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China's first aircraft carrier, the Liaoning (PLAN CV-16). Image source: Google Earth.

China has an aircraft carrier.

In fact, at the rate China is building aircraft carriers today, the Middle Kingdom could soon have two, three, or even four aircraft carriers in its fleet -- one of them nuclear. At the same time, U.S defense officials warn that China has begun taking steps to build "significantly" more nuclear-powered submarines for its fleet.

U.S. Pacific Command Admiral Samuel Locklear recently advised Congress on intelligence estimates that China will build five new "Type 094" nuclear-powered ballistic missile submarines during the next five years, each capable of carrying a round dozen Julang-2 long-range ballistic missiles. Estimates of Chinese intentions are in flux, but if correct, this would imply a build rate of one SSBN per year -- roughly triple the historical rate of production, and putting China on a path to nearly tripling the size of its SSBN fleet.

At the same time, other estimates speak of Chinese plans to build both a next-generation nuclear-powered fast-attack submarine, the "Type 095," and a second-generation SSBN, as well -- the "Type 096." If the exact ship types and ship counts are uncertain, however, one thing seems clear: China sure is building a lot of warships lately.

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China's Huludao naval base hosts nuke boats at top, and surface warships stacked up to the south. Image source: Google Earth.

Action, reaction
Spooked by China's growing ability to deploy naval warplanes over nearby seas, and submarines below them, Japan has asked the U.S. to help build two Aegis-equipped guided missile destroyers for air-defense and anti-submarine warfare roles. Congress was notified about the sale, which already had the green light from the State Department, by the Defense Security Cooperation Agency (DSCA) last month.

Pursuant to the rules laid down in Section 36(b) of the U.S. Arms Export Control Act, Congress had 15 calendar days to reject this sale (if it was so inclined). The deadline has passed, however, and the sale is now "a go." So what exactly is Japan buying, and how much will it cost them?

The details
According to DSCA's August 4 notification to Congress, Japan intends to build two new Aegis-equipped destroyers. Rounding out its existing fleet of six such vessels, the new warships will be designated DDG 7 and DDG 8. Japan is asking Lockheed Martin (NYSE: LMT) to help build them, and to provide and integrate:

  • two Mark 7 Aegis Weapon Systems
  • two MK 34 Gun Weapon Systems
  • two Vertical Launching Systems, and 24 missile launchers
  • surveillance and fire control radars needed for Aegis to operate
  • two Underwater Surveillance and Communication Systems and two Underwater Weapon Systems for submarine warfare
  • and a whole lot more

In total, Japan's shopping list stretches to 37 line items of equipment, all needed to turn its new guided missile destroyers into highly efficient killing machines. Total cost: $1.5 billion.

Who profits?
DSCA justified this sale to Congress by saying it represents "an important commitment by the U.S. Government in furtherance of foreign policy and national security goals for both the United States and Japan," and will help to ensure "peace and stability" in East Asia and the Western Pacific. Whether we agree or disagree that adding more warships to a region already armed to the teeth, what we really want to know as investors is, who gets the loot?

The answer is crystal clear. In an effort to control costs and streamline a project that will take perhaps seven years to complete, Japan has specifically requested Lockheed Martin serve as "sole source prime contractor" on this sale. DSCA notes that a "significant" number of other companies, including several from Japan, will contribute to the Aegis project -- but Lockheed Martin will lead it.

Profits-wise, this won't be a huge contributor for Lockheed Martin. According to the company's 10-K filings with the SEC, Lockheed Martin groups Aegis work under its Mission Systems and Training division. According to data from S&P Capital IQ, this is Lockheed's second smallest business unit, doing only $8.4 billion in revenues in 2014. It's also Lockheed's second least profitable division, earning an operating profit margin of just 10.1% last year.

Adding $1.5 billion in new revenues from Japan should go a long way toward fixing the first problem. Investors can only hope the new revenues come with better profit margins than usual.

Aegis
Lockheed boasts that aboard the USS Roosevelt (DDG 80), Aegis "seamlessly integrates the SPY-1 radar, the MK 41 Vertical Launching System, the SM-3 missile and the weapon system's command and control system." Next step -- integrating more profits into Lockheed Martin's income statement. Image source: Lockheed Martin.

Rich Smith does not own shares of, nor is he short, any company named above. You can find him on our public stock-picking service, Motley Fool CAPS, where he publicly pontificates under the handle TMFDitty -- and where he's currently ranked No. 269 out of more than 75,000 rated members.

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