Lockheed, Northrop May Gain on China Even as Defense Cuts Loom

By Tony Capaccio and Gopal Ratnam

Victorious House Republicans are likely to advocate a more muscular approach toward China, offering a potential boost to defense contractors such as Lockheed Martin Corp. and Northrop Grumman Corp. even as Congress comes under pressure to rein in the Pentagon’s budget.

“We have to look at the totality” of China’s efforts, said Representative Randy Forbes, a Virginia Republican who may become head of the House Armed Services readiness subcommittee. Once lawmakers focus on emerging challenges in areas from cyber warfare to aircraft carriers to missiles, they’ll say, “We better be changing our readiness capability.”

That would entail shifting more money toward weapons programs, rather than increasing spending, benefiting makers of sea-based anti-missile systems, submarines, destroyers and long- range drones. Another winner could be Alliant Techsystems Inc., which is developing targets to test defenses against a supersonic Chinese anti-ship missile.

Still, with U.S. troops deployed in two wars and concern over the federal deficit growing, Congress is being urged to curb the overall defense budget. Midterm elections yesterday gave Republicans a majority in the House and narrowed the Democrats’ margin in the Senate, according to television network projections.

House Republicans pledged to cut $100 billion in domestic discretionary outlays -- the spending set by Congress annually that isn’t mandated -- yet have exempted military funding, which makes up more than half of non-mandatory expenditures.

The political impetus to cut defense spending may grow when a bipartisan commission appointed by President Barack Obama next month releases recommendations on how to rein in the federal deficit. The Pentagon budget, which totaled $691 billion last year, may be one target.

‘1% Real Increase’

And Democrats retain control of the White House, which will submit a basically flat 2012 defense budget. The Senate also can block any moves by the House.

“The administration is saying there will be a 1 percent real increase in defense,” said Todd Harrison, an analyst for the Center for Strategic and Budgetary Assessments in Washington. “If that’s the case, I don’t think either party would produce a significant increase beyond that, given the growing pressure to reduce the deficit.”

As a result, investors have soured on the defense sector and sent stocks of the top five contractors including Lockheed, Northrop, General Dynamics, Raytheon and L-3 Communications Inc., down by 3.8 percent since the beginning of the year, according to Bloomberg data. The broader Standard & Poor’s 500 index has gained 7 percent.

Shifting the Money

Concern over the deficit won’t stop House Republicans from exploring ways to raise missile-defense spending and ensure the administration carries out plans to shift more money to weapons systems.

The Republicans will also probably press to continue funding General Electric Co.’s F136 backup engine on the F-35 fighter over the objections of both the administration and the military, and maintain strict oversight of the entire $382 billion aircraft project, the Pentagon’s No. 1 defense program.

The party has also come under fire from supporters in the Tea Party movement over the engine, which is partly made in Indiana. Indiana Representative Mike Pence, the House’s third- ranking Republican, defended the project in July, saying, “It is in the interest of taxpayers in the long run to have more than one source, more than one manufacturer of that engine.”

China’s Capability

On China, Republicans say the debate over how the U.S. should respond to the country’s military capability will shape the budget for weapons procurement and research, which is $187 billion in the 2011 budget that Congress is considering.

Defense Secretary Robert Gates is trying to maintain growth of 2 percent to 3 percent through 2015 in those accounts. The new House majority will try to make sure his plan to move $100 billion from accounts not directly related to arms making into weapons and research programs by 2015 is implemented.

China is strengthening military capabilities to extend its reach beyond its shores toward the Indian Ocean and the Pacific, in areas where the U.S. is seeking stronger alliances, the Pentagon said in an annual report to Congress in August.

Republicans want the Pentagon to release more information on China’s strategy of developing weapons designed to deny U.S. forces access to areas near Chinese waters, Forbes said.

Lockheed, Raytheon

The changes the Republicans will seek could benefit sea- based missile-defense companies such as Bethesda, Maryland-based Lockheed and Waltham, Massachusetts-based and Raytheon Co., said Loren Thompson, a defense analyst with the Lexington Institute in Arlington, Virginia.

Also standing to gain are ship and submarine-makers Northrop Grumman, based in Los Angeles, and General Dynamics Corp., based in Falls Church, Virginia, said James McAleese, a consultant to defense companies.

A representative of the Aerospace Industries Association said concern about “near-peer competitors” like China was likely to drive defense policy and budget decisions.

House Republicans may place a “greater focus on modernization, research and development and looking at near-peer competitors than ongoing operations,” said Cord Sterling, vice president of the Arlington, Virginia-based group, which represents companies such as Lockheed, Raytheon and Northrop Grumman. “Strategic defense, including missile defense, space, shipbuilding and aircrafts are all areas where investment is needed to focus on near-peer threats,” he said.

Protecting Home Turf

Lockheed and Raytheon are the Pentagon’s primary makers of the Aegis air-defense network on Navy carriers, destroyers and cruisers and the Standard-missile family of interceptors designed to stop anti-ship missiles.

Republican House defense leaders will also try to protect contractors in lawmakers’ districts, Thompson said.

Representative Howard McKeon, a California Republican, will become chairman of the Armed Services Committee. Bill Young, a Florida Republican, may replace Norm Dicks, a Washington Democrat, as head of the panel of the Appropriations Committee that approves defense spending.

Northrop Grumman was the top defense contractor in McKeon’s California district with contracts worth $1.01 billion in 2009, according to data compiled by Bloomberg Government. Lockheed was second with $253.2 million, and Raytheon received $87.6 million.

General Dynamics was the largest defense contractor in Young’s Florida district, spending $286.2 million, followed by Raytheon’s $221.8 million, Bloomberg Government data shows.

Afghanistan, Iraq

House Republicans have also signaled plans to review the administration’s July 2011 date to begin a gradual drawdown of U.S. troops from Afghanistan. And with the end of the U.S. military commitment in Iraq in December 2011, the Republicans will focus on State Department plans to administer the increased U.S. diplomatic presence, including whether it’s receiving enough money and manpower to accomplish the mission.

To contact the reporters on this story: Tony Capaccio in Washington at acapaccio@bloomberg.net; To contact the reporter on this story: Gopal Ratnam in Washington at gratnam1@bloomberg.net.