destroy moving targets," according to a Raytheon spokesman. To ensure that the Navy has enough missiles to meet its needs during the anticipated production downtime, therefore, Congress is authorizing additional funds to stock up.

What it means to investors
So in a nutshell: Don't expect any immediate "shock and awe" show of Tomahawks raining from the skies. But investors can still expect the Tomahawk program to "make it rain" for defense contractor Raytheon. Here's why.

The extra $82 million earmarked for additional Tomahawk purchases in 2015 is just the beginning. Maybe Raytheon won't be selling many new Tomahawks over the period from 2016 to 2019, while busy recertifying the missiles it's already produced and sold. But what Raytheon will be doing is booking hundreds of millions of dollars worth of revenue from upgrading the missiles it's already built.

Already, Congress plans to add $150 million in funding to install a new navigation and communications suite in Raytheon's Tomahawks as part of the recertification process. And Raytheon will get even more funds for recertification work on top of that.

A 2005 Pentagon contract, for example, shows that in a recent round of recertifications for Tomahawks, the Navy paid $29.3 million to recertify 150 All-Up-Round Tomahawk missiles. A 2008 contract for the recertification of 165 more AUR Tomahawks cost the Navy $33.9 million. In 2010 -- $33.5 million to recertify 148 Tomahawks, plus ancillary work.

All of this suggests that recertification of the Navy's entire Tomahawk arsenal, could be a project worth as much as $600 million to Raytheon -- and with the company earning 12.6% profit margins on these revenues, that's big news for Raytheon.

Keep up to date on all the biggest defense contracting news -- and find out how it relates to your investments. "Like" our defense news page today.

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The Tomahawk cruise missile: Even after it's been sold, it still makes money for Raytheon. Photo: Raytheon.


Rich Smith owns shares of Raytheon Company. The Motley Fool owns shares of Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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