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Inflation's Influence on Defense Budgets and Corporate Strategies

July 26, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • Robust Defense Budgets: Despite inflation, defense budgets remain strong with bipartisan support, ensuring continued funding for defense contractors.
  • Inflationary Pressures: Inflation has increased procurement costs and supply chain disruptions, adversely affecting profits and margins for defense companies.
  • Strategic Adjustments: Defense contractors are implementing strategic measures such as increasing production capacity, modernizing infrastructure, and collaborating with commercial partners to mitigate inflationary impacts.
  • International Demand: There is significant growth in international defense budgets, with notable contracts highlighting robust demand despite inflation.
  • Future Outlook: While the FY2025 Presidential Budget request suggests growth, some sectors like Space may see flat budgets, indicating a mixed outlook for the defense industry.

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Current State of Defense Budgets

Defense budgets are currently robust, with bipartisan support in Congress for maintaining or increasing spending levels. The U.S. government enacted a defense appropriations bill for FY 2024 totaling $825 billion, a 3% increase from FY 2023. Additionally, $844 billion was allocated to the U.S. Department of Defense.

"And as Congress is deliberating on that budget, we're encouraged in what we're seeing that there will be continued bipartisan support for defense spending at the President's budget level, if not higher. Yes. And on that, in your conversations on the Hill, do you" --- (NOC, conference, 2024/05/30)

"U.S. Budget Environment With approximately three quarters of our sales from the U.S. Government, U.S. Government spending levels, particularly defense spending, and timely funding thereof can affect our financial performance over the short and long term." --- (LMT, sec filing, 2024/Q2)

"On March 23, 2024, the U.S. government enacted a defense appropriations bill for the government’s FY 2024 totaling $825 billion, representing an increase of more than 3% over the enacted FY 2023 spending level." --- (GD, sec filing, 2024/Q1)

"Defense, Space & Security Overview The Consolidated Appropriations Act, 2024, and the Further Consolidated Appropriations Act, 2024, enacted in March 2024, provided fiscal year 2024 appropriations for government departments and agencies, including $844 billion for the United States Department of Defense (U.S. DoD) and $25 billion for the National Aeronautics and Space Administration (NASA)." --- (BA, sec filing, 2024/Q1)

"Defense bookings were approximately $11 billion and $13 billion for the quarters ended June 30, 2024 and 2023, respectively, and approximately $22 billion and $25 billion for the six months ended June 30, 2024 and 2023, respectively." --- (RTX, sec filing, 2024/Q2)

Inflation's Impact on Procurement and Costs

Inflation has significantly impacted procurement and costs in the defense industry, leading to increased expenses and supply chain disruptions. Companies like Lockheed Martin, General Dynamics, Northrop Grumman, and Raytheon Technologies have all reported adverse effects on profits, margins, and program cost estimates due to inflation and supply chain constraints.

"If we experience significant supply chain issues or high rates of inflation, and are unable to successfully mitigate the impact, our future profits, margins and cash flows, particularly for existing fixed-price contracts, may be adversely affected." --- (LMT, sec filing, 2024/Q1)

"But this is going to be a bit of a slog for the supply chain. Doug Harned: Well, and then also on shipbuilding, inflation has affected shipbuilding costs a lot over the last few years." --- (GD, earning call, 2024/Q1)

"has like every program and everyone experienced the impacts of inflation when the program was cost estimated last 4 years ago." --- (NOC, conference, 2024/05/30)

"These disruptions impacted our ability to procure raw materials, microelectronics, and certain commodities on a timely basis and/or at expected prices, and have been driven by supply chain market constraints and macroeconomic conditions, including inflation and labor market shortages." --- (RTX, sec filing, 2024/Q1)

"This notification, which has been driven primarily by increases in construction and procurement cost projections for the Production and Deployment phases, commenced the process to achieve recertification for continuance of the program and update its baseline cost estimates." --- (NOC, sec filing, 2024/Q1)

Strategic Adjustments by Defense Contractors

Defense contractors are making strategic adjustments to counter inflationary pressures. Northrop Grumman is combining strategic and tactical missiles to harvest synergies. Boeing is shutting down shadow factories and maturing defense programs. Raytheon is doubling production capacity and modernizing infrastructure. Lockheed Martin is collaborating with commercial partners to advance security solutions.

"And it also gave us the opportunity to bring together strategic missiles and tactical missiles into our Defense Systems portfolio and harvest some of the synergies that we anticipate those businesses will have by operating together." --- (NOC, conference, 2024/05/30)

"We'll also continue to make progress on other important objectives, including shutting down the shadow factories, maturing and derisking the defense fixed-price development programs and building on the continued strong results in services." --- (BA, earning call, 2024/Q1)

"And on the defense side, we're investing in test equipment and tooling to more than double production capacity by year-end in our Coyote program, which is a low-cost kinetic effector for the counter unmanned aircraft systems that directly address today's drone threats. In addition to creating new capacity, we continue to modernize our existing footprint as part of our Industry 4.0 initiatives." --- (RTX, earning call, 2024/Q2)

"Separately, we also continue to advance our 21st Century security solution through collaboration with strategic commercial partners across the tech, telecom, microprocessor, and other industries to support the national defense." --- (LMT, earning call, 2024/Q1)

"Defense system sales increased 3%, primarily due to growth on multiple programs in our weapons business, and as expected, were partially offset by lower volume on an international training program." --- (NOC, earning call, 2024/Q1)

International Defense Budgets and Inflation

Defense contractors like Northrop Grumman and Raytheon are capitalizing on double-digit growth in international demand, particularly in armaments and integrated air and missile defense. Significant contracts, such as Raytheon's $1.2 billion Patriot systems for Germany, highlight the robust international defense budgets despite inflationary pressures.

"So we're just building up the muscle to be able to do more international sales within our company to seize these opportunities and see our international portfolio grow as a percentage of our mix, especially if U. S. Budgets stay flattish to low single digit because we expect international demand to be double digit growth and so really helping to give us a platform for continued growth." --- (NOC, conference, 2024/05/30)

"In addition to a number of smaller bookings, in the quarter ended March 31, 2024, Raytheon booked $1.6 billion on a number of classified contracts, $1.2 billion to provide Patriot Air Defense systems to Germany, $818 million to provide Guidance Enhanced Missiles (GEM-T) for NATO Support and Procurement Agency (NSPA), $623 million to provide GEM-T for an international customer, $282 million to provide NASAMS for Ukraine, and $251 million to provide GEM-T for an international customer." --- (RTX, sec filing, 2024/Q1)

"That's where the other opportunities that we just talked about and the increase there that we see in international, in armaments and integrated air and missile defense will become the stronger growers in the portfolio and aero returning to growth." --- (NOC, conference, 2024/05/30)

"Notable defense bookings during the quarter included: $1.6 billion of classified bookings at Raytheon$1.2 billion for Germany Patriot production at Raytheon$818 million for NATO GEM-T production at Raytheon$623 million for international GEM-T production at Raytheon$282 million for Ukraine NASAMS production at Raytheon$251 million for international GEM-T production at RaytheonSegment ResultsThe company's reportable segments are Collins Aerospace, Pratt & Whitney, and Raytheon." --- (RTX, press release, 2024/04/23)

"The organic net sales increase of $0.3 billion in the quarter ended June 30, 2024 compared to the quarter ended June 30, 2023 was primarily due to higher net sales of $0.4 billion from land and air defense systems programs primarily driven by higher net sales on certain international Patriot programs, higher net sales on Counter-Unmanned Aircraft Systems (C-UAS) programs, and higher volume on Stinger." --- (RTX, sec filing, 2024/Q2)

Future Outlook for Defense Budgets

Defense budgets are expected to grow, driven by the FY2025 Presidential Budget request and supplemental funding, providing confidence for companies like Lockheed Martin. However, Northrop Grumman anticipates flat U.S. budgets and limited international growth in Space, reflecting a mixed outlook for different sectors within the defense industry.

"We expect FY2025 Presidential Budget request and additive supplemental funding will provide a strong underpinning for future growth over the next several years for our company, giving us further confidence in our long range plan." --- (LMT, earning call, 2024/Q1)

"Yes. With U. S. Budgets being flat and not really a strong international growth market for Space, I don't expect Space to be a strong contributor to our company growth rate." --- (NOC, conference, 2024/05/30)

"So we can't say very much about it. There is increasing budget available for NGAD and so that whenever we see good budget associated with the program that's got capabilities that are aligned with us, it presents an opportunity for us, but that's about all we can say." --- (LMT, conference, 2024/05/30)

"And then, of course, the restricted space program that we mentioned, but those we have now digested and, of course, reflected not only in our outlook, but my comments about the FY 2025 budget." --- (NOC, earning call, 2024/Q1)

"So again really good start that enables that. As we think about 2025, what you saw in the budget, what we're seeing here in supplemental, give us higher confidence that we'll continue to grow." --- (LMT, earning call, 2024/Q1)

Technological Innovations in Response to Inflation

Defense companies like RTX and LMT are focusing on next-generation technologies and revolutionary capabilities, such as the Air-launched Rapid Response Weapon (ARRW), to counteract inflationary pressures and maintain operational excellence.

"So with the best portfolio within A&D, core driving our continuous improvement in operational excellence and ongoing investments in next generation technologies, I'm incredibly confident in RTX's future and our ability to transform into the best company in A&D." --- (RTX, earning call, 2024/Q1)

"the Air-launched Rapid Response Weapon or ARRW with full confidence in its revolutionary capabilities." --- (LMT, earning call, 2024/Q1)

Supply Chain Challenges and Solutions

Defense companies are addressing supply chain challenges through various strategies, including increasing production capacity (RTX), product redesign (LMT), and maintaining supply chain stability (BA). Despite improvements, challenges remain, particularly in ramping up production (GD). Northrop Grumman's experience reflects industry-wide efforts to tackle these issues.

"We are working to address supply chain challenges, as you have heard across the entire shipbuilding enterprise, our experience is very consistent with that." --- (NOC, earning call, 2024/Q1)

"Robert Spingarn: Phebe, you said recently that even though the Aerospace supply chain is improving, your ramp this year could challenge that improvement." --- (GD, earning call, 2024/Q1)

"And of course, we also continue to look at product redesign. But I'd say, by and large, we are seeing an improvement in the in the supply chain, which also gives us confidence for that continued growth in the future." --- (LMT, earning call, 2024/Q2)

"And again, big part of that is supply chain. And we're adding production capacity as well to meet the demands of this ramp." --- (RTX, earning call, 2024/Q1)

"But then again, stability of the supply chain is also a priority. So in the event that 737 MAX production and deliveries continue to be under pressure beyond the first half of this year, how long can you keep the supply chain at a higher rate?" --- (BA, earning call, 2024/Q1)

See also