Times are tough for the defense-related industries as the much-talked-about adverse effects of the defense budget cuts have finally started to become a reality. Let's take a quick look at the misfortunes encountered by defense contractor Lockheed Martin's (NYSE: LMT) F-35 program -- and what might come to its rescue.
The infamous fighter jet
The F-35 is expected to become the centerpiece of military forces in the U.S. and other countries. Lockheed Martin is supposed to develop 2,400 F-35s for the U.S. and other nations, helped by industry peers Northrop Grumman (NYSE: NOC), accounting for nearly 25% of the F-35 program, and UK-based BAE Systems, which accounts for 17%. But that's where the good news ends.
Into bad weather
With the Pentagon slashing a considerable part of the defense budget, the postponement of its decision to purchase the Lockheed F-35 jets over a span of five years will lead to significant savings to the tune of $15.1 billion. At the same time, it spells doom for Lockheed. And the company's troubles don't end there.
In 2002, Italy placed an order with Lockheed Martin to buy 131 F-35s, which were expected to be delivered by 2018. However, last month, the country decided to trim this order by about 40 aircraft. Italy is planning to cut down on its defense-related investments as a part of its austerity measures to counter the prevailing tight economic conditions. The 30% cut in the order is sure to pinch Lockheed's top line.
More pain for the company?
The order cut poses a dual problem for Lockheed Martin. One, its revenue growth looks questionable. Two, the company cannot make bulk purchases of its supplies. This inevitably means Lockheed's cost of production will rise sharply, making its products more expensive. In fact, the cost of this program has now increased to $385 billion from $233 billion earlier, and it may go up even further.
Possible fallout of the cost increase: Japan may consider canceling its multibillion dollar order for 42 F-35s if it faces price hikes and delivery delays. Potentially damaging? Yes.
Silver lining
Lockheed Martin is definitely in big trouble, but not out of options yet. With Norway planning to acquire around 50 F-35 jets, there is a glimmer of hope. Lockheed is also looking to bridge the "F-35 gap" by strategically focusing on bigger sales from international operations and increased service revenue (primarily from the information systems division, as well as training and consulting revenues). While the efforts seem encouraging, they have yet to crystallize. Until then, I would prefer to watch this company from a distance.
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