Industry's growth rate is starting to level. Certain pockets of high-tech weapons may buck the trend
New York — The ink has dried on most major military contracts. Factories are humming. And the aerospace industry, by and large, is sitting pretty. But what lies ahead?
While the outlook for the nondefense sector of the aerospace industry could not be better, the same can't be said for defense sector, as the momentum in Washington for more defense dollars ebbs.
Since 1977, procurement spending has risen at an average annual rate of almost 20 percent. Now 3 percent growth is the most optimistic forecast. The Gramm-Rudman balanced-budget law -- constitutional or not -- has slowed, perhaps even halted, the rise in spending.
``We do not regard the defense industry as a growth industry,'' states Judith L. Comeau, an aerospace analyst at Goldman, Sachs & Co., in a recent report. ``Inventories of fighters, tanks, ships, and electronics have been upgraded; the upward cycle is over. We project a flat-to-declining procurement budget over the next five years.''
There are areas for potential growth. Wolfgang Demisch at First Boston Corporation dubs them ``the Five S's:'' surveillance, software, smart weapons, the Strategic Defense Initiative (SDI), and ``stealth'' technologies, designed to make aircraft more difficult to detect.
But overall, ``we're seeing a flattening of the growth rate'' in defense spending, says Paul H. Nisbet, aerospace analyst at Prudential-Bache Securities. ``It peaked temporarily in fiscal 1985. It came down in fiscal 1986 on a real- and nominal-dollar basis. Fiscal '87 will be about flat with this year. And past 1987, I see very nominal growth in defense spending.''
The current growth lull has yet to reach the factory floors. Lockheed, for example, is looking at a hefty 20-percent hike in earnings this year. General Dynamics has enough projects in hand to ensure strong earnings for the next three years. If the economy remains relatively robust, then pressure for actual reductions in defense spending will be modest, analysts say. And it's possible that international clashes, such as that with Libya, could alter the outlook for defense spending.
Even so, hard choices are not far away.
``All of General Dynamics' major programs peak this year. There's nothing new in the starting blocks,'' points out David L. Smith, a partner at Sanford C. Bernstein & Co. ``Lockheed will see a peak in earnings and revenue in '87 or '88 unless something supplants the C-5'' giant cargo plane.
And ultimately, most corporate boards must face the tough decision of where to go from here.
Mr. Smith cites three basic choices: Diversify into nondefense products, target a military niche and spend to hold it, or share the current wealth with shareholders and patiently look for the next opportunity.
In the past, the flop-rate for forays into nondefense products has been rather high. Still, a few companies are making acquisitions or plan to. For instance, General Dynamics bought ailing Cessna Aircraft last year. How profitable that move was remains to be seen -- the general-aviation market remains a poor one.
So far, more than half a dozen corporations have decided to use their heavy cash flows to buy back shares of their own stock.
``They're just pulling in their horns,'' Mr. Demisch says. ``The industry's response to the slowdown in growth is to reduce capitalization. I view that as an unfortunate development.''
He advocates a riskier development strategy -- a course, he says, few companies are willing to take. It includes developing automated aircraft, robotic tanks, sophisticated computers, and electronic surveillance. But he says it's difficult for the companies to lead their primary customer, the Pentagon, into a ``next-generation military concept'' when the ``military today is living off the intellectual capital of the 1930s.''
Some companies, such as Martin Marietta, are buying back stock and moving to capture money earmarked for the Strategic Defense Initiative. The ``star wars'' program is one of the few areas in the defense budget which is likely to grow in the years ahead.
And other companies are positioning themselves to ride the ``stealth'' aircraft program into the future. Northrop, for instance, should prosper with its well-established lead in the program.
But neither SDI nor stealth funding can pull every company into the 1990s. ``With funding levels at $2 billion to $3 billion -- relative to a military budget of some $300 billion -- SDI is a car that won't accommodate too many passengers,'' Demisch says. The competition between companies will ensure that ``for the next five years, SDI will be a loss-leader for all participants.''
On the nondefense side, however, the aerospace industry is doing well. The big three aircraft manufacturers -- Boeing, McDonnell Douglas, and Airbus Industrie (a European aircraft consortium) -- are benefiting from a strong surge in jetliner orders.
Last year was a banner year. In 1985, the three companies received orders totaling more than 700 jets, up from just under 300 in 1984.
``The commercial aircraft segment is in the best shape it's been in a number of years,'' says First Boston's Demisch. Aircraft demand is up primarily because airline traffic is up. Deregulation has brought competition and the now ubiquitous fare wars among the airlines. As airlines cut prices to capture market share, the planes fill up. ``The airline industry is facing a sellout in seats,'' says Sanford C. Bernstein's Mr. Smith.
Also, stricter noise abatement laws both here and in Europe are forcing the airlines to replace older aircraft.
``Clearly, Boeing is the chief beneficiary of this trend,'' Smith says. ``They've made some tremendous gains in productivity. Their costs are going down drastically'' at a time when new orders are coming in.
Mr. Nisbet at Prudential-Bache agrees, noting a shift in demand toward the larger, more profitable models. ``Boeing got three sizable 747 orders in the last few weeks. In the last six months, over fifty 757s were ordered, that's more than the last three years combined. This is the best of all worlds for Boeing.''
Another beneficiary of the commercial aircraft boom is United Technologies. Some 30 percent of its earnings come from the market-leading Pratt & Whitney engine division.
On the aerospace industry's ``final frontier,'' the outlook is promising, too. The explosion of the shuttle Challenger in January and the now-stalled shuttle program have not proved a major setback for most participating aerospace companies, Nisbet says.
Yes, it has damaged Morton Thiokol's reputation and reduced business. And it has caused layoffs and slowed production of the $30 million Martin Marietta external fuel tanks.
But overall, Nisbet says, ``the impact has been to create more business for the industry.'' He says Martin Marietta will profit handsomely from producing Titan expendable launch vehicles to complement the shuttle program. Orders should also rise for Atlas-Centaurs, made by General Dynamics, and Delta rockets, manufactured by McDonnell Douglas. And Rockwell International ``will get $2 billion or $3 billion to build at least one shuttle, maybe two,'' he says.