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Lawmakers Sign Off on Major Navy Expansion, but All Bets Are Off Until They Find a Way to Pay for It

By Lou Whiteman - Dec 18, 2017 at 7:14AM

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There's desire among lawmakers to grow the Navy. But investors in shipbuilders could be in for a long wait before there's progress toward that goal.

Lawmakers have officially endorsed the idea of growing the Navy by 27%. But they haven't yet figured out a way to pay for that growth.

The 2018 National Defense Authorization Act, signed into law by President Trump on Dec. 12, included a provision calling for the country to boost the Naval fleet to 355 ships "as soon as practicable." The Navy currently deploys a fleet of 279 ships in the battle fleet, but Pentagon officials for years now have been calling for that number to increase so the Navy is better equipped to sustain its presence around the globe.

USS Ralph Johnson

The USS Ralph Johnson, an Arleigh Burke-class destroyer, undergoing sea trials from Huntington Ingalls' Mississippi shipyard. Image source: Huntington Ingalls.

"Building up our nation's fleet is essential to protecting our national security and projecting American power around the globe," Sen. Roger Wicker (R-Miss.), sponsor of the provision, said in a statement. "We are asking too few ships to do too many things, and today the president took a major step toward rectifying that problem."

A Navy buying binge would be welcome news for Huntington Ingalls (HII 1.37%) and General Dynamics (GD 2.64%), the two primary U.S. shipbuilders. Huntington is the rare non-diversified large defense contractor and has warned that it expects revenue to be flat through 2020 as it works through its existing order book. General Dynamics, meanwhile, has been bogged down by its Gulfstream commercial aerospace unit and would benefit from a spark at another business unit.

Funding plans still adrift

But the provision making the 355-ship fleet national policy was short on details, not allocating any money to the project or setting up any specific timeline for it to be accomplished. So far, despite Republican control of both Congress and the White House, lawmakers haven't been able to find a workaround to the 2011 Budget Control Act, which put a cap on defense spending, and growing the fleet was just one of a number of priorities the Pentagon set out for once sequestration is lifted.

President Trump campaigned on the idea of boosting the fleet but is expected to prioritize growing troop numbers and restocking missile supplies with any additional defense funding.

It seems unlikely that lawmakers will be willing to commit to the massive spending levels that would be required to make the 355-ship fleet happen.

The Congressional Budget Office has estimated that expanding the Navy to 350 vessels would cost more than $20 billion a year over the next 30 years. And according to a recent report from the Center for Strategic and International Studies, the base budget for the Navy has grown by nearly 50% from 1997 to 2015 even while the fleet size shrank by 20%, raising questions about whether it would be possible to operate a vastly expanded fleet even if all those new ships were built.

Reason to hold, not to buy

Even if the 355-ship goal is not a reason to run out and buy shipbuilder stocks, there is some good news here for company investors. Including the target numbers in the defense authorization act should help build momentum for growing the Navy.

There's a lot of money on the line. Huntington Ingalls and the marine systems unit of General Dynamics each have backlogs of between $22 billion and $25 billion, but for both companies unfunded orders comprise about one-third of the total. Having both Congress and the White House sign off on growing the Navy shrinks the risk that a portion of the order book won't be funded, helping to ensure that the shipyards will be busy for some time.

It seems clear new ships are coming to the Navy. But we're still a long way away from having those ship orders arrive at a rate that would supercharge shipbuilder stocks.

Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

General Dynamics Corporation Stock Quote
General Dynamics Corporation
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Huntington Ingalls Industries, Inc. Stock Quote
Huntington Ingalls Industries, Inc.
HII
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