By Doug Cameron
Two big Pentagon contractors on Wednesday pledged to continue
their stock buyback programs, in part because there is nothing they
want to buy.
Northrop Grumman Corp has led the defense industry's buyback
charge, and said it is likely to extend the program after retiring
a quarter of its shares between 2013 and 2015. General Dynamics
Corp. spent more than its free cash flow in the first quarter on
stock repurchases.
The Pentagon budget is expected to stabilize after years of
decline, giving executives more clarity for long-term planning, but
the resumption of large-scale deal activity among defense firms
predicted by many bankers and analysts hasn't materialized.
"I'm not thinking about M&A because I'm not seeing anything
[to buy]," General Dynamics' Chief Executive Phebe Novakovic said
on a post-earnings' call Wednesday.
She isn't alone. Raytheon Co., with recent plans to spend more
than $2 billion on cybersecurity assets, remains the outlier among
the group of five big U.S. contractors that includes Lockheed
Martin Corp. and Boeing Co.
The planned $4.6 billion purchase by Harris Corp of Exelis Inc.
and a number of smaller transactions also haven't swayed
executives, who have successfully driven productivity to boost
margins and earnings despite the drop in revenue, helped in part by
the tailwind from new pension rules that reduce their retirement
costs.
"It's really weird," said one veteran defense deal maker, noting
how contractors have expanded their internal M&A teams.
"They're not just twiddling their thumbs."
The big companies have been tidying up their existing
portfolios. Ms. Novakovic sparked a clear out of some of the
company's earlier acquisitions when she took on the CEO role in
2013, and peers including Boeing and BAE Systems PLC plan to shed
assets such as cybersecurity systems that don't gel with other
businesses.
There is also still a significant valuation gap between buyers
and sellers for many assets, according to bankers and executives,
particularly in areas such as cyber or defense electronics where
assets are scarce.
However, another reason for the absence of deal activity remains
strong operating performance.
"The CEOs are producing," said the deal maker. All of the big
five contractors reported forecast-beating first quarter
results.
General Dynamics's first quarter profit rose 20%, and though
Northrop Grumman reported a 19% decline, most was due to a $500
million pension contribution, and the company also raised its
full-year guidance.
Defense executives said on first quarter calls that they were
broadly happy with their existing portfolios, and have also
suggested analysts and investors may be overplaying the impact of
some big upcoming Pentagon awards.
The biggest by far is plans by the U.S. Air Force to spend as
much as $90 billion on a new long-range strike bomber, sparking a
fierce contest between Northrop Grumman and a team of Boeing and
Lockheed.
Wes Bush, Northrop's chief executive, on Wednesday played down
widespread speculation that the loser would effectively have to
withdraw from a primary role in the combat aircraft business. That
would leave Lockheed Martin--the main contractor on the huge F-35
fighter program--as the sole U.S. assembler of combat jets.
Mr. Bush said investors should be careful about assuming that
the bomber award would reshape the industry, noting it was among an
array of opportunities for Northrop, which unlike Boeing has a
large presence on the F-35 program.
A decision on the bomber is expected over the summer, though
Pentagon officials and lawmakers have said in recent weeks that
this could slip.
General Dynamics shares were recently up 3.2% at $137.75, while
Northrop was down 0.3% at $160.04.
Write to Doug Cameron at doug.cameron@wsj.com
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