Overview

The aerospace and defense industry found its largest base in the U.S. with a military budget fittingly impressive. The country's global leadership position requires it to maintain the capacity to respond to the ever-changing national security environment. But unlike many other countries, the U.S. relies on the private sector to meet its defense needs.

The U.S. Army, Air, and Naval forces enter into long-term contracts with aerospace and defense companies to meet their various needs for systems and equipment. As such, the outlook for the industry is closely tied to the outlook for defense spending by the U.S. government.

Earlier this month, the Obama administration proposed defense budget for FY14 of $526.6 billion, down $0.9 billion from the FY13 annualized continuing resolution level of $527.5 billion. However, the FY14 request does not yet include a detailed budget for Overseas Contingency Operations ("OCO"), which is essentially government-speak for foreign wars and war on terror operations. The government is preparing a separate OCO request that is expected to be released soon.

Under the continuing resolution, OCO funding for FY13 is $88 billion. This is lower than the $115 billion enacted for FY12 OCO activities as a result of reduced operations in Afghanistan and conclusion of operations in Iraq. Going forward, OCO funding is expected to continue to decline as troops redeploy out of Afghanistan. In fact, the request for future OCO funding will likely be closely correlated to the amount of troops required for each operation.

Budget Issues - the Sequester

The budget sequester that went into effect at the start of March 2013 and that has a direct bearing on the U.S. government's defense spending is a function of the country's fiscal and economic challenges.

As a background, Congress passed the Budget Control Act of 2011 in order to resolve the debt-ceiling crisis. The Act provided for a Joint Select Committee on Deficit Reduction known as the super committee to produce legislation by late Nov 2012 that would decrease deficit by $1.2 trillion over ten years.

However, Congress failed to reach an agreement. This would have led to automatic cuts known as sequestrations, split evenly between defense and domestic spending, beginning on Jan 2, 2013. However, the 'Fiscal Cliff' was averted at the last moment and the date was postponed by two months by the American Taxpayer Relief Act of 2012.

But it finally took effect last month. The cuts as a result of the budget sequester are evenly between the defense and non-defense categories. The spending reductions are approximately $85.4 billion during fiscal year 2013, with similar cuts for years 2014 through 2021.

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Aerospace & Defense Stock Overview - Apr 2013 - Industry Outlook