As sequestration looms, contractors don’t fret

January 30, 2013

The next few months could look even scarier than the last few for defense contractors already battered by federal budget cuts, thanks to the threat of automatic reductions looming in March. But industry executives had a surprising message for shareholders this week: Don’t worry about it.

In call after call with investors, officials at some of the area’s largest contracting firms refused to guess how much it would cost them if Congress allows the “sequester” to kick in on March 1. Even as their lobbyists keep warning how much the cuts would hurt the industry, the executives are projecting confidence that the sequester will not happen.

Northrop Grumman chief executive Wes Bush said Wednesday that his company’s outlook for the year projects “the sequestration is not triggered” and that Congress barely touches federal contract spending levels for 2013. General Dynamics chief Phebe Novakovic said last week that she had developed a “realistic” risk assessment for the company’s bottom line — and it, too, assumes no sequestration.

Their confidence defies the emerging consensus on Capitol Hill that Congress will not find an agreement in time to cancel or delay the cuts. It also threatens to disappoint investors in the event the sequester goes through, and it leaves thousands of Washington area contracting employees to wonder how safe their jobs are.

If the sequester cuts take effect in full, economists estimate they will destroy about 1 million jobs nationwide, including hundreds of thousands in the Washington area.

You’ve heard the word “sequester” mentioned by politicians a lot lately. The Washington Post’s Ed O’Keefe explains what the term means, and why it matters. (The Washington Post)

The executives do not appear to believe that will come to pass. It may be because Congress keeps averting fiscal crises at the very last minute, and because the Obama administration asked contractors last year not to issue layoff notices in preparation for cuts that were originally scheduled to begin this month.

It may also be because contracting firms appear confident in their ability to lobby for sequester relief.

‘Encouraging action’

Lockheed Martin chief executive Marillyn A. Hewson warned analysts last week that the automatic cuts would hurt her company and the country’s defense capabilities. But Lockheed’s projections, like its competitors, excluded the possibility of the sequester going through. In her remarks, Hewson noted “encouraging action” taken by President Obama and Congress to delay the sequester in December, and she promised that “in the weeks ahead, we’ll continue to work with our government leaders to encourage a more effective solution to our nation’s fiscal challenges.”

Contractors say they cannot account for possible sequestration costs, because of huge uncertainty over whether the cuts will happen and how they would be distributed across programs.

“We are just now starting to see conversations around what cost would be reduced if we go into sequestration,” Samuel R. Strickland, the chief financial officer at Booz Allen Hamilton, said Wednesday. “So we still haven’t yet been able to identify how much that would impact us, if at all.”

Some industry analysts note that the contracting firms routinely account for various risks and liabilities in their earnings projections. They seem puzzled by the executives’ reluctance to quantify the risks associated with sequestration.

The notion that the cuts will not happen “is what the management teams of these companies think is the most likely case scenario,” said William Loomis, managing director at the financial services firm Stifel Nicolaus. He said analysts do not buy into their optimism. “We don’t have a lot of confidence in the numbers because of it.”

Several analysts caution that large contractors are certainly working on contingency plans behind the scenes in case sequestration goes through.

An earlier round of budget cuts is already hurting the industry, executives acknowledge. Federal spending reductions squeezed profit margins and stunted hiring last year for contractors, a trend driven home by Wednesday’s report from the Commerce Department that defense cuts pushed the economy into contraction in the fourth quarter.

In Virginia

Virginia’s secretary of finance said in a report late last year that jobs in professional and business services, the sector that includes federal contracting, grew only half as quickly as forecasters expected in 2012. That slowdown was a prime reason that the state lagged the national average in job growth last year.

Sequestration brings the threat of much greater pain. An economists’ report prepared last year for the Virginia Economic Development Partnership estimated that the defense and non-defense components of the sequester would push the Virginia economy into recession and eliminate more than 80,000 jobs a year for two years.

The job losses would probably begin immediately, said Ann Battle Macheras, vice president of the regional economics division at the Federal Reserve Bank of Richmond’s research department.

“I don’t want to sugar-coat it that we wouldn’t feel it,” Macheras said. “There’s some pulling back that would occur right away.”

Contractors were one of the first groups to cry out about those possible economic effects, warning that the cuts would damage not only their bottom lines and their workforces but also the broader defense industry. The companies attended rallies this summer and announced that they were considering issuing layoff notices to all of their employees.

But the Labor Department and the Office of Management and Budget persuaded companies not to issue those notices, a signal that seemed to calm the industry and suggest that sequestration might not happen — a sentiment bolstered by the delay of the January deadline. Macheras said that probably amounted to “mixed signals” from the Obama administration to the industry.

The Aerospace Industries Association, the main defense industry lobbying group, has sent loud and constant signals that sequestration would be devastating, including a news release Wednesday. Meanwhile, small manufacturers who supply the larger contractors are beginning to speak out about how sequester cuts would affect their businesses, said Chad Moutray, the chief economist at the National Association of Manufacturers.

Moutray said he holds out hope that Wednesday’s report on gross domestic product — and the large effects of spending cuts it showed — will push Democrats and Republicans back to the bargaining table to find a sequester alternative.

“Hopefully, this is a little bit of a wake-up call,” he said. “This is real. Government spending contracted 1.2 percent of GDP. That’s a big hit, and it’s just the beginning.”

Jim Tankersley is the editor of Storyline, where he explains complex public policies and illuminates their human impact.
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