It’s a horrible word, “sequestration”. But defence industry bosses are getting used to it, even though none really knows yet quite what it might mean. US defence spending has been cut by $490bn over 10 years, but a further $500bn of cuts loom under the guise of sequestration in an attempt to cut the US budget deficit. The big defence contractors are bracing for the hit to revenue, but they have massive order backlogs to weather the downturn. Mid-sized contractors look more vulnerable.
Interim results over the past few days suggest that diversification may be key to maintaining shareholder returns. Some midsized companies are in fact more diversified already than their larger rivals. UK group Meggitt generates only 40 per cent of revenue from its military division, but its specialist engineering applies equally to commercial aerospace and the energy sector. Its energy division – which accounts for 15 per cent of group revenue – has just won its biggest contract, from Petrobras. US avionics specialist Rockwell Collins gets nearly half its annual revenue from civil customers. So does French contractor Thales.
Others lack that balance. Numbers from Cobham on Wednesday showed a company still dependent on defence spending for over two-thirds of first-half revenues. Its acquisition of Danish satellite communications specialist Thrane & Thrane in the spring has boosted its commercial arm’s revenues from a quarter to nearly a third of the group total, and new chief executive Bob Murphy says more can be expected.
Companies in the midsized defence sector trade on forward earnings multiples of between 10 and 14 times, compared with between 8 and 9 for their bigger rivals. The higher rating will be justified if they can exploit military technology for commercial purposes. The US defence budget always looked a bit bubbly. Welcome back to the real world, guys.
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