The U.S. is the worlds largest aerospace and defense market, and also home to the worlds largest military budget. The growth of the Aerospace and Defense industry depends largely on the spending outlook of government departments, with the U.S. defense budget being the primary driver. The industry largely depends on U.S. government contracts.

Given the uncertain macroeconomic environment, not just in the U.S. but also globally, the industry faces the risk of fewer new orders as customers are more likely to postpone or cancel contractual orders and/or payments.

Defense spending is the major source of revenue for the top nine global aerospace and defense companies, with the US accounting for more than 40% of total global defense spending. However, with the U.S. government expected to institute greater austerity in its defense budget going forward, defense companies will need to source more orders from global clients. The geostrategic significance of the industry and the related heavy export restrictions will come in the way, to some extent, of those marketing efforts by U.S.-based operators.

The U.S. defense budget for 2012 was $645.7 billion, with the base budget at $530.6 billion and $115.1 billion approved for Overseas Contingency Operations (OCO) as supplementary defense spending, mainly to fund ongoing wars.

In February this year, the Department of Defense (DoD) requested a Pentagon base budget of $525.4 billion for 2013, which is approximately $5.1 billion or 1% less than what is approved for fiscal 2012, with $88.5 billion earmarked for OCO spending. The significant reduction in OCO funding is mainly due to the decline of U.S. military operations in Iraq in 2011. Going forward, OCO funding is expected to continue to decline as troops redeploy out of Afghanistan.

Since the September 2001 attacks, the U.S. government has spent significant amounts on military campaigns overseas. The country has already decided to gradually move out of Afghanistan, and the war in Iraq has finally ended, which is expected to lower its expenditure on foreign campaigns. However, its clandestine military operations in other nations as part of anti-terrorism operations will continue to add to foreign war expenses. However, the overall trend in overseas military spending is unmistakably on the downtrend.

OPPORTUNITIES

Acquisition, Merger and Strategic Alliance

The big defense operators armed with a strong balance sheets are expanding their operations inorganically through acquisitions. The U.S. Defense department also endorses mergers among U.S. defense companies, provided they dont involve the top five or six suppliers acquiring each other.

Lockheed Martin Corporation (LMT) bolstered its product portfolio by acquiring Procerus Technologies, a company specializing in autopilot and other avionics for micro unmanned aerial systems. In November 2011, it had acquired Sim-Industries B.V., a commercial aviation simulation company located in the Netherlands. This acquisition would expand both companies closely related markets and expand the customer base.

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Aerospace & Defense Stock Overview - May 2012