Defense contractors

[villainx]

Aftermarket suppliers, software, as well as ancillary military tech may be worth considering. 

 

 

[Spekulatius]

On elections, i don't think it will be a factor, in the "pivot" back to great power competition.

U.S. national security is far less concerned with the Persian Gulf, now that U.S. is the top oil producer.

 

The long term trend will be that of dis-engagement from the Gulf region, and subcontracting Saudi and Israel to do their bidding.

 

I agree. This decade, the focus will be to counter the Russians and most importantly the Chinese.

 

Just to name one example, the Chinese got their own GPS satellite network up and running. This is of strategic importance to become independent from the US for both commercial as well as for military uses for the Chinese.

[Spekulatius]

LHX (one of my holdings) got some love in VIC recently at $182.5. Now trading at $164, I can’t help but add some shares. generally speaking, defense stocks have been weak lately, anyone have any idea why? Fear of defense cuts if Biden wins the election?

 

In any case, I am familiar with LHX (more so with L3 than with the Harris part) and the combinatory Company looks like a good bet to me. in my opinion, this is a good GARPy stock pick.

https://www.valueinvestorsclub.com/idea/L3HARRIS_TECHNOLOGIES_INC/8346441774

[scorpioncapital]

Are you not worried that 80% government funded defense companies will suffer when government itself is weakened by overspending, debt, and possible inflation? It doesn't even have to stop spending, but could it be forced to reduce spending and thus reduce the profits to these companies? The key question to me is if world governments are now at the strongest - or weakest they've been in history. In some ways if you look at the numbers alone it looks as if they are the weakest. Anybody know how did defense spending evolve after WW2? I guess it may not be a good example today as there you had winners and losers. But who is winning today? The over indebted Western military industrial complex or perhaps something like China and emerging markets? Or nobody is winning?

 

 

[Spekulatius]

Are you not worried that 80% government funded defense companies will suffer when government itself is weakened by overspending, debt, and possible inflation? It doesn't even have to stop spending, but could it be forced to reduce spending and thus reduce the profits to these companies? The key question to me is if world governments are now at the strongest - or weakest they've been in history. In some ways if you look at the numbers alone it looks as if they are the weakest. Anybody know how did defense spending evolve after WW2? I guess it may not be a good example today as there you had winners and losers. But who is winning today? The over indebted Western military industrial complex or perhaps something like China and emerging markets? Or nobody is winning?

 

Yes a smaller military budget would br a headwind, but the composition matters. The thinking expressed before is that future spending will go more towards high tech and less towards boots on the ground. This is based on the the threats from China and Russia increasing and become ing more sophisticated. Our future military might become much smaller, but also more technologically advanced. This would be a very good news for defense contractors.

[scorpioncapital]

In other words efficiency. I just wonder if one day military spending will be outsourced to third parties, large oligopolies with great competitive advantages. Wait a sec...that describes the current situation! )

[Xerxes]

 

Spekulatius,

probably you will find this interview with the L3 boss interesting.

https://aviationweek.com/ad-week/video-interviews/l3harris-eyes-foreign-defense-expansion-shakes-commercial-dip

 

On the overall A&D sector, my view is that in the short term, while defense might to better than commercial, in the long term, the defense budget will be very much impacted due to the massive spending governments around the world have undertaken to re-build their economies. Also defense is not immune, as their supply chain did get impacted. Lockheed Martin for instance for the first time in 10 years its F-35 production deliveries is not growing y-o-y.

 

------------------------------------------------------------------------------------------------------

L3Harris Eyes Foreign Defense Expansion, Shakes Off Commercial Dip

Michael Bruno July 16, 2020

L3Harris executives

L3Harris Chairman and CEO Bill Brown (left) and Vice Chairman and Chief Operating Officer Chris Kubasik.

Credit: L3Harris

 

L3Harris Technologies is celebrating its first anniversary as a combined company after predecessors L3 Technologies and Harris Corp. came together in the summer of 2019. The merger created a so-called “sixth prime” defense contractor that enjoyed growing civil aerospace work through pilot training, simulation, avionics, FAA support and NASA work. But the merger was envisioned long before COVID-19 upended the aerospace and defense marketplace. Like other companies, Melbourne, Florida-based L3Harris is adapting. Chairman and CEO Bill Brown and Vice Chairman, Chief Operating Officer and President Chris Kubasik talked with Senior Business Editor Michael Bruno about the past year and looking ahead.

 

AW&ST: You just completed the first year of a three-year plan to integrate L3Harris Technologies. How is it going?  Brown: Chris and I couldn’t be prouder of the broader leadership team and all the employees for all that we’ve accomplished over the last year to make this merger successful. And it has been a success in an environment that is truly unprecedented in many ways. Strategically, if you remember a year ago, we set out to leverage our broader scale and complementary technologies to create sort of a new agile, innovative mission solutions prime that goes across all of the domains. I think we have proven that out through a lot of the revenue synergies we’ve already started to capture in the big pipeline ahead of us operationally, and we’re making really good progress. We’re also building a strong culture of operational excellence within the company to sustain our performance beyond the integration period.

 

More international defense work targeted

Cost-takeout from operations could increase

Commercial aerospace drop not alarming

Many financial analysts have named L3Harris a favorite stock pick. You have a $300 million goal for cost takeout from the merger, and you just accelerated that by a year to 2021. Do you feel pressure to do even more?  Brown: I think maybe what people are excited about is that we were underpenetrated internationally. So we have opportunities to grow there. We’re going after broader end-to-end mission solutions and we’re starting to capture synergy.

 

So we believe we have an opportunity to gain share in a defense market, in a global market. But we also have really good execution on the cost side to allow earnings per share to grow and margins to expand, regardless of what happens on the top line. I think that’s what investors are excited about—just that execution on the fundamentals. If we hit $300 million next year and we keep running it into that third year—calendar 2022—it should be better than we first expected.

 

The merger was marketed in part about becoming a sixth prime defense contractor with accompanying heft. Did it work? How are you growing?  Kubasik: We see a lot of opportunities in the classified environment dealing with command and control, with integrating capabilities from both legacy companies. We put in 41 proposals—neither one of us would have primed or put these bids in had we not merged. That gives you an idea of volume. A lot of these start out relatively small, whether they’re with DARPA or other agencies where you’re downselected as one of three, and then a year from now you get another opportunity and keep going. We’re pretty pleased. We’ve had eight awards so far.

 

About 20% of annual revenue comes from international sales. Can you still grow there?  Kubasik: There is a couple of billion dollars of opportunity on the international front. We have a pretty big presence in Australia, Canada and the UK. We haven’t seen any budget pressures for 2020. Do we expect many for 2021? That will be something we watch. Most of these countries fund defense as a percent of GDP, so if GDP drops, maybe there’s an impact there in the out years. But we continue to see a lot of interest in the Pacific region. And, of course, the Mideast is somewhere that both companies had worked in historically and continue to work.

 

Since the merger was announced in October 2018, you have been busy with divestitures. Are you interested in more acquisitions, especially as prices may drop for some targets due to COVID-19?  Brown: It’s early to talk about it, frankly. We’re busy; we’ve got a lot of stuff going on just integrating the companies, stabilizing it, taking costs out, improving systems, capturing revenue opportunities and dealing with the COVID pandemic. We believe we’re adding a lot of value by focusing on building fundamentals, building a strong foundation upon which to grow over time, and [acquisitions] will play a role. It’s not on the near-term horizon. We’ve got our hands full just executing our game plan as we see it today.

 

Your commercial aerospace businesses took a hit from COVID-19 along with the rest of the marketplace. How much of a setback is that to the business model?  Brown: That business might be evolving in the future, but it’s not a big part of the company. Commercial aerospace, which is all the pilot training and academy work plus avionics, is less than 5% of the company. Roughly speaking, it’s about $500 million of revenue this year—down 30-40%, about $300 million. We do see that business under pressure, and we see that also in the pilot training side. It’s very difficult to train new pilots when you can’t have them come to your academies, or have airline pilots that aren’t flying. They’re not going to be in the training systems. So that does slow pretty dramatically.

 

Both of you are veteran leaders and have seen downturns before, but how does COVID-19 differ?  Kubasik: This is clearly one of the more significant declines. You look at all the different events over history that have caused commercial aerospace to hit a bump, and most of those have bounced back relatively quickly from events like 9/11 or SARS. This one is global in nature, and I think the whole discussion is going to be about the recovery. Ultimately, I think people are going to get back on planes and fly, clearly.

 

We’ve found some ways to be a little more efficient with Zoom and Skype, and maybe there are fewer business trips. If everything gets back to the same way we were pre-COVID-19, we will have missed an opportunity to reimagine the future of the workplace and productivity.

 

Brown: There are implications for the overall supply base, on both the aerospace and defense sides. Clearly we need more resilience. This has a great impact on some of the smallest suppliers on which we’re leaning to survive. This is not a temporary situation where you advance cash and things get better in three months. This is going to be a longer-term downturn, and we have to make sure that those precious small suppliers who are very vulnerable can see their way through this crisis. Larger companies can; the concern is really the smallest ones.

[Foreign Tuffett]

Everything HII builds is either a monopoly or one half of a duopoly

 

Newport News

Only shipyard that can build, refuel, or decommission nuclear aircraft carriers

Duopoly with GD's Electric Boat on the building of nuclear subs

 

Ingalls

Duopoly with GD's Bath Iron Works for the building of Arleigh Burke class destroyers (only Large Surface Combatant (LSC) ship currently being built for US Navy)

Only builder of San Antonio-class

Only builder of America-class

Only builder of Legend class cutters for Coast Guard

 

 

Reading between the lines a little bit, shipbuilding (particularly large ships) for US Navy is so highly consolidated that the Navy is determined to (and has little choice but to) feed its remaining builders steady work to avoid having its industrial base erode away.

 

https://www.maritime-executive.com/article/u-s-navy-puts-industrial-base-first-fleet-size-second

[KJP]

Everything HII builds is either a monopoly or one half of a duopoly

 

Newport News

Only shipyard that can build, refuel, or decommission nuclear aircraft carriers

Duopoly with GD's Electric Boat on the building of nuclear subs

 

Ingalls

Duopoly with GD's Bath Iron Works for the building of Arleigh Burke class destroyers (only Large Surface Combatant (LSC) ship currently being built for US Navy)

Only builder of San Antonio-class

Only builder of America-class

Only builder of Legend class cutters for Coast Guard

 

 

Reading between the lines a little bit, shipbuilding (particularly large ships) for US Navy is so highly consolidated that the Navy is determined to (and has little choice but to) feed its remaining builders steady work to avoid having its industrial base erode away.

 

https://www.maritime-executive.com/article/u-s-navy-puts-industrial-base-first-fleet-size-second

 

HII has elsewhere been described as just a "metal bender," but I think you're correct.  There is either no or one competitor for most of what they do.  And I also think you're correct that the Defense Department knows HII and GD are irreplaceable and essential to national defense.  So long as the US seeks to be a naval power and naval power involves large surface ships and manned submarines, HII and GD are too big and too important to fail.  You can look at the US's current capacity (or lack thereof) to build nuclear reactors for energy production to see what happens when you let a specialized manufacturing and skill base erode.

 

BWX Technologies is another naval monopoly -- naval nuclear reactors, but the stock is significantly more expensive.

 

The main risk is that sometime in the next 5-10 years or so the US chooses not to continue to build traditional naval ships or to significantly shrink the Navy.  Given the apparently emerging rivalry with China, the US giving up on being a naval power seems unlikely to me.  But at the end of the day, that's a political question, rather than something that can be analyzed through traditional financial or economic analysis.  A bigger risk, perhaps, is that large surface ships and manned submarines are rendered obsolete by unmanned drone-like ships that can fire torpedoes and missiles (think much more intelligent and capable mines). 

 

I view HII as similar to Williams (WMB) and, in some ways, Equity Residential (EQR).  They each own infrastructure/large physical assets that appear to be irreplaceable at a reasonable cost.  The main question for each appears to be whether the world has moved on from the needs that infrastructures serves (or, perhaps, whether the US/cites is/are in significant terminal decline). 

 

 

 

 

[rb]

I don't have any doubts that HII and GD are gonna be around building ships for a long time. The question is around is around growth. Will there be any? Will the Navy have more ships in the future? I'm leaning the less ships way (historical trend) though not many less ships. I'm certain there won't be a meaningful increase in the number of ships.

 

So then NII and GD are kinda working the run rate of the US navy, replacing ships as they come due. Little growth if any. In such an environment the multiple for such a business should be rather modest.

[KJP]

I don't have any doubts that HII and GD are gonna be around building ships for a long time. The question is around is around growth. Will there be any? Will the Navy have more ships in the future? I'm leaning the less ships way (historical trend) though not many less ships. I'm certain there won't be a meaningful increase in the number of ships.

 

So then NII and GD are kinda working the run rate of the US navy, replacing ships as they come due. Little growth if any. In such an environment the multiple for such a business should be rather modest.

 

I think you're right that growth (or lack thereof) is an issue.  My understanding is the overall size of the fleet has stabilized over the last 15 years and there is an ongoing push to increase the size of the fleet over the next few decades from ~290 ships to ~355 ships.  See, e.g., https://www.secnav.navy.mil/fmc/fmb/Documents/20pres/PB20%2030-year%20Shipbuilding%20Plan%20Final.pdf (page 16 has a chart so the historical decline in fleet size that you mentioned and the recent stabilization I'm referring to).  Of course, I would not put too much stock in multi-decade "plans," particularly those that are ultimately subject to political control.  But there is a possibility of growth in fleet size or at least not a continued decline in fleet size.

 

In addition, HII has cyclical high and lows in capex as it periodically does major upgrades of its shipyards.  It's just finishing a relatively high portion of its capex cycle, and thus capex should come down substantially beginning next year.  (See slide 66:  https://huntingtoningalls.gcs-web.com/static-files/cdc0dcb8-e072-4672-911a-09a854c4c851).  Meanwhile, the company generated about $2 billion in FCF over the preceding four years (all returned via dividends or buybacks) despite being in relatively high portion of its cyclical capex phase.  (See slide 65)  Over the next five years, they project low to mid-single digit revenue growth, with most of it already booked (but again, I believe some of this is subject to appropriation) (See slides 69-70), leading to mid-single digit annual operating income growth over the next 4-5 years (slide 71), leading to roughly $3 billion in FCF over the five-year period 2020-24 (slide 72). 

 

Now, of course, these are management projections, not gospel.  But $2.5 - $3 billion in FCF returned to shareholders via dividends and buybacks over the next five years seems a reasonable outcome.  And at the end of that period, I think you'll still have a company that's dominant in its industry, though the industry has uncertain growth prospects.  You get that profile for a market cap of just over $7 billion and a trailing p/e of ~13 - 15 (depending how you view CAS/FAS adjustment).  I also think the company will be able to pass on cost inflation to the US government to the extent it arises.  So, at the end of the day, I think you're trading the high potential upside of a higher growth company for the stability of a dominant, highly free-cash flow generative business trading at a below market multiple. 

 

Those are the reasons I own HII as part of the ballast portion of my portfolio, with other portions of the portfolio devoted to high growth/higher upside investments.  If I were 15 years younger and more concerned about using all of my savings to build wealth, rather than devoting a portion of it to simply preserving purchasing power, then I probably wouldn't be interested in HII.

[Spekulatius]

Thanks on the color for HII. I heard the “metal bender” characterization of HII business in a MF industry focus podcast. I do think there is a bit of truth in it.

 

I looked at HII too, but ultimately decided to buy the higher tech LHX and NOC instead. My portfolio is already “armed to the teeth” with holdings in RHM.DE, BAESY, NOC, GD and LHX and I simply don’t want to own them all.

[KJP]

Thanks on the color for HII. I heard the “metal bender” characterization of HII business in a MF industry focus podcast. I do think there is a bit of truth in it.

 

I looked at HII too, but ultimately decided to buy the higher tech LHX and NOC instead. My portfolio is already “armed to the teeth” with holdings in RHM.DE, BAESY, NOC, GD and LHX and I simply don’t want to own them all.

 

I also own GD and likely will buy one or more of LHX/NOC/LMT/RTX as well if the prices are right.  I don't want all of my eggs in the Navy basket.

[Castanza]

Thanks on the color for HII. I heard the “metal bender” characterization of HII business in a MF industry focus podcast. I do think there is a bit of truth in it.

 

I looked at HII too, but ultimately decided to buy the higher tech LHX and NOC instead. My portfolio is already “armed to the teeth” with holdings in RHM.DE, BAESY, NOC, GD and LHX and I simply don’t want to own them all.

 

I also own GD and likely will buy one or more of LHX/NOC/LMT/RTX as well if the prices are right.  I don't want all of my eggs in the Navy basket.

 

The thing that's difficult about defense contractors is there is a lot of overlap between the companies. You never know who the new contract will get awarded to. I mean look how many companies have contributed to the A-10 Warthog over the years. I think Boeing was the most recent to work on it with the wing replacements.

 

Then we have the current situation where the Army wants to replace the M4 and M249. This doesn't happen but once a generation. Small arms probably isn't as lucrative as new jets, weapons systems, or tanks but it's a solid recurring revenue stream that doesn't come around often. Then you see the top three contenders for this contract and you just shake your head (except one). General Dynamics(interesting), Textron(what?), and Sig Sauer(makes sense). Where is the Colt, FN, Beretta, etc? Point being, you never know with these companies.

 

Personally I like RTX a lot. Maybe a bit simple, but I view them as the coke producer of the defense industry. Missiles are used by so many systems and aircrafts all across the globe. RTX happens to make a lot of them. They have also diversified a lot over the past decade which is never a bad thing. Still, I think the best approach to defense companies is to buy whoever looks cheap or possibly even an ETF approach if you're just looking for some exposure.

[Xerxes]

Bingo.

 

RTX is the one to get.

They supply the picks and shovels to all.

You want exposure to F-35 production ramp-up, well, Pratt & Whitney is the sole-source provider of the F135 engines.

You want narrow body exposure, the P&W has duopoly of on that range of thrust.

You want actual growth, then look for where the Hypersonic investment money is going => Lockheed and Raytheon.

You want have a diversified exposure between production and Aftermarket, it has  (i.e. Boeing pendulum is heavily titled toward production, hence all the cash flow problems)

 

Personally, my top 4 are RTX, Northrop Grumman, Lockheed Martin and L3-Harris.

There is a bit of overlap on the F-35 program between the first 3 companies though.

 

If you drop Lockheed Martin but keep => RTX, Northrop Grumman and L3-Harris.

I think that combination has much less overlaps and really vectored differently.

[Gregmal]

I own a bit of LMT, but I've also always really liked Elbit Systems. A bit smaller and more specialized, but very well managed company.

[Foreign Tuffett]

Re: Discussion about unmanned surface vehicles

 

L3Harris getting some work in this area

 

https://insidedefense.com/insider/l3harris-reports-growth-maritime-business

[Spekulatius]

NOC’ earnings were Good (guidance raised) and LHX were solid (guidance confirmed ). It was good to see that LHX is basically going to generate the same margins that Harris had (~19% EBIT vs ~11.5% for L3) with the combined entity.

 

I also went through RTX release and while commercial is suffering, they should be able power through and continue paying their dividend and invest until commercial rebounds. I agree that P&W and Collins are great business. I can’t help but bought a few starter shares.

[Xerxes]

https://aviationweek.com/ad-week/video-interviews/raytheon-technologies-ceo-riding-out-covid-19-crisis

 

Great read !

 

---------------------------------------

Raytheon Technologies CEO On Riding Out The COVID-19 Crisis

Joe Anselmo Michael Bruno July 13, 2020

 

When he was United Technologies Corp. chairman and CEO, Greg Hayes took a lot of heat for merging his company with Raytheon to create aerospace powerhouse Raytheon Technologies. But the critics have been silenced as defense has cushioned the company from the battering the commercial downturn has inflicted on its Collins Aerospace and Pratt & Whitney operations. Hayes spoke via videoconference with AW&ST Editor-in-Chief Joe Anselmo and Senior Business Editor Michael Bruno.

 

AW&ST: How long will it take the commercial aviation industry to recover from the COVID-19 crisis? Initially, we thought this was going to be like the severe acute respiratory syndrome (SARS) in 2002-03. We thought it was going to be relatively short-lived, where air traffic would go down for a little while but then gradually recover. I don’t think any of us envisioned the morbidity or the scope of this pandemic and its impact on travel. I would say we’re looking now at getting back to 2019 in 2023, maybe 2024. It is going to be a slow recovery.

 

The good news is we’ve got plenty of liquidity. We’ll see our way through this, but it is going to be a tough road. We are hunkering down for a protracted recession on the commercial aero side. Our aftermarket orders are down 50%-plus at both Collins Aerospace and Pratt & Whitney. That’s where a lot of the profits come from. The reason we can spend $2.5 billion a year on R&D for the commercial businesses is because we have this spares business that generates strong cash. When that goes away, it’s tough. And as a result, we’re going to cut R&D this year by $500 million on the commercial side.

 

Unfortunately, the airlines are not in a position to weather this storm for probably more than another 12 months without government assistance. That’s really going to be the key. Do governments in the U.S., Europe, South America and across Asia step up to support what is a critical industry in aerospace?

 

Is the industry underplaying the severity of the COVID-19 downturn? A vaccine is the key, and it has to be widely available. The World Health Organization is working on that, but we’re going to have hotspots with this pandemic for the next year or two. So even if the U.S. and Europe are completely vaccinated, what does that mean for travel to Africa, Asia, to the fast-growing markets?

 

I’d almost bifurcate the aerospace industry between a narrowbody recovery and widebody recovery. The narrowbody is primarily domestic, whether it’s Europe, the U.S. or even China. That will recover more quickly as people become confident-—there’s either a vaccine or they’ve found new treatment options. But on the international side, we can’t fly today into Europe, and we don’t want the Europeans to fly to the U.S. We can’t go to South America or China. Those routes are going to take much, much longer to recover.

 

The fact is there are so many excess aircraft out there right now that we believe you’re going to see more parting out of existing fleets before we see a resurgence. And that’s why even when passenger traffic starts to come back, there’s probably a full 6-12 months before we’re going to see a return to normalcy in our aftermarket organization.

 

Pratt supplies the PW1000G engine option for the Airbus A320neo. How much downside risk is there for -deliveries? We’re planning for about a 40% reduction in A320 deliveries this year and next year compared with February 2020 production rates. Airbus would love to build more, but it’s not clear to us that customers are going to be around to take more than that. The good news is our market share went from about 42% [of A320neo engines] to north of 50% in the last year. Customers are starting to believe in the geared turbofan because of the fuel efficiency.

 

Do you see the market share between Airbus and Boeing shifting? The order book for the A320 is much stronger today, with all the cancellations that we’ve seen on the 737 MAX because of delays. We still think the 737 will get back in the air this year, and we continue to work with Boeing on software updates. We firmly believe it’s a great aircraft. Keep in mind we have about $2.5 million of content per shipset on the 737. It’s going to be a tough couple of years, but we ultimately have faith in the airframe and the certification process.

 

Where are you focusing your future efforts with Boeing and Airbus? We were optimistically cautious about the [proposed Boeing] new mid-market airplane (NMA), but there is a lot of excess capacity now, and it’s not clear another evolutionary design is going to be the answer. So our focus right now is the next-generation single--aisle. And we think that’s probably been pushed out a couple of years, to maybe 2033 or 2035.

 

They’re talking about a 30% efficiency gain from the current single-aisle. Two-thirds of that gain has to come from engine design. At the Paris Air Show last year, we talked about a hybrid electric design [Project 804]. We’re going to continue on that path. We’re trying to figure out how you can have enough power at takeoff while having a much lower fuel consumption at cruise. And that’s where hybrid electric comes in. It’s going to take us at least a decade to prove that out.

 

I don’t know if hybrid electric is the answer. There are other things that we’re working on. But obviously it’s got to be something completely different than what we’ve been building in the past.

 

Governments around the world are taking on huge debt to alleviate the coronavirus crisis. Are you worried that will put pressure on military spending over the long term? You would have to have your head in the sand to not understand what’s going to happen to defense budgets over time. When [Raytheon CEO] Tom Kennedy and I first talked about this merger, it was, “What can we do together that we can’t do separately?” And it really was bringing the technologies of the two companies together to solve customer problems in new and innovative ways.

 

Defense budgets will go down, but I think the real question is where Defense Department spending is going. I remember talking two years ago with [then-Defense Secretary] Gen. [James] Mattis, and he said, “Bring us innovative solutions, not to fight the last war but to fight the next war.” And the next war, he said, is going to be fought in cyberspace and outer space. The capabilities of the legacy Raytheon business are second to none in space and are outstanding on the cyber side. You marry that up with the manufacturing and material science that Pratt & Whitney brings, with the communication systems that Rockwell Collins brings, and this is going to be a great play.

 

The U.S. Air Force wants more software-driven capabilities, delivered in weeks or even days. How does that square with your businesses, which often involve long-term hardware evolutions? It’s making sure that we’re continuing to evolve our products. The missiles we’re delivering today, such as the SM-3 [interceptor] or the SM-6 [anti-air/anti-surface/-ballistic missile defense] are state of the art, and we continue to find new uses for them.

 

A lot of things will change over time in terms of how the weapons are deployed. Think about the Storm-Breaker missile that we just demonstrated, which has the tri-mode seeker. It can do things the last generation of missiles could never do in terms of going through smoke, fog, dust and sand. The LRSO [Long-Range Standoff nuclear cruise missile] is another example. And the Tomahawk is an established product that we will evolve as the needs of the battlefield change to meet new requirements. That’s really what we want to focus on: How do we continue software-driven solutions but also find ways to redeploy and reinvigorate the product line and bring new capabilities to the warfighter?

 

Are you making long-term investments in hypersonics? Hypersonics are a destabilizing technology. There’s only so much we can talk about, but we know we’re behind the Chinese and probably behind the Russians. I think in 3-5 years we’ll be on a level playing field. Our focus has been on defensive systems, using space-based assets to track hypersonics. It’s nothing that a ground radar could ever do because they move too fast. And then countermeasures that we could use to defend against hypersonics is the bigger market. We’re obviously investing. We’ve got a program, the HAWC [Hypersonic Air-breathing Weapon Concept], which is an air-breathing hypersonic missile that we’re working on. I think we’ll flight-test that later this year.

 

Also think about the materials science that Pratt brings. The key to hypersonics is how to keep the electronics from getting fried when you’re operating at something like 5,000F. We’re investing in  cooling materials—that will be one of the big bets that we’re going to have to make. Tom Kennedy saw the need to make these investments, and we’re going to do that. The other piece is on the space side. There’s not a lot that we can say, other than that we think space will be the frontier that will differentiate us—that is, the defense of space assets, as well as using space assets to detect, track and target hypersonic weapons.

 

When the merger of United Technologies and Raytheon was announced, there was a lot of criticism from investors. Now they’re happy about how well-positioned the combined company is to weather the COVID-19 storm. There was a lot of pushback from investors, especially from the hedge fund guys. They saw us taking a lower-margin business, and they didn’t like the fact that the technology takes 5-10 years to pay off. I was roundly criticized. All I can say is I was an idiot a year ago and now I’m a genius, through no fault of my own.

 

We did this for the long term, and it was completely fortuitous that the merger happened when it did. The commercial businesses won’t make any money this year, and they are going to struggle for the next couple of years, but now we’ve got a rock-solid balance sheet and a lot of cash. And that defense business is going to grow 5-8% this year. We’ve got a good backlog. I’d like to say it was genius, but it really was just doing what’s right for the long term. My goal is to leave this company better than I found it.

 

You have reshaped this company, starting with selling Sikorsky to Lockheed Martin in 2015. Then you acquired Rockwell Collins and moved to break up the UTC conglomerate, and it looked like UTC was going to be a commercial aerospace company. Now comes Raytheon. Are you done, or is there more to come? I’m never done until I’m gone, but we don’t need to do anything else big. The driving force [behind the Raytheon merger] was putting two big technology companies together with cyclical balance [between commercial and defense]. Tom Kennedy always felt he was at a disadvantage against the Lockheeds of the world because of the scale of Lockheed versus Raytheon. This gives us the scale to invest and compete head on with the Lockheed Martins and Northrop Grummans, as well as being the largest supplier to both Boeing and Airbus. We have some clout in the marketplace.

 

We’ve got 700,000 different things that we deliver to customers: missiles, APUs, engines, communications gear. Some we really love; others don’t have the returns that we want or require too much investment for a limited market. We hope to have a portfolio review done by the end of the year. And you’ll probably see some divestitures, but not big pieces. We also continue to look for technology bolt-ons as we think about what’s next in defense and the space and cyber spectrums.

 

Longer term, the big question in my mind is what happens to Rolls-Royce, a great technology company that is facing challenging financial circumstances. We loved the partnership Pratt had with Rolls on International Aero Engines. Could we recreate that someday? Perhaps, but not now. Ian Davis, who’s the chairman over there, is a good guy. We always say, “Look, we need to find ways to collaborate so we can take on GE Aviation.” Despite the fact that GE may be on its heels today, they’ve got over 30,000 engines out there. Their aftermarket will recover, they will get better, and they will be the formidable competitor for both Rolls and Raytheon Technologies for the foreseeable future.

 

We’re hearing from Wall Street that you’re expected to sell off the Forcepoint business. Forcepoint is a commercial cyber business Tom Kennedy created when he brought a couple of companies together about five years ago. It has some great technology, but it clearly doesn’t fit in the portfolio. We’ll figure that out in the next six months.

 

How is the integration going? Nothing went according to plan except the merger itself. We sent everybody home the week of March 12 [because of COVID-19], and we were still three weeks away from the merger. So we had to complete the merger and all of the integration remotely. And we had to spin off Carrier and Otis. All of that came to fruition on time and exactly as we had planned while working from home. The resilience and the ingenuity of our folks to figure all this out has probably been the most pleasing.

 

There was some concern that the cultures at Raytheon and the commercial guys at Pratt and Collins would never come together. That is the last thing I worry about. Everything we laid out has gotten done. We’re on track for synergies in cost, technology and revenue. The difference is I have yet to have a staff meeting in person. I’ve got 17 people who work for me, and we do everything on Zoom. Each one of our three board meetings since the merger has been done on Zoom. If you had told me 3-4 months ago that we would be working from home for a good deal of time, I’d have really panicked. But we figured it out.

[Spekulatius]

Every one of the defense contractors I follow has done well, except HII. HII has done considerably worse than GD with their shipyard business, it seems they have operational issues. Luckily that’s the one I don’t own, because I consider it low tech.

They do have a substantial backlog, but need to execute better.

[sleepydragon]

Every one of the defense contractors I follow has done well, except HII. HII has done considerably worse than GD with their shipyard business, it seems they have operational issues. Luckily that’s the one I don’t own, because I consider it low tech.

They do have a substantial backlog, but need to execute better.

 

NII has revenue per employee of something like 100k, I think?

And I imagine it’s not easy for these defense companies to lay-off a lot of workers. Won’t be popular with congress members.

 

 

[Foreign Tuffett]

Every one of the defense contractors I follow has done well, except HII. HII has done considerably worse than GD with their shipyard business, it seems they have operational issues. Luckily that’s the one I don’t own, because I consider it low tech.

They do have a substantial backlog, but need to execute better.

 

Worth mentioning that GD's Bath Iron Works workforce just wrapped up a two month long strike.

 

Yes, HII builds big boats and not (Dr Evil voice) "frickin' laser beams" like some of the other defense contractors. Of course, the same objection could have been made when the company was spun off from NOC and was trading at $30 or $40. You are trading low margins for (1) very high revenue visibility (2) a strong competitive position (3) a biz that doesn't change very quickly.

 

The risks are that (a) margins deteriorate* and (b) US Navy moves away from big boats. Long term, I think margins will be OK, and (for reasons that are too lengthy to get in to here) I also think the Navy will continue to build big boats. If Newport News lays off 50% of its workforce as soon as CVN-81 is delivered in 2032 then I will have been wrong about the latter.

 

 

* We saw this in Q2, largely due to COVID

 

 

 

 

 

 

[Spekulatius]

Every one of the defense contractors I follow has done well, except HII. HII has done considerably worse than GD with their shipyard business, it seems they have operational issues. Luckily that’s the one I don’t own, because I consider it low tech.

They do have a substantial backlog, but need to execute better.

 

Worth mentioning that GD's Bath Iron Works workforce just wrapped up a two month long strike.

 

Yes, HII builds big boats and not (Dr Evil voice) "frickin' laser beams" like some of the other defense contractors. Of course, the same objection could have been made when the company was spun off from NOC and was trading at $30 or $40. You are trading low margins for (1) very high revenue visibility (2) a strong competitive position (3) a biz that doesn't change very quickly.

 

The risks are that (a) margins deteriorate* and (b) US Navy moves away from big boats. Long term, I think margins will be OK, and (for reasons that are too lengthy to get in to here) I also think the Navy will continue to build big boats. If Newport News lays off 50% of its workforce as soon as CVN-81 is delivered in 2032 then I will have been wrong about the latter.

 

 

* We saw this in Q2, largely due to COVID

 

Yes, HII was very cheap when spun off, but so were most defense peers at that time. I see that the 2021 earnings projection for HII is $11.2/share down from $14.5. Any idea why earnings for next year are projected to fall that much?

[Foreign Tuffett]

Every one of the defense contractors I follow has done well, except HII. HII has done considerably worse than GD with their shipyard business, it seems they have operational issues. Luckily that’s the one I don’t own, because I consider it low tech.

They do have a substantial backlog, but need to execute better.

 

Worth mentioning that GD's Bath Iron Works workforce just wrapped up a two month long strike.

 

Yes, HII builds big boats and not (Dr Evil voice) "frickin' laser beams" like some of the other defense contractors. Of course, the same objection could have been made when the company was spun off from NOC and was trading at $30 or $40. You are trading low margins for (1) very high revenue visibility (2) a strong competitive position (3) a biz that doesn't change very quickly.

 

The risks are that (a) margins deteriorate* and (b) US Navy moves away from big boats. Long term, I think margins will be OK, and (for reasons that are too lengthy to get in to here) I also think the Navy will continue to build big boats. If Newport News lays off 50% of its workforce as soon as CVN-81 is delivered in 2032 then I will have been wrong about the latter.

 

 

* We saw this in Q2, largely due to COVID

 

Yes, HII was very cheap when spun off, but so were most defense peers at that time. I see that the 2021 earnings projection for HII is $11.2/share down from $14.5. Any idea why earnings for next year are projected to fall that much?

 

I don't know what inputs were used to get to that 2021 EPS #. Midpoint of preliminary 2021 guidance has shipbuilding and technical solutions* revenue and margins all up modestly Y/Y.

 

 

* ex UPI and San Diego shipyard to make it an apples-to-apples comparison

[Spekulatius]

I know this is totally irrelevant, but Rheinmetall has some pretty cool YouTube Videos demonstrating the Oerlikon 35mm cannon air defense system and other stuff.

 

Here are two for nerds. I can’t wait for the consumer version to come out  ;D

 

FWIW, Rheinmetall has put up some impressive numbers with their defense business recently. I own a few shares.