On Tuesday, a Senate subcommittee approved a measure that would give the Pentagon $594 billion for fiscal 2014 but would put deep spending restrictions on Lockheed Martin's (NYSE:LMT) F-35 program. Here's what you need to know.
The reality of budget cuts
Sequestration may not be making the headlines it once was, but that doesn't mean it's not wreaking havoc on defense spending. In fact, subcommittee Chairman Sen. Dick Durbin, D-Ill, said about the recently passed measure:
We are crafting this support in a highly uncertain and tumultuous budget environment. We cannot continue like this. Across-the-board sequestration cuts are forcing us to play Whac-a-Mole with the defense budget.
And it appears that Lockheed's F-35s are the proverbial mole -- at least for 2015 procurements. The subcommittee approved the $98.4 billion needed to buy 29 F-35 fighters in 2014 but reduces "advanced procurement for fiscal year 2015." In other words, the money to continue ramp-up in production just isn't there. This is especially bad news for Lockheed, as it generates approximately 15% of its revenue from the F-35 program.
It's also bad news for Lockheed's main suppliers on the F-35 program, Northrop Grumman (NYSE:NOC), and United Technologies (NYSE:UTX), which, through their Pratt & Whitney subsidiary, build the engine for the F-35.
The silver lining
The good news is the proposed measure still has to be reconciled in the House before going to the president for his signature, so there's a chance the cuts won't take place. However, the measure is in line with the Obama administration's request, and the reality of sequestration. If the measure does pass, the good news is that it fully funds the Navy's $100 million request for 10 DDG-51 destroyers. This is great news for General Dynamics (NYSE:GD), which builds the Aegis destroyer through its Bath Iron Works shipbuilding company, and Huntington Ingalls Industries (NYSE:HII), which also builds the destroyer through its Ingalls Shipbuilding company -- the Navy typically buys ships from both builders.
What to watch
The reality is that without a resolution to across-the-board spending cuts, "essential" programs like the F-35 will feel the squeeze more and more. This will undoubtedly affect company profits and, in turn, could negatively impact stock prices. But, as I've written before, defense giants, like Lockheed, offer a service that is absolutely essential. As such, they'll be able to weather defense spending cuts -- even if it does cause more turbulence than most would prefer.