Two years ago, the U.S. Navy issued a challenge: Faced with the spiraling cost of -- and incessant delays in -- building new warships, the Navy asked its defense contractors to propose a new design for amphibious warships to carry Marines into battle. Furthermore, these contractors were asked to keep their budgets close to $100 million per ship -- and deliver the fleet to the Navy in record time: Just six years start to finish.
It was an ambitious project for the Pentagon...and it proved a bridge too far.
A good plan...
As first envisaged, the Navy's new Light Amphibious Warship (LAW) would bend the definition of the term "warship" almost to breaking. Measuring as little as 200 feet stem to stern and displacing as few as 1,000 tons (although some designs are bigger), each LAW would seem like a dinghy if placed next to the 1,100-foot bulk and 100,000 ton-displacement of a Ford-class aircraft carrier.
Furthermore, the LAW will act more like an armed transport than a warship, per se. Armed only with a handful of chain and machine guns, the ship's primary purpose is to shuttle reinforced Marine platoons of 75 persons between islands in the South China Sea.
...runs into some difficulties
And yet, as time has gone on, the Navy's wish list for LAW has gotten bigger -- and so have contractors' estimated price tags. One potential LAW design has the ship measuring twice the minimum estimated size -- and at 150% to 200% of the desired cost. As a recent report from the Congressional Research Service (CRS) relates, the Navy's fiscal-year 2023 budget request anticipated building the first of up to 35 LAWs for $247 million, the second for $203 million, and the third and fourth for about $145 million each.
Thus, a 35-ship LAW fleet that might originally have been purchased for $3.5 billion is now quickly approaching $5.2 billion in total estimated cost.
And even these figures may be out of reach. A 2022 USNI report cautioned that the Marine Corps is actually pushing for the average cost of the LAW fleet to be $150 million, while the Navy wants Congress to authorize funds to spend $300 million per ship.
Goodbye, $3.5 billion. Hello, $10.5 billion.
What it seems to mean for investors
Now, depending on how you look at it, that might sound like good news for (at least one of) the four companies in the running to win the LAW contract: Privately owned Bollinger Shipyards and TAI Engineers, Australian shipbuilder Austal, and Italian shipbuilder and longtime Lockheed Martin (LMT 1.23%) partner Fincantieri. A higher price tag on the ships, after all, should mean more revenue for whichever company wins the contract to build the ships -- except for one thing.
If you're familiar with the history of defense contracts in the United States (see the B-2 bomber, for example), you can probably guess what happened next. "The Navy had previously envisioned procuring the first LAW in FY2023, but the Navy's FY2023 budget submission defers the procurement of the first LAW to FY2025," as CRS put it.
Citing questions of the LAW's "viability" (i.e., both its usefulness for its intended purpose and survivability in combat) and also its cost (potentially three times what it was supposed to cost), it now appears the Navy will at least postpone buying LAWs for a couple of years. Potentially, the entire program could be scrapped. As CRS observes, "dozens" of "existing Army watercraft known as Logistics Support Vessels (LSVs) ... have similar capabilities to those required of the LAW" -- such that it's possible the Navy might not need to buy any new ships at all!
What it really means for investors
So should investors abandon all hope that the LAW contract will actually be awarded -- and abandon ship on defense stocks? Not necessarily.
The thing about defense budgets is that if the money isn't spent on one thing, it will almost certainly be spent on something different. Even if the LAW contract never sees the light of day (and right now, I'd bet it won't), the money will still get spent -- just on other ships, built by other companies.
In fact, if you think about it, removing Bollinger, TAI, Austal, and Fincantieri from the mix could well mean more Navy money going to bigger naval shipbuilders like General Dynamics (GD 1.35%) and Huntington Ingalls (HII 0.05%), who were shut out of the LAW competition. Huntington in particular -- the Navy's traditional builder of amphibious assault ships like the LAW -- looks both attractively positioned to benefit from any Navy decision to build something else and also attractively valued at a P/E ratio of only 15. That's an expected growth rate of 22% and a price-to-sales ratio of 0.8 (according to data from S&P Global Market Intelligence).
If I were to bet on one single defense stock most likely to benefit from the LAW contract being delayed, or canceled, Huntington Ingalls would be it.
