Defense industry gets a boost

October 8, 2001 Posted: 1634 GMT

By Staff Writer Mark Gongloff

NEW YORK (CNNmoney) -- With American warplanes flying over Afghanistan, defense-industry stocks got a boost Monday morning, though the long-term impact of the United States' war on terrorism on the sector won't be known for some time, analysts said.

Shares of Northrop Grumman Corp. (NOC: up $0.26 to $107.76, Research, Estimates), Lockheed Martin Corp. (LMT: up $1.73 to $49.46, Research, Estimates) and other defense stocks rose Monday as the United States and its coalition partners geared up for a second day of air strikes against targets in Afghanistan.

The attacks are the early stages of a war against the ruling Taliban regime in Afghanistan and a broader war on terrorism around the globe. Though these conflicts are certain to lift the defense industry in the short run, the long-term outlook is less clear.

"There's probably going to be more money coming to the industry, but it's difficult to put precise numbers on it right now," SG Cowen analyst Cai von Rumohr said.

Among the short-term boosts to the industry will be fulfilling immediate needs arising from the attacks on Afghanistan -- spare parts for airplanes, precision bombs and other equipment being worn down or used up in the attacks.

In the longer run, a higher priority likely will be given to defense spending in general by the U.S. government. Defense suffered cutbacks early in the administration of President Bill Clinton, though spending had increased in recent years.

"Funding for weapons has been moving up for four years," von Rumohr said. "This creates momentum for bigger numbers in the future."

Some bullish observers have compared the defense industry's position in 2001 to its position in 1981, when new President Ronald Reagan began a long campaign to beef up a weak military after the hostage crisis in Iran and the Soviet Union's gains in weapons development.

"With the [Bush] administration, we'll see a rebuilding of the military to bring it back to where it was eight years ago," said JSA Research analyst Paul Nisbet. "We'll see a considerable appreciation in defense stocks, as we saw in the Reagan years."

Those stocks most likely to benefit, Nisbet said, are companies without significant commercial airline businesses, especially Northrop Grumman, Lockheed Martin, General Dynamics Corp. (GD: up $3.14 to $95.74, Research, Estimates) and Raytheon Co. (RTN: up $1.76 to $36.73, Research, Estimates).

Other analysts aren't so sure that the unique nature of America's enemy and the fight that must be waged against it make comparisons with Reagan-era defense spending obsolete.

"The answers to the questions of 1979-80 were very different than what we are expecting in the months to come," Merrill Lynch analyst Byron Callan said.

And the level of public support for the defense industry will depend on several variables, including the perceived success of the U.S. military campaign and the length of time it takes. A long, drawn-out campaign will divert government money to operations costs and away from new weapons.

Another key variable is the type of spending that will be done. If modernization programs are accelerated, the government might be less inclined to buy older weapons when it knows more effective systems will be available soon.

"Several next-generation systems are still in development," Callan said. "Would it really make sense to buy more current generation platforms?"

And defense companies also will have to be able to handle the influx of money and the increased production while staying profitable.

"Rapid growth in new orders and sales does not automatically translate to higher profits," Callan said. "New employees will need to be hired and trained. Suppliers need to expand capacity too. Can all this be handled without margin degradation?"

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