General Dynamics Embarks on a Long, and Lucrative, Underwater Mission

Markets Motley Fool

It has begun -- the program that could blow a hole in the U.S. Navy's shipbuilding budget for years to come. The effort to replace the entire U.S. strategic, nuclear-missile armed, nuclear-powered "SSBN" fleet with a new fleet of Columbia-class nuclear missile submarines.

Continue Reading Below

Here's what you need to know about it.

The price of (nuclear) security

The news broke last week when the Pentagon's daily digest of contract awards to defense contractors included a bombshell announcement. One single contract issued to military shipbuilder General Dynamics (NYSE: GD) would consume 78% of the funds allocated that Thursday -- a monster $5.07 billion contract award to have General Dynamics design the new Columbia-class of nuclear missile submarines, designed to replace the Navy's aging Ohio-class "boomers."

As the Pentagon explained in its announcement, General Dynamics' "Electric Boat" subsidiary has been awarded a "cost-plus-incentive-fee with special incentives contract" to perform "design completion ... component and technology development, missile tube module and reactor compartment bulkhead prototyping and manufacturing" work on the USS Columbia. As you might expect, the prototype submarine -- the first in a family of nuclear missile submarines that could eventually swell to a dozen boats -- is expected to be the most expensive. Some experts estimate the first submarine of the new class could cost as much as $13 billion to design and build, roughly the price of an aircraft carrier.

That sounds like bad news for taxpayers. But for taxpayers who also invest in the stocks of General Dynamics and Huntington Ingalls (NYSE: HII) -- America's two premier military shipbuilders, and the companies tasked with bringing the Columbia program to life -- it could be very good news indeed.

Continue Reading Below

How much will Columbia cost?

How good, you ask? According to the latest estimates out of the Government Accountability Office, building 12 Columbia-class nuke boats for the Navy will cost just over $100 billion -- $12.6 billion for research and development, plus a further $87.4 billion to buy the boats themselves. Amortizing the cost of the R&D work across the entire envisioned fleet, that works out to a per-submarine cost of $8.35 billion, or about 26% higher than the Navy's earlier, optimistic estimates.

Again, this sounds like a lot of money -- because it is. And yet, if submarine-borne nuclear missiles are to remain the third leg of the U.S. nuclear strategic deterrence "triad," this is an expense that must be borne. As the GAO explains in a recent report to Congress, the Navy's Ohio-class SSBNs are aging, and will "begin to retire in 2027." That means that unless the U.S. is willing to accept a gap in its nuclear deterrence, we have less than a decade to get a new fleet of nuke-boats built.

Current plans call for detailed design work to begin with General Dynamics' contract this year and proceed toward laying a keel on USS Columbia in 2021, floating that boat in 2028, and putting it into service in 2030. Construction of the rest of the fleet would proceed apace over the course of about 20 years, with each new SSBN taking about 70 months to complete (i.e. once up and running, several boats would be in various stages of construction at any given time).

What it means for investors

From an investor's perspective, here's what that means: Money. Big money, with multiple contracts for multiple $8.4 billion-boats ongoing at any given time -- and over a 20-year timespan. Simply put, assuming all goes well with the prototype, General Dynamics, and its partner in producing the Columbia fleet, Huntington Ingalls, should be swimming in oceans of taxpayer money for the next two decades at least.

With the Columbia program in full swing, Huntington Ingalls' Newport News Shipbuilding division should remain the company's largest business division for years to come. Meanwhile at General Dynamics, "Marine Systems" -- currently GD's second smallest division -- could swell in importance. (And if more business and more scale of production help to lift Marine Systems out of its current last place in earning profit margins at GD, so much the better).

Another likely winner, albeit on a much smaller scale, will be Lockheed Martin (NYSE: LMT), which has lately been racking up a series of smaller contracts for work on the Columbia-class submarines' Trident II (D5) nuclear missiles.

Finally, don't take your eye off of Britain's BAE Systems (NASDAQOTH: BAESY). In addition to winning smallish contracts to work on the Trident systems for the U.S. Navy's Columbia-class submarines, BAE is also one of the three main contractors working on Britain's new "Successor" class of SSBNs, which will be sharing a lot of technology with the Columbia class. With "only" $36 billion up for grabs in the Successor program, and three main contractors splitting the work, BAE's opportunity is somewhat less than what investors will see at GD and Huntington Ingalls.

But it's still a substantial opportunity.

10 stocks we like better than Wal-Mart
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, the Motley Fool Stock Advisor, has tripled the market.* 

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Wal-Mart wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of September 5, 2017
The author(s) may have a position in any stocks mentioned.

 

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.