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President Biden’s proposed defense budget for the next fiscal year is likely to benefit technology suppliers amid spending constraints imposed by Congress, according to defense industry analysts at several financial services firms.
Within the request for a 1% increase to approximately $850 billion, the Pentagon expects staffing and maintenance costs to “squeeze modernization spending,” Wells Fargo analyst Matthew Akers said in a March 11 report.
The military budget is a significant indicator of the performance of many aerospace and defense stocks. The request from the Biden administration, which faces months of negotiations with lawmakers, is consistent with funding levels approved by Congress in the Fiscal Responsibility Act of 2023 that limited federal spending.
The proposed budget is largely a symbolic document whose spending levels are subject to change, if recent history is anything to go by, through what are known as continuing resolutions to avoid a government shutdown.
“While the Department of Defense has its hands tied on what it can request, ultimately the true spending total will be known later with incremental funding from Congress,” Bank of America analyst Ronald Epstein said in a March 12 report.
Prioritize staffing and maintenance
The Pentagon has said in briefings this week that increased spending on personnel and maintenance is needed to retain soldiers while remaining conflict-ready. By postponing spending on research and future weapons systems, it has more time to plan and prioritize those programs.
“The FRA, poor recruiting numbers and a higher-than-expected operational tempo are consuming budget resources,” Jason Gursky, an analyst at Citigroup, said in a March 12 report. “This is putting downward pressure on the outlook for arms accounts in the near term, given the more flexible nature of such spending.”
He said the proposed budget does not change the investment thesis for the aerospace and defense stocks researched by Citigroup.
The “winners” of technology
Meanwhile, analysts at financial services firm Wells Fargo highlighted how the proposed budget would affect a broad swath of government contractors.
IT services companies such as Booz Allen Hamilton Holding (NYSE:BAH), CACI International (NYSE:CACI), Leidos (NYSE:LDOS) and Science Applications International (NASDAQ: SAIC) are poised to benefit from the proposed 2% increase in operations and maintenance funding, according to Wells Fargo.
Analysts at Bank of America agree that technology-related companies have emerged unscathed from the Pentagon’s targeted reductions. Providers of command, control, communications, computers and intelligence – or C4I in military jargon – can be seen as “winners”.
“C4I saw the largest increase in budget requests, up approximately 46% to $21.1 billion over the previous budget,” according to BofA. “We see the increase as a very positive factor, as it has shown us, despite the constraints, that technological development remains a priority to improve US military capabilities.”
Wells Fargo outlined how other defense contractors would fare in the proposed budget.
General Dynamics (NYSE:GD), which has an information technology unit, would also benefit from increased spending on the Columbia-class nuclear ballistic missile submarine and Arleigh Burke-class destroyer for the U.S. Navy. Lower spending on Virginia-class submarines would partially offset these gains, “although we believe Virginia funding could potentially be replenished by Congress later,” according to Wells Fargo.
Lockheed Martin (NYSE: LMT), the largest U.S. defense contractor by revenue, would benefit from increased spending on persistent infrared satellites, Trident submarine-launched nuclear missiles and the C-130 Hercules military transport aircraft. However, funding for the joint air-to-surface missile, Aegis combat system, long-range anti-ship missile and Apache attack helicopter would be lower.
RTX (NYSE:RTX), formerly called Raytheon Technologies, would also be “challenged” with cuts to the Aegis, the SM-6 missile and the AIM-120 advanced medium-range air-to-air missile, according to Wells Fargo.
The Pentagon has cut by 9% the spending plan for the F-35 fighter plane, whose prime contractors are Lockheed (LMT) and RTX (RTX). However, that spending is likely to be reinstated in future years once the technology upgrade is complete, according to Wells Fargo.
Financing for some of Northrop Grumman (NYSE:NOC) programs “look disappointing,” with unchanged spending on the B-21 Raider stealth bomber and cuts to the Sentinel land-based intercontinental ballistic missile, according to Wells Fargo.
Boeing (NYSE: BA) would see cuts to the F-15 fighter jet, the Apache helicopter, the ground-based medium-range defense missile system and the E-7A radar aircraft, according to Wells Fargo.