The 2010 U.S. defense budget creates winners and losers

For example, although Gates’s budget caps purchases of Lockheed’s F-22 fighters at the 187 jets already ordered, it increases 2010 funding 65 percent to $11.2 billion for Lockheed’s next generation F-35 Joint Strike Fighter. The Pentagon plans to acquire 513 F-35 fighter jets, priced at $80 million apiece, over the next five years and at least 2,300 F-35 fighter jets over the 30 year life of the contract.

The Department of Defense also announced plans to purchase two expensive new imaging satellites as part of a contract likely to be awarded to Lockheed Martin, and the Navy shared its plans to purchase three Littoral Combat Ships (LCS) manufactured by General Dynamics and Lockheed Martin. These ships, designed to operate in shallow seas and within 100 miles of shore, are priced at approximately $500 million apiece.  

A major change in the new defense budget is the gutting of the Army’s $200 billion Future Combat Systems (FCS) program and its eight program ground vehicles. These vehicles include next generation tanks, cannons, and infantry carriers. When first announced six years ago, FCS was lauded as the program that would equip a twenty-first century military force with high-tech combat vehicles able to outgun and out-maneuver any enemy. Springer writes that the hard lesson learned in Iraq and Afghanistan, however, was that these lightweight vehicles were too thinly armored to survive insurgent attacks with road-side bombs. A few pieces of the FCS program will continue to be funded such as ground robots and unmanned aerial drones. This is welcome news for AeroVironment (NASDAQ: AVAV), a small cap defense contractor and leading supplier of military unmanned aerial vehicles.

Budget plans that defer spending on next-generation FCS platforms are also positive news for defense contractors supplying assemblies and spare parts for existing military vehicle platforms. Because of FCS program cuts, Abrams tanks and Bradley and Stryker ground vehicles are likely to remain the workhorses of the U.S. military for at least the next twenty years. Optex Systems Holdings, Inc. (OTCBB: OPXS ) is a small cap company benefiting from this trend. Founded in 1987, Optex supplies sighting systems and replacement optics installed on most types of U.S. military vehicles, including Abrams, Bradley, and Stryker fighting vehicles. In addition, the company’s optical sighting systems target the big Howitzer guns used by the U.S. military to pound insurgent positions in the mountains of Afghanistan with lethal effectiveness. Demand for Optex sighting systems is likely to rise as the war in Afghanistan intensifies and the company is working with its military customers to increase its production and capabilities. Besides military sales, Optex also sees opportunities to integrate some of its night vision and optical sight product lines into retail applications.

Springer writes that in fiscal 2009, Optex expects to recognize $27.4 million in revenues from its sizable contract backlog and the company is actively pursuing on other large government contracts. Backlog was $44 million at fiscal year-end and $39 million at the end of the first quarter of fiscal 2009. Optex revenues rose 64.5 percent year-over-year during first quarter of fiscal 2009 to $7.2 million and net losses fell to $0.03 million from $0.69 million one year earlier.

Lisa Springer