‘War Dividend’ Buoys Economy, Defense Stocks

Like the U.S. Cavalry riding to the aid of a weakening economy, military spending, with a potential to spread billions to communities across the land, is going back up.

The weapons procurement portion of the defense budget, meal ticket of contractors and workers nationwide, is scheduled to get another boost to $48.7 billion in fiscal 1999 (which began Oct. 1). That’s up from $45 billion in the fiscal year just ended and confirms a reversal of the declining trend that took weapons spending from $90 billion at its 1985 peak to a low of $43.1 billion two years ago.

There is bipartisan support from the White House and Congress for higher defense outlays. Sen. John McCain (R-Ariz.) of the Senate Armed Services Committee said last week that overall, Pentagon budgets going into the new century could rise by $15 billion a year from this year’s total.

Support stems from many causes. There is a need to renew supplies of fighter planes, ships and tanks because constant training of U.S. forces wears out equipment. Also, obviously, there are the missions of U.S. military personnel keeping the peace in Bosnia, trying to prevent disaster in Kosovo and striking at terrorists in Sudan and Afghanistan.

The American people favor more defense spending at this time, reports analyst George Shapiro of Salomon Smith Barney. Shapiro, who takes an annual survey of public opinion polls, reported recently that 60% of the people support higher military outlays, up strongly from poll results a year ago.

It has been a scary year, with terrorist bombings of U.S. embassies, the firing of missiles by Iran and North Korea, and nuclear weapons detonations by India and Pakistan. Those events told the public that the “new world order” anticipated at the end of the Gulf War in 1991--not to mention the end of the Cold War in 1989--is still some ways off.

So instead of taking money from the military to pay for other programs, as the “peace dividend” was supposed to do after the Gulf War, the new focus is to pay for the globally ready military the U.S. has decided it wants.

No accident, therefore, that many defense stocks have held up well in this stock market. General Dynamics, for example, is near an all-time high. Litton Industries has risen sharply in the last month. Both are shipbuilders for the Navy, which needs new ships.

Lockheed Martin remains near its all-time high. It makes a current top fighter plane, the F-22, and will compete with Boeing for the next big plane contract, the Joint Strike Fighter, which will be sold to U.S. allies when it is built early in the next century.

Raytheon is up, even as it lays off workers in some areas while consolidating the defense business of Hughes Electronics. And Northrop Grumman, its stock down dramatically since the cancellation in July of its merger with Lockheed, is recommended by Shapiro and other analysts because the company is a leading subcontractor to all makers of aircraft.

As ever, it doesn’t hurt the defense budget’s chances that its contracts create jobs and incomes in many congressional districts. But the new spending may be different from the Pentagon’s old practice of financing many ambitious programs at once. In fact, the effort right now in Washington is to tailor spending to a new military strategy.

Behind the scenes, there are arguments between Pentagon chiefs and key members of Congress over U.S. military policy--and how the money should be spent.

Briefly put, says Lawrence Korb, a former assistant secretary of defense who is military analyst with the Council on Foreign Relations, the military chiefs are offering budget requests geared to “two-front wars, as if the Cold War had not ended.”

But some members of Congress note that the armed forces’ mission today is often in places like Bosnia. “That calls for flexible forces equipped with weaponry that can be purchased less expensively than the high-tech missiles that were meant to fight the Soviet Union,” Korb says.

Other experts say the Pentagon’s need to pay salaries and pensions, and to finance maintenance and training, may well eat up increased defense funds.

“I don’t think there will be as much for weapons as analysts on Wall Street are counting on,” says Jon Kutler, head of Quarterdeck Investment Partners, a Los Angeles-based investment bank specializing in small defense companies.

Still, the global mission of the U.S. military requires that more money be spent on weapons, points out Loren Thompson, a defense analyst with Lexington Institute, an Arlington, Va., think tank. Policy shifts will go on over time, “but budgets will be expanded now because the Navy needs ships and equipment needs renewal,” Thompson says.

The C-17 transport made by Boeing in Long Beach, which is a plane that can haul troops to all parts of the world, gets a 20% boost in funding to $2.9 billion in this year’s budget, Thomspon notes.

In that light, General Dynamics is a company to watch. GD, which is based in Falls Church, Va., is owned in part by savvy investors--Chicago’s Crown family and Warren Buffett’s Berkshire Hathaway, among others. In the early ‘90s, GD was one of the first companies to realize that the defense business would change. So it sold its missiles and aircraft operations and shrank in annual revenue from $10 billion to $3.4 billion. But it kept its ship- and submarine-making businesses--and went from great losses in 1990 to more than $200 million a year profit in the mid-’90s.

In the last few years, GD has embarked on a new strategy. It added to its shipbuilding capabilities by acquiring Bath Iron Works in 1995. Along with Litton, GD is now the Pentagon’s chief supplier of destroyers and cruisers.

And just last week, GD agreed to acquire San Diego’s National Steel & Shipbuilding, which specializes in auxiliary and small amphibious ships, the kind of vessels needed for short-term missions around the world.

In addition to that, National’s ships can serve a growing civilian market for ferryboats, notes Robert Paulson, a former defense consultant who heads Aerostar Capital and Transtar Metals, two companies that aid in combining small defense suppliers to gain economies of scale.

The defense industry is entering a new phase, Paulson says. The time of downsizing and merging of companies is coming to an end. “Today it is a more efficient and global industry,” he says, an industry entering a time of new growth. Employment in the industry is already rising again, to 890,000, after suffering a decline of more than half a million workers in the 1990s.

Nobody is going to call spending for Kosovo and Bosnia a “war dividend,” but it could buoy a weakening economy all the same.

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James Flanigan can be reached by e-mail at jim.flanigan@latimes.com.

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Defense Reloads

The weapons procurement portion of the U.S. defense budget, which supports the work of defense companies and their employees, has reversed a long decline. A rising trend is taking hold, as these Pentagon figures show.

Fiscal year outlays for weapons procurement, in billions of dollars:

2003: $63 billion (Pentagon estimate)

Source: Defense Department