The $500 Billion Push to Modernize the Nuclear Triad

On this segment of Industry Focus: Energy, The Motley Fool's Nick Sciple and Fool.com contributor Lou Whiteman discuss a Congressional Budget Office report that estimates the U.S. needs to invest nearly $500 billion to modernize its nuclear weapon systems. That includes new submarines, bombers, and rockets, as well as the systems that support them.

A full transcript follows the video.

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This video was recorded on Jan. 31, 2019.

Nick Sciple: When it comes to our nuclear arsenal, it's really reaching the end of its useful life. We're going to have to put some serious investment in to bring those resources up to date. What can you say about what needs to be done when it comes to our nuclear arsenal? How much money is going to need to be pumped into those resources?

Lou Whiteman: The big overriding themes -- and this applies here, and it applies, as we'll talk about later, to things we all know. The world is not getting safer. It's a dangerous place, and we do need weaponry. The second part is, we're now paying the price for the so-called Cold War dividend. When the Cold War ended, the United States was the only superpower. Not that the Pentagon spending went away, but we did go into a lull. And we're now using Cold War-era technology, competing with, in theory, a resurgent Russia, a resurgent China. And, yes, that means spending, that means modernization.

The CBO just updated a study on the triad. They determined almost $500 billion, $494 billion, needs to be spent in the next 10 years on nuclear triad modernization. That's up considerably, 20% or more, from their 2017 estimate. Part of that is, we have a road map for some of this spending. Part of it is, now, we're getting into the years where hopefully, those investments will be made. So, some of that increase was expected. But it's a massive amount, half $1 trillion is going to go into new bombers, new subs, new rockets, new warheads to put on them, plus all the support. It's a huge area. The details, some of them have to be worked out, but it's almost guaranteed revenue for some of these companies, the lucky winners of these, because it's a huge priority for the United States.

Sciple: Lou, you alluded to this, and I should have asked you this off the top -- for our listeners who may not be familiar, can you talk about what the nuclear triad is? What does it mean when we say the nuclear triad?

Whiteman: Sure. There's three ways that we deliver nuclear weapons. We have our missiles, we have bombers, and then we have our submarines, which is perhaps the most important, because that's the deterrent. It's a grim Cold War tale, but the idea was, we needed to be able to launch, and we also needed to be ready for the event that we were surprised. And even if the homeland was decimated, if there's a submarine out there that can quickly respond, that's the best deterrent against launching into the United States.

It's the formula that's still in place. There's some debate about some parts of it, but this is how we defend the country. This is how we think of nuclear weapons. And all of our equipment is getting old. It's time for renewal. These are big-ticket items, unfortunately for the United States' spending.

Sciple: Let's talk about some of these items. Northrop Grumman is developing a new bomber, the B-21. The number that I saw is, between now and 2028, the Pentagon is expected to spend $49 billion on that program. Can you talk about the significance of that aircraft for Northrop Grumman, as well as for our defense arsenal as a country?

Whiteman: That's the keystone project for Northrop Grumman. They won that bomber. It's been a slow road. Of all the parts of the triad, that's probably the most controversial simply because, even though it's stealth, with technology, it's increasingly hard to get a bomber in place over an enemy in a war zone.

This is a huge expense. They're doing their best to modernize it. It's replacing an aircraft that isn't that old, the stealth bomber from our youth, in part because there's a feeling they did not forward-proof that enough. The downside, is they are trying to forward proof this one, but it's incredibly expensive. This a plane that's going to be a significant portion of Northrop Grumman's revenue for the years to come. There's a set number in place. The Air Force, if anything, says we need more of those. The Air Force is trying to expand its fleet in both attackers and bombers. There's no way this going to be cut completely.

There is a little bit of long-term risk to Northrop, though, if this project will ever be what they hope it will be, which is over $50 billion, a monster that's a huge portion of the revenue well into the next decade.

Sciple: Let's talk about another monster program, and that's the new submarines that are being developed currently, the Columbia-class sub under development. The numbers I saw there is that there are 12 subs planned at a cost of $107 billion over the next 10 years. Again, same as for the bomber, can you talk about the importance of that program both for the defense contractors who are developing it as well as for our defense capabilities?

Whiteman: Naval is a big part of the bull story on General Dynamics. They're not as exposed to some of this aerospace, and they're not as big on space as some of the other contractors. They have a lot of Army land gear, which, while modernizing, isn't as sexy and doesn't tend to be as big-ticket as the submarines or aircraft.

This is out of General Dynamics' Electric Boat subsidiary. They're working with Huntington Ingalls. That's our nuclear carrier contractor. They'll get some revenue here, too. This is a boat that, as I said, is designed to be the deterrent. This the reason why a foreign power does not want to attack the United States. Even if they work, even if they get the sneak on us, there are these state-of-the-art submarines out there with brand-new warheads that can fire back. There is, again, some debate over how many we need. A lot of the numbers, the dozen or so, is based on Cold War planning. These are better submarines. However, you do want them patrolling the whole ocean. I would be shocked if we don't get a full allotment of this.

General Dynamics has had a lot of things going not their way in recent years. Columbia-class is early. It's not really a contributor to earnings right now. But, again, if you look out a few years, one of the reasons why General Dynamics works as an investment is that the Columbia-class, as it matures, is going to see margins. It's a priority, we're not going to see it cut back, and there's pretty reliable revenue streams out of that going out a long time. In the investing world, you don't get that with many sectors.

Sciple: You said full set. When we're talking about that, how big or small is that relative to the dozen that we're talking about?

Whiteman: Oh, I meant the dozen. Some of the Navy would like to see more. I'd be surprised with that. There's an outside chance you might see that shaved, but that would be in the out year of this decade we're talking about. If there's risk to that program, you have to go out nearly a decade to find it. I think that's a pretty reliable program for General Dynamics, as far as we can reasonably look out.

Sciple: Sure. To close out the triangle of the nuclear triad, let's talk about what is being developed when it comes to our missile capabilities. Currently, Boeing's Minuteman is the only operational ICBM in the arsenal. There's a priority to come up with a new delivery vehicle, or at least new options for how we can deliver our warheads. Can you talk about what's going on when it comes to that program, and what companies are involved?

Whiteman: Sure. The Minuteman, it's been modernized, but this, again, a 1960s rocket that we're using. Due to treaties and due to cost cuts, we used to have a number of ICBMs, now we don't. The Minuteman is our go-to rocket. It needs to be replaced. That's the only part of this triad that we don't know who the eventual winner is. It's going to be a big deal for either Northrop or Boeing. Right now, Northrop and Boeing each have about $300 million to develop their model. It's going to be an old-fashioned bake-off for a very large deal. Northrop spent $10 billion to buy Orbital Sciences in part for this in particular. There's a lot that they'd like to do in space, and space is definitely an area that they think they're going to see growth in.

But the Minuteman, the ability to offer the whole package, for Northrop, which doesn't have Boeing's commercial exposure and which does have some programs -- it does have the B-21 -- this would be a very big win for Northrop. This almost would justify the Orbital Sciences deal or not. They want it. Boeing definitely wants it, too. It's going to be very interesting. It's not going to come this year, but it's going to be very interesting to watch this. You don't get this big of a contract coming up very often, and we don't have a lot of them on the horizon right now.

Sciple: Across this nuclear triad, the takeaway for investors is, there's a lot of money on the table up for grabs. It's something that's key to our defense arsenal coming into the future, so we're going to have to spend the money on it sooner or later. Definitely going to be a bullish sign for these defense contractors going forward.

Whiteman: Exactly right. You can maybe wonder about individual quarters and exact timing, but over the long haul, if you're a long-term investor, this is pretty close to guaranteed, that these programs are going to be invested in, and this is revenue that's going to be coming in.