Budget Lifts Defense Stocks, but the Boost May Not Last

Is Wall Street about to blow a few holes in defense stocks?

That would seem counterintuitive, considering that the Bush administration on Monday proposed fattening the Pentagon’s budget 7% in fiscal 2005.

But the proposal ended up fueling only a momentary surge in defense stocks.

The trouble, so far as the market is concerned: Although the Pentagon wants to increase spending until at least 2009, pressure is growing in Congress to reduce the nation’s deficit and to curtail cost overruns on new weapons.

Byron K. Callan, an analyst for Merrill Lynch & Co., cautioned that the Pentagon’s spending goals could change “depending on broader fiscal pressures, immediate needs of Iraq and Afghanistan and cost growth of specific defense programs.”

Investors seemed to heed the warning. Many of the defense stocks that rose Monday with the unveiling of the proposed defense budget later eased off. For example, shares of Century City-based Northrop Grumman Corp., the nation’s third-largest defense contractor, went up nearly $3 before closing at $98.19 on the New York Stock Exchange, $1.48 higher for the day.

Boeing Co., headquartered in Chicago and the largest private employer in Southern California, gained 79 cents to close at $42.54. Raytheon Co., based in Waltham, Mass., and with a sprawling defense electronics operation in El Segundo, rose 48 cents to end at $30.99.

Since the Sept. 11 terrorist attacks, military spending has climbed 20% in an ascent not seen since the defense buildup in the 1980s by the Reagan administration.

But shares of most major aerospace conglomerates are still trading at the same level as in the late ‘90s -- largely because the uptick in defense spending has been insufficient to offset a dramatic slowdown in the companies’ commercial aerospace businesses.

Still, industry analysts and company executives did find good news in the Bush administration spending plan. “On balance, we see the budget as a positive for the defense sector,” Callan said.

The Pentagon’s $401.7-billion proposal focuses heavily on developing new high-tech weapons, such as unmanned aerial vehicles, precision bombs and missiles, and battlefield information technology. And in the short term, the biggest beneficiaries probably would be Boeing and Northrop.

“We are very pleased with the level of support and funding for Northrop Grumman’s key programs,” said Ronald Sugar, the company’s chairman and chief executive.

Northrop, with 24,000 employees in the region, makes spy satellites, high-tech stealth destroyers and unmanned spy planes -- all programs that could enjoy the biggest boosts in spending.

The Pentagon wants a 53% jump in spending, to $2 billion, on remote-control planes, which reportedly played a key role in providing real-time intelligence in the Afghanistan and Iraq wars.

Northrop’s Global Hawk reconnaissance plane, for instance, can fly long distances and provide satellite-like images from high altitude. The unmanned aircraft is built in Palmdale.

For its part, Boeing could see a boost to its missile defense programs and development of new Army weapons and systems.

The Pentagon wants to spend $4 billion in fiscal 2005 to buy 14 Boeing C-17 military transport jets, up from the previous order of 11.

The big cargo planes, assembled in Long Beach, take about a year to make.

Smaller closely held firms that work on developing unmanned aerial vehicles -- such as San Diego-based General Atomics Aeronautical Systems and Monrovia’s Aerovironment Inc. -- would get more business under the proposed budget.

The Pentagon has been focusing on the development of the nation’s most high-tech weapons, from more powerful spy satellites to precision-guided bombs.

As such, Boeing, with major research facilities in Seal Beach, Anaheim, El Segundo and Long Beach, has been on a hiring binge. Much of the work on developing equipment and weapons for the Army, including robotic land cruisers, is spearheaded by Boeing engineers in Anaheim.

Boeing’s Integrated Defense Systems unit could get a lift as the proposed budget calls for nearly doubling spending on so-called Future Combat Systems to $3.2 billion in fiscal 2005. Many Boeing engineers in Anaheim also work on developing missile defense systems; in all, Boeing has 36,000 employees in the Southland.

Under the proposed budget, spending on missile defense would grow 13% to $10.2 billion.

Raytheon also has benefited from the uptick in defense spending.

For the first time in years, the company has been asking many engineers to work overtime because it has been unable to hire enough engineers.

Raytheon, with about 6,000 engineers in El Segundo, develops and manufactures laser weapons, missile guidance systems and radars.

Some analysts contend that though spending on traditional weapons such as fighters, bombers and tanks is likely to be under pressure, the Pentagon will continue to pour money into the electronics that allow soldiers to be more lethal while keeping them out of harm’s way.