Fired from a Paladin self-propelled howitzer, Raytheon's new M982 Excalibur munition is a 155 mm "smart" howitzer round that can strike targets 30 miles away -- and with unparalleled accuracy. According to Raytheon, in recent test-firings, 90% of Excalibur rounds fired landed within two meters of their targets. When you consider that the average "dumb" howitzer round aims to hit within 267 meters of its target, that's more than 100-times improvement in accuracy.
Armed with Excalibur, the Army's Paladins can travel farther, carrying less ammunition, and requiring shorter supply chains to support them. They can destroy more targets, more accurately, than just about any other weapons system in the U.S. Army's arsenal. But Excalibur does have one small drawback ...
These magic bullets cost $70,000 each.
Accuracy versus economy
That's not necessarily a fatal flaw. At $1,000 a pop, "dumb" howitzer rounds cost 1/70th what Excalibur costs. But in terms of dollars spent versus targets destroyed, "smart" Excaliburs are still about two-times cheaper than their less savvy counterparts.
But even so, the Army has been looking for a cheaper alternative -- and may have found it in a new product from Orbital ATK (NYSE:OA).
PGK looks A-OK
Orbital ATK produces an add-on Precision Guidance "Kit" (PGK) that can be attached to a dumb howitzer round to smarten it up. Dubbed the "XM1156," Orbital's kit recently won a $54 million order for 4,002 M1156 PGKs from the Australian Army. That works out to roughly $13,500 per kit, or an 80% discount to the cost of Raytheon's Excalibur.
Granted, PGK isn't as accurate as Excalibur. Recent test firings showed PGK-guided rounds falling within about 21 meters of their target when fired from 15 miles away. Thus, while a vast improvement over traditional dumb artillery rounds, PGK is still both shorter-range, and less accurate, than Excalibur. But between the cost savings, and the still-significant improvement in accuracy, it's possible that Orbital ATK will win some business for PGK.
Speak of the devil
And in fact, they have won some business. Last week, the Pentagon announced a new order for PGK kits -- an order more than twice the size of Australia's buy. Valued at $119.8 million, the Army's exercise of an "option" on the original August 2013 contract instructs Orbital ATK to supply PGK kits for both the U.S. Army and U.S. Marine Corps, plus additional kits for Canada, and more PGKs for the Australians as well. So apparently, PGK is getting even more popular Down Under.
This could be crucial for Orbital ATK. As website Defense Industry Daily points out, the U.S. Army ordered 403 of Raytheon's Excalibur rounds for $28.7 million in July, and apparently planned to reduce purchases of Orbital ATK's PGK in tandem. As the website pointed out, "the quantity reductions risk increasing costs" by denying Orbital ATK the ability to produce PGK in volume. Conversely, by instructing Raytheon to ramp Excalibur production, the Army would be helping Raytheon attain efficiencies of scale on its competing weapons system.
What it means to investors
From an investor's perspective, this looks a lot like a "race for scale" between two weapons designed to perform much the same mission. At the same time as Raytheon tries to win orders to ramp production of its hyper-accurate Excalibur, and bring that weapon's price down, Orbital ATK must try to expand production -- just to maintain the cost advantage it currently enjoys. As we all know, the low cost provider tends to have a huge advantage in such races.
Who will win this particular race? As of last year, DI Daily was still giving the advantage to Raytheon based on last year's Excalibur buy and the continuing decline in Excalibur's unit cost. The Army's doubling down on PGK last week, however, seems to shift the advantage back in Orbital ATK's favor.
That's good news for investors, who can't help but notice that at $120 million, Orbital ATK's new contract gives the newly merged aerospace and defense company an immediate revenue bump worth nearly 3% of the company's annual sales. The more such sales Orbital ATK makes, the cheaper its PGK kit will become -- and the greater its cost advantage over Raytheon's Excalibur.
In contrast, Raytheon is much larger than Orbital ATK. According to S&P Capital IQ, Raytheon's Missile Systems division alone, which makes Excalibur, does $6 billion in annual business -- more than all revenues from all parts of Orbital ATK combined. (And as a whole, Raytheon does more like $24 billion in business a year).
Result: Even at $70,000 a pop, it's hard for Excalibur sales to move the needle significantly at Raytheon -- certainly much harder than for a large contract win on PGK to boost Orbital ATK. If you're looking to place a bet on which of these two companies ultimately comes out "on top" in smart weapons, then Orbital ATK stock appears to be the one with the most potential upside.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 305 out of more than 75,000 rated members.
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