July 27, 2011 – By Scott Malone
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BOSTON (Reuters) - Two top U.S. defense contractors posted sales that missed Wall Street's expectations on Wednesday in a sign that federal efforts to rein in military spending are starting to take a toll.
General Dynamics Corp <GD.N> and Northrop Grumman Corp <NOC.N> nonetheless managed to beat earnings expectations, reflecting their drive to scale back less-profitable businesses at a time of declining U.S. defense spending.
With lawmakers in Washington battling over how to cut the nation's deficit -- and whether to raise the debt ceiling or to allow the U.S. to slip into default -- defense contractors acknowledge their businesses will be in the cross-hairs in the coming years.
"Although it is not yet certain today how or when the debt ceiling is raised, it is clear that defense spending will play a role in helping to ease the country's economic challenges," said General Dynamics Chief Executive Jay Johnson, on a conference call with analysts.
He expects the heaviest cuts to the nation's defense spending to come in the second half of the current decade rather than in the next few years.
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Army General Martin Dempsey, the nominee to become the nation's top military officer warned a U.S. Senate panel on Tuesday that it would be "extraordinarily difficult" to cut $800 billion from the nation's defense budget.
That $800 billion cut represents a doubling of President Barack Obama's prior proposal that some in Congress have suggested as way to reduce the nation's $14.3 trillion debt.
Despite the weak revenue, both General Dynamics and Northrop raised their full-year profit forecasts, a day after the No. 1 Pentagon supplier, Lockheed Martin Corp <LMT.N>, did likewise.
"We are increasing our EPS guidance and maintaining our guidance for cash generation, despite a reduced top line outlook that reflects the realities of our current budget environment," said Wes Bush, CEO of Northrop, with businesses that include making unmanned spy planes.
Both companies' shares fell on a day that U.S. markets were broadly lower, spooked by the debt talks and worries of a slowing U.S. economy. General Dynamics shares were down 3 percent to $68.24 and Northrop fell 4.5 percent to $62.46. Both trade on the New York Stock Exchange.
Northrop raised its 2011 profit target to a range of $6.75 to $6.90 per share, which at its midpoint would represent an increase of a little under 1 percent from 2010. Its previous forecast implied a 2.5 percent drop. That move came even as it lowered its full-year sales forecast by 2 percent to $27 billion.
"While we think there will continue to be long-term margin pressure for defense names, Northrop continues to hold in well," wrote RBC Capital Markets analyst Robert Stallard, in a note to clients.
General Dynamics, which makes tanks, ships and Gulfstream jets, raised its full-year profit forecast to a range of $7.15 to $7.20 per share from continuing operations, representing growth of about 5 percent. Its prior forecast had implied growth of 3 percent.
Northrop has been moving to streamline its operations over the past year, and in March spun off its ship operations, citing little synergy with its other businesses that include drones and ballistic missile defense work. The spin-off created Huntington Ingalls Industries Inc <HII.N>.
Its second-quarter net profit fell 27 percent to $520 million, or $1.81 per share, compared with $711 million, or $2.34 per share, a year earlier, when Northrop recorded a large tax benefit.
Analysts, on average, had looked for profit of $1.68 per share, according to Thomson Reuters I/B/E/S.
Northrop reported revenue of $6.56 billion, down 9.6 percent and shy of the $6.98 billion analysts had expected.
General Dynamics' second-quarter net income was $653 million, or $1.76 per share, up less than 1 percent from $648 million, or $1.67 per share, a year earlier.
Factoring out one-time items, profit came to $1.79 per share, above the $1.72 that analysts had forecast.
Revenue fell 2.8 percent to $7.88 billion, below the $8.24 billion analysts had expected.
As of Tuesday's close, General Dynamics shares were little changed for the year, while Northrop had risen close to 11 percent. The Dow Jones U.S. defense index <.DJUSDN> was up 6 percent for the year, a slightly lower gain than the overall U.S. market as measured by the Standard & Poor's 500 index <.SPX>.
(Reporting by Scott Malone; Editing by Derek Caney and Tim Dobbyn)