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Defense Giants Vulnerable to Slower Spending

By Jerry Knight
Monday, December 27, 2004; Page E01

Facing a record federal budget deficit, the White House and Congress are considering slowing the growth of defense spending, which could make it far less attractive to invest in the stocks of Washington's Pentagon contractors.

The defense spending debate has yet to get specific, but analysts are already at odds over what it might mean.


Northrop Grumman Corp., which owns the Newport News Shipbuilding yard in Virginia, stands to suffer if the growth of defense spending is slowed by Congress and the White House. (Jeff Caplan -- Bloomberg News)

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Wachovia Securities LLC recently warned clients that curbing Pentagon spending "would likely be interpreted by the market as a negative and supports our thesis that we are in the final stages of the defense authorization upcycle."

But the investment bank Friedman, Billings, Ramsey Group Inc. counters that there is "more smoke than fire" in newspaper reports of an impending slowdown. "We continue to view the defense sector as an outperformer vis-a-vis the broader markets in 2005."

The two big regional investment firms are not as far apart as they might appear at first because they are focused on two different parts of the defense industry.

Wachovia's defense industry analysts are most cautious about the giant Pentagon suppliers -- fighter-plane-manufacturer Lockheed Martin Corp. of Bethesda, tank- and submarine-maker General Dynamics Corp. of Falls Church and Northrop Grumman Corp. of Los Angeles, which makes ships and other products for the military.

FBR's analysts are most sanguine about the next tier of Pentagon players -- companies such as defense electronics-maker Argon ST Inc. of Fairfax, combat-vehicle-maker United Defense Industries Inc. of Arlington, information-tech company CACI International Inc. of Arlington and other smaller firms here and across the country. FBR, a regional firm based in Arlington, handles investment banking for several of the smaller local defense contractors and does not research the defense giants, which have a national following.

The key differences in outlooks for the two segments of the defense sector are that Lockheed Martin, General Dynamics and Northrop Grumman supply huge Pentagon "platforms" that are high-cost, high-visibility and sometimes highly controversial.

The smaller players mostly provide specialized supplies and services -- computers, communications, even running prisoner of war camps, such as Abu Ghraib near Baghdad, which drew CACI into a prisoner-abuse scandal.

When Congress starts looking for cuts, it's easy to target the new multibillion-dollar aircraft carriers, submarines and ships that would be built by General Dynamics and Northrop Grumman, or Lockheed Martin's F/A-22 Raptor, which costs $258 million each, the most expensive jet fighter ever. Last week an F/A-22 crashed during flight testing in Nevada in the plane's first accident since combat-style testing began last spring.


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