The Navy's Path to 355 Ships Won't Be Easy
The U.S. Navy has rolled out a detailed analysis of how it intends to grow the fleet to 355 ships over the next two decades, a goal of Pentagon leaders and military planners that has been embraced by the White House. The plan makes the case for why the fleet has to grow from its prior target size of 308 vessels but also makes clear how challenging it will be to get to that higher number.
Chief of Naval Operations Adm. John M. Richardson, in a report to Congress outlining the long-range plan for ship construction, said the current fleet, which today is barely half of what the Navy floated in the Cold War era, needs to grow as part of the Pentagon's focus on major power threats like China or Russia. He stressed the need to balance growth with fiscal responsibility and the importance of sustaining a healthy industrial base to support operations.
"The dynamic threat environment continues to drive creative, adaptable capability development, new operational concepts, and alternative force structure composition," the report says. "The shipbuilding plan realistically supports this dynamic environment and reflects the unwavering imperative to remain fiscally balanced."
The plan, which calls for the Navy to hit 314 ships by fiscal 2024 and then accelerate to 355 ships by 2034, is far from set in stone. Richardson, in budget discussions, has stressed the need for the Navy to adapt to new technologies, including the possibility of autonomous ships that would be more affordable to operate.
But if nothing else, the plan offers investors insight into the Navy's thinking and lays out the opportunity for shipbuilders including Huntington Ingalls (NYSE: HII) and General Dynamics (NYSE: GD).
More boats with longer lives
The Navy anticipates spending more than $100 billion on new ship procurement through fiscal 2024, taking delivery of 55 ships during that time period. About half of the total will be spent on ballistic and attack submarines, with work on two new aircraft carriers also included in that total.
Over the next two decades, those big-ticket new vessels will largely replace older ships, with the overall number of carriers and subs expected to remain relatively flat between 2020 and 2034. The growth will mostly come from large and small surface combatants, including the Navy's mainstay Arleigh Burke-class destroyers and smaller attack vessels including the littoral combat ship and a proposed new frigate.
The Navy's projected battle force inventory anticipates the number of large combatants in the fleet growing by 24% to 117 by 2034, while the fleet of smaller combatants would grow by 73% to 53.
The destroyers, like the subs, are made by both General Dynamics and Huntington Ingalls, with Huntington Ingalls also the nation's sole aircraft carrier builder. The next-generation frigate is still up for grabs, with GD, Huntington, and current small warship builders Austal (NASDAQOTH: AUTLY) of Australia and Italian firm Fincantieri, partnered with Lockheed Martin, all expected to be involved in the competition.
The Navy is also hoping to extend the service lives of certain ships including Ohio-class submarines and Arleigh Burke destroyers to help reach the 355-ship goal. If so, that would add maintenance revenue to the coffers of the major shipbuilders and potentially to commercial yards as well.
Operating costs could sink the plan
Ships are expensive to build but even more costly to operate due to the personnel, maintenance, and resources they consume. As a rule of thumb, military planners assume 30% of a ship's cost is procurement and 70% is operations and sustainment, so a ship that costs $1 billion to buy would cost $3.3 billion over its lifetime to own.
The Navy estimates the sustainment cost of a 314 fleet Navy in 2024 to be $30 billion annually in today's dollars. By 2034, the fleet is expected to be 13% higher, at 355 ships, but the estimated cost to sustain the fleet grows by 32% to nearly $40 billion. And that's before extra costs including ordnance, training costs, and extras such as aircraft for carriers.
The service is concerned that lawmakers will underestimate this cost when coming up with purchasing plans.
"Because the Navy has been shrinking not growing, and because of the disconnected timespan from purchase to delivery...there is risk of underestimating the aggregate sustainment costs looming over the horizon that must now be carefully considered in fiscal forecasting," according to the report.
While sustainment costs can be an argument against a bigger fleet, it can be an argument for newer ships and continued purchases. For example, the Navy said the current generation Ford aircraft carrier was designed to reduce the sustainment costs of the last-generation Nimitz carriers by $100 million annually, resulting in more than $4 billion in savings over the life of the ship.
Keeping the shipyards open
The Navy has other reasons to boost spending. Over the past 60 years, 14 defense-related new construction shipyards have closed and another three have left the defense industry, while only one new shipyard has opened.
Eight of those yards closed or stopped doing military business during the post-Cold War drawdown.
Shipbuilding since World War II has been a boom/bust business, with large buildups in the 1950s and 1980s, followed by periods of little production in which yards suffered. The "boom" periods have also complicated Naval efforts to manage the fleet, as vessel service lives tend to be clumped together based on the building surges and necessitate a new surge for replacement purposes.
Today, the Navy relies on just seven shipyards owned by four contractors. The Navy is worried about how much longer even this smaller base can be sustained without a commitment to increased buying.
"We are at a level of fragility that, without consistent and continuous commitment to steady acquisition profiles as proposed in this plan the industrial base will continue to struggle and some elements may not recover from another 'boom/bust' cycle," the report said.
The Navy sees fleet expansion as a way to ensure adequate funds go to the remaining military shipyards and potentially to entice some commercial shipyards such as the Mississippi operation of Singapore's ST Engineering and Philadelphia Shipyard Inc., which is owned by Aker ASA of Norway, to dabble in defense.
This is far from over
From the earliest days of the 355-ship talk, the obvious obstacle has been how to make that expansion affordable. Two years later, the Pentagon is no closer to solving that puzzle.
Investors should expect this plan to evolve over time. The Navy today is much closer to operating autonomous ships than it was just two years ago, and programs that seemed locked in like the San Antonio-class landing dock ships have now been pushed to the back burner. It's likely this construction plan and even the target number of ships will get numerous tweaks and edits over the decade to come.
But while the details are still vague, the Navy makes a compelling case for why the fleet must grow. And as the service lays out in its report, General Dynamics and Huntington Ingalls are well positioned to win significant additional procurement business in the years to come to make that growth happen.
I wouldn't bet on the Navy reaching 355 ships by 2034. Fortunately for investors, the shipbuilders should have ample growth opportunities regardless.
10 stocks we like better than General DynamicsWhen 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, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and General Dynamics wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of March 1, 2019
Lou Whiteman owns shares of General Dynamics. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.