The Pentagon has declared defense contractor employees to be "essential critical infrastructure workforce," clearing the way to allow contractors to keep operations running in areas that have shut down to battle the COVID-19 coronavirus pandemic.
Defense contractors have been hit along with the broader markets in recent weeks as the impact of the novel coronavirus has rippled through the economy. The SPADE Defense Index, a gauge of U.S. commercial aerospace and defense stocks, is down 41% in the last month.
In a statement Sunday, Defense Department spokesman Lt. Col. Mike Andrews said the Pentagon will "aggressively partner with the defense industry to mitigate impacts from COVID-19." The Department said it will raise progress payments to improve company cash flows, as well as accelerate payments to prime contractors so they can keep subcontractors liquid.
The Pentagon also pledged invoices will continue to get paid on time, and said it is working with the Small Business Administration on an emergency loan program for smaller contractors.
Is "essential" defensible?
The workforce comments are likely the most controversial statements, and it is unclear whether they are enforceable. The essential workforce language is a guidance only and would likely not override a state governor's declaration. Therefore, the announcement could add to uncertainty if a contractor tries to stay open in the face of a shutdown.
If nothing else, the Pentagon's memo should help defense contractors when making their pitch to state and local officials that they should remain open.
Practically, it might be hard for defense facilities in hard-hit areas to remain open despite the Pentagon's best efforts. Earlier this month Lockheed Martin (NYSE:LMT) halted production of the F-35 Joint Strike Fighter in Japan and told employees at an Italian facility to work from home due to concerns about COVID-19.
Ellen Lord, the Pentagon's Undersecretary of Defense for Acquisition and Sustainment, in a memo discussing the designation urged contractors to "follow guidance from the Centers for Disease Control and Prevention as well as State and local government officials regarding strategies to limit disease spread."
What does this mean for defense stocks?
The Pentagon can't step in and alleviate all of the potential issues that come with a pandemic, but the statement if nothing else is a clear signal that the Department is trying to stay out in front of potential issues, and is willing to work with the supply base to mitigate the potential impact.
Large prime contractors have ample resources to get through a slowdown, but Pentagon officials appear focused on ensuring there is no major disruption to the supply chain due to the virus. Many top suppliers to the primes, companies like TransDigm Group (NYSE:TDG), Spirit AeroSystems (NYSE:SPR), and Heico (NYSE:HEI), also have significant commercial aerospace exposure. That business has been hard hit by a dramatic decline in air travel demand.
With commercial aerospace potentially heading for an extended down cycle, the Pentagon is trying to make it clear to the companies and their creditors that the defense business will not dry up overnight as well.
For investors, the Pentagon's comments are unlikely to cause the stocks to rebound and surge higher. But it is a reminder that particularly on the defense side the pandemic impact, as bad as it might be, is transient.
We could be in for a couple of rough quarters, but the case for buying best-of-breed defense stocks is as valid today as it was at the beginning of the year.