Wall Street and the Pentagon
The Economic and Business Outlook for the Defense Market
David J. Berteau
July 19, 2010
Presentation to the National Contract Management Association
2
PART ONE: The Economic and Business Outlook for the Defense Market
PART TWO: The Effects of Policy on the Financial Health of the Defense Industry
PART THREE: How Does the Market View the Defense Industry?
AGENDA:
3
Part One: Defense Outlays and the Federal Budget Deficit 1947-2020
Source: OMB; CBO; analysis by CSIS Defense-Industrial Initiatives Group
-400
-200
0
200
400
600
800
1,000
1,200
1,400
1,600
1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Est.
2015 Est.
2019 Est.
US
$, b
illio
n (
con
stan
t FY
2009
)
Net Interest (Interest Rate + 1%)
Net Interest
Federal Budget Deficit
Federal Budget Deficit (Interest Rate +1%)
National Defense
4
The Near-Term Challenge: DoD Budget Authority, 2001-2015Including Supplementals (current US$, bn)
Source: DoD Comptroller; analysis by CSIS Defense-Industrial Initiatives Group
297328
365 377 400 411 432480 513
531 549 563 578 594 610
1917
7291 79
124169
187 153 163 159
50 50 50 5050 4030 20
100
200
300
400
500
600
700
800
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Cur
rent
US$
, bn
Base Budget (BA) OCO to Base OCO "What if" OCO
Base Budget
OCO
5
Part Two: The CSIS Defense Index
• CSIS selected 34 companies (including legacy companies) that reflect the diversity of the industry supplying the Defense Department• Revenue: ~$100m to $45bn+• Electronics to heavy metal • Both products and services
• Companies added as data become available
• Benchmarked to S&P 500 and S&P 1500 Industrials – broad mix of products and services and company size
Year 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09Companies 17 17 17 19 20 22 23 22 20 22 20 21 22 23 21 20 19 23 24 24 23 23 23
6
Operating Margins, 1988-2009including CSIS Defense Index (revenue weighted)
*Excluding Defense ** Excluding Defense & Financials
Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
0%
2%
4%
6%
8%
10%
12%
14%
1988 1991 1994 1997 2000 2003 2006 2009
CSIS Defense Index S&P 1500 Industrials* S&P 500**
7
Cash Flow Return on Investment (CFROI), 1988-2009 including CSIS Defense Index (revenue weighted)
Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
*Excluding Defense ** Excluding Defense & Financials
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1988 1991 1994 1997 2000 2003 2006 2009
CSIS Defense Index S&P 1500 Industrials* S&P 500**
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Part Three: What Do Investors Think?
Key Points:
1. Wall Street is a short-term actor with a long-term view.
2. Investors’ perception is that the defense budget has peaked and, as a result, that revenue growth for defense companies may have peaked as well.
3. Current P/E multiples have already priced in not only a significant reduction in the top-line budget but also program uncertainty.
4. Markets are concerned with U.S. fiscal austerity—deeper cuts in defense budgets?
5. Investors are concerned that DoD does not have a contingency plan to preserve critical niche capabilities.
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Index Performance, 1999-20101999 = 100
Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
50
100
150
200
250
300
350
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Spade Defense Index S&P 500 Index S&P 500 AERO Index
Top Bottom Middle
1999=100
10
Defense Stocks Performance Parallels the Broader Market 2010 Index Performance, Year-to-Date (2010 = 100)
Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
90
95
100
105
110
115
120
1/1/2010 2/1/2010 3/1/2010 4/1/2010 5/1/2010 6/1/2010 7/1/2010
Spade Defense Index S&P 500 Index S&P 500 AERO IndexTop Bottom Middle
11
Index Performance, 1999-2010 (2010 = 100)
40
60
80
100
120
140
160
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Spade Defense Index S&P 500 Index S&P 500 AERO Index
2010 = 100
Middle Top Bottom
Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
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P/E Multiples: Price / Trailing 12M Earnings (as percentage of S&P 500 P/E)
* Big 4: Lockheed Martin, Raytheon, Northrop Grumman, General Dynamics
Source: Standard & Poor’s, Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group
0
1
2
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
S&P 500 Big 4 Avg.
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About CSIS At a time of new global opportunities and challenges, the Center for Strategic and International Studies (CSIS) provides strategic insights and policy solutions to decisionmakers in government, international institutions, the private sector, and civil society. A bipartisan, nonprofit organization headquartered in Washington, DC, CSIS conducts research and analysis and develops policy initiatives that look into the future and anticipate change.
Founded by David M. Abshire and Admiral Arleigh Burke at the height of the Cold War, CSIS was dedicated to finding ways for America to sustain its prominence and prosperity as a force for good in the world.
Since 1962, CSIS has grown to become one of the world’s preeminent international policy institutions, with more than 220 full-time staff and a large network of affiliated scholars focused on defense and security, regional stability, and transnational challenges ranging from energy and climate to global development and economic integration.
Former U.S. senator Sam Nunn became chairman of the CSIS Board of Trustees in 1999, and John J. Hamre has led CSIS as its president and chief executive officer since April 2000
CSIS does not take specific policy positions; accordingly, all views expressed in this presentation should be understood to be solely those of the author(s).
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