Profits complicate defense contractors' case against sequester

The largest defense contractors have shielded their bottom lines from the sequester.

Defense firms are boosting their profits despite the automatic spending cuts by laying off workers, cutting facilities, buying back stock and taking advantage of prior-year contracts.

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Lockheed Martin and Boeing this week both notched double-digit upswings in their quarterly profits from last year.

Revenues dipped at Lockheed, Northrop Grumman and General Dynamics, but their profits were up.

Since sequestration took effect on March 1, Lockheed’s shares have increased 53 percent to $134, while Boeing’s stock has risen 73 percent to $131, partly on the strength of its commercial sales. The Dow Jones has increased 11 percent in the same time frame.

Experts agree the cuts will have an increasingly large impact in the coming years; the sequester will take a $20 billion bite from the Pentagon in January.

But for now, the cuts aren't hitting contractors’ bottom lines, which makes their case for ending the sequester a tougher sell.

“This divergence between sales and profits is typical of the final stage in a defense build-up,” said Loren Thompson, a defense analyst at the Lexington Institute who consults with several defense firms. 


“It’s the point at which the customer’s spending has started declining, but the companies are still booking profits from better times. But the implication is that eventually the profits will follow the revenues down,” he said.

Defense analysts say there are a several reasons why the sequester isn’t taking a bigger bite out of defense profits right now.

One factor is that the firms knew the cuts were coming as the end of the wars in Iraq and Afghanistan neared and were ready for them.

Lockheed Martin, for instance, has cut its workforce 30 percent over the last several years, from 146,000 employees to 116,000.

The company has also slimmed down, cutting 1.5 million square feet from its facilities — with plans to reduce another 2.9 million square feet by the end of 2014, Lockheed spokeswoman Jennifer Allen said.

Layoffs across the defense and aerospace industry have jumped to 28,000 this year, compared to 15,900 at the same point in 2012, according to research from Challenger, Gray & Christmas, a firm that tracks employment trends.

Defense companies have also piled up on cash reserves and bought back considerable amounts of stock to keep their earnings-per-share up.

“Unlike most of the other sectors, this has been going on for awhile, and these companies have essentially been able to cut costs, streamline, frankly downsize in some cases, but they are managing very well.” Marion Blakey, CEO of the Aerospace Industries Association (AIA), said in a Bloomberg Television interview Tuesday. “There's a limit though if in fact the kind of cuts that sequestration requires continue to roll on top of us.”

In the next year or two, the cuts will have a direct impact, analysts say, because defense contracts have lag time built in.

“Nobody expects the defense industry is going to be as profitable in five years as it is today if the current reduction continues,” Thompson said.

Sequestration cut the Pentagon’s budget by $37 billion in 2013, and would prompt another $20 billion reduction in January.

The problem for the industry is that its profits have hampered its ability to convince Congress to reverse sequestration after defense executives warned the cuts would be devastating right away.

“The marketing campaign that industry used last year to try to scare people out of sequestration backfired because it got the immediacy of the impacts wrong,” said Todd Harrison, a defense analyst at the Center for Strategic and Budgetary Assessments.

“They communicated immediacy in the impact and the impact is not immediate,” he said. “I think that’s left a lot of people thinking, ‘Hey, you cried wolf.’”