US Defense Biz Outlook Grim, Foreign Sales Won’t Save It: Deloitte

Even if Congress somehow averts sequestration, the defense industry is headed for layoffs and, at best, anemic growth, and the much-vaunted surge in foreign military sales won’t turn that around.

If the automatic cuts known as sequestration do take effect as currently scheduled in January, the impact would be “a devastating blow.”

That’s the bleak verdict from Tom Captain, head of the aerospace and defense practice at Deloitte LLP, who previewed the consulting firm’s mid-year overview of the industry in a conversation this morning with Breaking Defense. (Updated: Click here for the report.).

The US defense industry revenues grew a nominal 0.3 percent over the first six months of 2012 -and that’s before factoring in inflation. In constant dollars, revenue actually shrank. That’s better than last year, which saw a 3.3 percent decline in the US (“call it five” after adjusting for inflation, Captain said). It’s also better than Europe, where defense revenues dropped 4.5 percent in the first half of this year. But that’s distinctly chilly comfort.

“In 2011, there were at least 44,000 layoffs” from US defense firms, Captain told Breaking Defense. “[That’s] just the ones you read about.” And we’re only halfway done, according to Captain’s calculations:

Last year’s Budget Control Act cut $487 billion from defense spending over the next 10 years, roughly $50 billion of which is already reflected in the president’s budget request for 2013. Since about half of Pentagon spending goes to contractors, that’s about a $25 billion hit to industry — whose annual revenues are only about $210 billion. That’s a 12 percent hit to revenues. If the defense industry’s 724,000-strong workforce takes a proportional blow, that’s 86,000 layoffs.

If sequestration hits, the cuts double, so multiply all the damage done by two. Captain was very skeptical of suggestions that the industry would be buffered from the near-term impact by work already paid for and in the pipeline from prior years. After all, both managers and investors have to plan ahead, which uncertainty over sequestration renders impossible. They have to account for the uncomfortably plausible worst-case scenario that the sequester takes full effect, and that is going to hurt.

So between the cuts required last year and sequestration looming now, the Budget Control Act is a one-two punch, Captain said. “When you add all that up,” he said, “the defense industry will have shrunk by about 25 percent. One in four defense workers, gone.”

Of course the industry isn’t standing there slackjawed waiting for the punch. “One in four would be absent any offsetting growth strategies, which companies are feverishly working on,” Captain said.

First on his list? Foreign Military Sales, which have grown to record highs. “US companies are becoming more successful at that,” Captain said, “especially in those areas of the world where defense budgets are going up, like India, the UAE, Brazil, Singapore, South Korea, and Japan.”

But there are plenty of companies — US, Western European, Russian, and more — all going after that same small pool of customers. In one of the biggest recent competitions, for the Indian air force’s new Medium Multi-Role Aircraft (MMRA), America’s Boeing and Lockheed faced four European rivals and were both eliminated before the final round, which ultimately went to the French Dassault Rafale. Comparable US contracts, by contrast, tend to have only two or three bidders — most of them, obviously, American — so the odds are a lot worse abroad.

“It’s a buyer’s market,” Captain said. “The reality is that foreign military sales [are] promising, but it’s very competitive.”