Budget deal leaves U.S. defense firms in limbo

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Published January 02, 2013

| Reuters

Shares in some major defense companies trailed the broad U.S. stock market on Wednesday as investors fretted that hiring and investment at weapons makers could remain slow until a longer-term fiscal solution is in place.

"Merely delaying sequestration by a couple of months will do little to resolve the uncertainty and chaos surrounding the defense budget," said Todd Harrison, an analyst at the private Center for Strategic and Budgetary Assessments.

Lockheed Martin Corp , the Pentagon's biggest supplier, said it hoped the last-ditch agreement to avoid the "fiscal cliff" would pave the way for the permanent elimination of automatic across-the-board cuts that it said would harm government programs and damage national security.

Until then, "there will be an overhang on our industry that stifles investment in plant, equipment, people, and future research and development essential to the future health of our industry," said Jennifer Whitlow, spokeswoman for the maker of F-35 fighter jets and Aegis missile defense systems.

Lockheed's shares rose 0.5 percent on the New York Stock Exchange, trailing the almost 2-percent gain in the overall Arca Defense Index and a 1.8-percent advance in the Standard & Poor's 500 Index .

The defense industry's biggest trade group, the Aerospace Industries Association, said a long-term solution was urgently needed.

"If sequestration is not solved in the next 57 days, it would be an abdication of responsibility by the leaders of this country, one that will only heighten Americans' cynicism and cement the public image of a gridlocked Washington that simply doesn't work," said the group's president, Marion Blakey.

Lockheed and other big arms manufacturers including Boeing Co and Northrop Grumman Corp have complained about the difficulty of running their businesses while facing the potential indiscriminate, automatic spending cuts.

Northrop Grumman shares rose by 0.3 percent on Wednesday while Boeing advanced 1.7 percent.

Blakey last week called the indiscriminate cuts required under sequestration a "mindless meat axe" and urged lawmakers to give the Pentagon more authority over any cuts required.

The 157-page deal reached on Tuesday to avert the "fiscal cliff" delayed $109 billion in spending cuts by two months and delayed the pain of tax hikes for almost all U.S. households, but left many larger issues unresolved.

The spending cuts, which had been slated to take effect on January 2, have been delayed until March 27, giving lawmakers time to debate how to come up with $1.2 trillion in deficit-reducing measures over the next decade.

Of the total cuts slated for fiscal year 2013, which ends September 30, $54.7 billion were to come from the Pentagon's budget, excluding military pay.

Loren Thompson, a Virginia-based defense consultant, said the last-minute agreement by lawmakers signaled that sequestration cuts were unlikely to be ever implemented as currently planned, although some additional cuts were likely.

"When the chips are down, the two parties can find common ground and that means sequestration is not going to happen the way it is currently mandated," Thompson said. "This is not just a reprieve for the defense industry, it's a signal that the worst aspects of sequestration are never going to occur."

Byron Callan, analyst with Capital Alpha Partners, said the deal meant weapons makers would face challenges in framing their financial guidance when they announce quarterly earnings later this month since lawmakers were unlikely to reach a final deal by the next deadline at the end of March.

"Defense spending absolutely will be part of the next debt ceiling/sequestration cliff debates," Callan wrote in a note to investors, noting that any reductions in the Pentagon budget agreed as part of a final solution could be even more disruptive since half the 2013 fiscal year would already be over.

The delay means the defense reductions are now slated to go into effect just when the U.S. Treasury runs out of the ability to borrow money, making for another cliff-hanger.

The deal also leaves unresolved whether the Pentagon would be given more flexibility in how its savings are achieved. The Pentagon has sought to prioritize rather than trim by the same percentage its more than 2,500 programs or projects. Getting more flexibility would require another act of Congress.

The existing law calls for stripping more than $500 billion from projected Pentagon spending levels over 10 years - on top of $487 billion in cuts already being wrung out under a deficit-reduction deal enacted into law in August 2011.

If the same level of security-related cuts were maintained under a future deficit-reduction deal, they would be crammed into the final half of the fiscal year that ends September 30, which could pose fresh challenges for Pentagon budget officials.

(Reporting by Jim Wolf and Andrea Shalal-Esa; editing by Ros Krasny and Phil Berlowitz)

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