Bearish Appropriations (Updated)

Wall Street analysis firm Credit Suisse isn't too bullish about the fiscal year 2012 defense appropriations conference agreement, which lawmakers hammered out last night as part of an omnibus spending bill. According to a just-released Credit Suisse research note:

*      Army Most Impacted Given OCO Reliance, but "Network" Capabilities Protected: The Army received $9B in RDT&E (-10% vs. request), $22B in Procurement (-12% vs. request), and $76B in O&M funding (-4% vs. request). Clear winners were communications and electronics, tactical wheeled vehicles, and support equipment. We believe part of the procurement cuts were as a result of the JTRS Manpack delay (GD/COL/BAE), JTRS GMR cancellation (BA), WIN-T delay (GD), and EMARSS cancellation (BA), all of which were previously known.

[UPDATE Dec. 21: Credit Suisse just issued an updated version of its research note, changing the EMARSS language to read: ". . . and EMARSS (BA) procurement funding which was zeroed out from the FY'12 request."]

*      Navy Seems to Weather the Storm Given Program Diversification; at least for the Short-Term:  The USN received $18B in RDT&E (-1% vs. request), $46B in Procurement (-4% vs. request), $46B in USN O&M (-1% vs. request), and $9B in USMC O&M (-2% vs. request). The winner in our view is shipbuilding which was fully funded (HII, GD). We believe cuts to aircraft procurement are partially a result of the presidential helicopter (VXX) manufactured by LMT, flat-lining of F-35 (LMT), and cuts to the weapons account appear to include AMRAAM and Standard Missile (both RTN).

*      Air Force Encounters the Least Turbulence Due to Size of Investment Accounts: The USAF appears to have the greatest resilience of the major services because of the sheer size of investment accounts, plus the ability of its large RDT&E account to absorb punishment to protect the critical procurement account. The service received $27B in RDT&E (-4% vs. request), $41B in Procurement (-2% vs. request), and $46B in O&M (-2% vs. request). In our view, the winner was the aircraft procurement account, with modest cuts to KC-46A tanker program (BA), F-22 upgrades (LMT), and the HH-60 recap (UTX). We believe the reduction in aircraft procurement is also partially attributable to the slowing of F-35 CTOL (LMT).

*      Our View: While the budget offers some modest short-term upside in RDT&E & procurement, the reality is the [Budget Control Act] is being enforced and DoD funding is being flat-lined. This leaves minimal opportunity for substantive growth unless one defense contractor can take work from another.