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4 Winners and 2 Losers From the Pentagon Budget Proposal

The U.S. budget-negotiation season kicked off Feb. 10 when the White House submitted to Congress a $740 billion national security budget request. The document laid out a potential roadmap for defense spending over the next five years, offering some good news and bad news for various defense contractors.

It's important for investors to view the request as the opening salvo in a negotiation and not a final spending plan. Congress has the power of the purse, and lawmakers can and will cut and add to procurements over a long, drawn-out process.

This budget carries even more uncertainty than usual, as it's an election year. And lawmakers are sure to seize on the proposed cuts to nondefense discretionary spending at a time when defense spending is set to hold steady.

With that said, the budget request is a glimpse at how defense leaders prioritize various programs and provides a guide for what to expect in the years to come. Here are the programs and contractors that look like winners in the budget, as well as a few that could see difficult times ahead.

Winner: Nukes

The Pentagon has said modernizing the nation's aging nuclear triad is a top priority, and backed it up with more than $45 billion in fiscal 2021 funding split between the Pentagon and a semiautonomous Department of Energy department that manages nuclear security.

The triad is the nation's land, sea, and air deterrent, designed to give the United States broad ability to launch a nuclear counterstrike should the country come under attack. It was a plan designed in the early days of the Cold War, and much of the equipment currently in use dates back to that era.

Image source: Getty Images.

The budget requests more than $4 billion to be invested in the Columbia-class submarine program, led by General Dynamics (NYSE: GD), with help from Huntington Ingalls (NYSE: HII), with the Columbia seen by many inside the Pentagon as the nation's top military priority. There's also $2.8 billion earmarked for development of the B-21 bomber, a Northrop Grumman (NYSE: NOC) program, as well as $1.5 billion for the intercontinental ballistic missile-replacement program, expected to be awarded to Northrop.

The one-year totals are a small part of the estimated $494 billion the U.S. will have to spend over the next decade to fully implement its modernization program. But the large totals funneled into research and development (R&D), in a budget where a lot of programs once thought to be U.S. priorities were sidetracked due to cost, is a sign of the long-term stability of General Dynamics' and Northrop Grumman's flagship programs.

Winner: Textron's tiltrotor

The U.S. Army has been laying the groundwork to modernize its helicopter fleet over the next decade, and the 2021 budget request would turn those plans into action. The new budget proposes to spend $1.57 billion annually on the Army's Future Long-Range Assault Aircraft (FLRAA), designed to replace its UH-60 Black Hawk, up from $950 million annually last year.

The Army hopes to award a contract by fiscal 2022 and eventually buy upwards of 700, at a total program cost of about $40 billion.

Textron (NYSE: TXT) is expected to battle a joint bid from Lockheed Martin (NYSE: LMT) and Boeing (NYSE: BA) in a final bake-off, and I like Textron's chances of winning the final award. Textron is offering the V-280 tiltrotor, which has the ability to reach airplane-like speeds while maintaining helicopter-like maneuverability. The V-280 has been flying since 2017 and matured to the point of demonstrating futuristic features, including autonomous flying.

Rendering of Textron's V-280 tiltrotor aircraft. Image source: Textron.

Lockheed and Boeing, by comparison, are offering their Defiant prototype, which has a coaxial design with two main rotors spinning in opposite directions. A coaxial helicopter on paper is more stable and able to fly faster than a traditional one-rotor design, but it's tricky to get right. The Defiant only got airborne last year, two years behind schedule, and will have to play catchup quickly to compete with the V-280.

The Defiant, if it works as planned, should be the favorite to win a separate planned competition to replace the AH-64 Apache. But FLRAA could provide a much-needed boost to Textron.

Winner: Lockheed Martin

Lockheed Martin's trillion-dollar F-35 program continues to be a favorite with Congress, in part because its supply chain is spread among a number of districts. Last year, the Pentagon asked for funding to buy 78 jets, and Congress provided cash for 98.

This year's request is for 79 jets, and I'd expect the final number to again come in higher after lawmakers have their say. As the fleet grows, Lockheed Martin and United Technologies, makers of the plane's engines, are also seeing secondary benefits. The Pentagon is upping its request for funding for aircraft modernization and continued maintenance to accommodate the larger number of planes available for deployment.

The budget also includes $106.6 billion earmarked for research and development, which the Pentagon says is the largest single-year research request in history. That total is going to be spread around the contractor base, but with a heavy emphasis on hypersonics -- missiles that travel at least five times the speed of sound.

Expect Lockheed Martin to be a major beneficiary of the uptick, as it's viewed by the Pentagon as the clear leader in hypersonics. Look for Raytheon (NYSE: RTN) to also benefit from the focus on research spending, as the company is both the most likely rival to Lockheed Martin in hypersonics and also a leader in microelectronics, sensors, and other areas ripe for Pentagon investment.

Winner: Space Force

This is Space Force's first year as an official budget priority, and the overall spending request, at $15.4 billion, is significantly above the $12 billion space figure from a year ago. Some of that is start-up costs and operations, but $10.3 billion is slotted for research and development.

Expect that funding to be split among a large number of contractors, but the investment and focus on space should benefit companies including L3 Harris Technologies (NYSE: LHX) and Northrop Grumman. An under-the-radar potential space winner is Leidos Holdings, (NYSE: LDOS) a government-services company that just completed a $1.65 billion deal for Dynetics. The target is a research shop headquartered down the street from NASA's massive George C. Marshall Space Flight Center and has made deep inroads into the military space sector.

Loser: Shipbuilders

The Navy is requesting funds to buy eight warships, down from the 12 funded in fiscal 2020. The Pentagon has an ambitious goal to build the fleet to 355 ships, but the high costs of building and staffing ships is standing in the way of that goal.

Speaking to reporters after the budget was released, Vice Adm. Ronald Boxall said that "we have a desire to get" to 355 ships, but he suggested the fleet growth won't be driven entirely by new orders for large ships from General Dynamics or Huntington Ingalls. He mentioned the growth of unmanned vessels, including a submarine built by Boeing and autonomous surface vessel trials as an important part of the long-term plan.

Leidos' Sea Hunter autonomous ship. Image source: U.S. Navy photo by John F. Williams.

Not only are those ships more affordable, but they also have lower ongoing operating costs because they don't need to be crewed.

Textron was also among the losers on the Navy side, with its Ship-to-Shore Connector hovercraft among the cuts. The Navy isn't seeking to procure any in 2021 and wants to cut its orders in fiscal 2022 and 2023.

There's still work for the major shipbuilders, with Huntington Ingalls' carrier program continuing and the emphasis on subs as part of the nuclear triad. But it's safe to say that the promise of a 355-ship fleet, which seemed so lucrative to shipbuilders when first discussed, might not turn out as originally envisioned.

Loser: Oshkosh

Oshkosh (NYSE: OSK) was among the losers in last year's budgeting process as the Pentagon reduced its request for Oshkosh-made Joint Light Tactical Vehicles (JLTVs) from 5,900 in fiscal 2019 to 4,090 in fiscal 2020. The news isn't much better this year, with the request coming in at 4,247 vehicles for fiscal 2021. That's about $1.37 billion in spending, down from $1.928 billion in fiscal 2019.

The Army is in the process of making difficult decisions as it tries to figure out how to pay for priorities, including the aforementioned helicopter-modernization push. Overall, the Army plans to cancel 41 programs and cut or delay another 39, freeing up $13.5 billion over the next five years.

The JLTV is an impressive vehicle, but it's increasingly becoming a product of a lost age. The vehicle was designed specifically to address the shortcomings that the last-generation Humvees were found to have while operating in the desert, including the legacy-vehicle's vulnerability to improvised explosive devices. With the Pentagon currently fixated on its so-called great-power competition against China and Russia and not the Middle East, the JLTV seems to be fading as a priority.

The Army had originally planned to spend at least $28 billion over the next 20 years to acquire more than 49,000 JLTVs. The vehicle is clearly still wanted in the arsenal, but with each passing budget, it seems less likely that the original goal will be met.

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Lou Whiteman owns shares of General Dynamics and L3Harris Technologies. The Motley Fool recommends Textron. The Motley Fool has a disclosure policy.


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