Defense 2015 Preview: Downturn Ends but Industry Troubles Not Over

Pentagon contractors are entering the new year with a mix of caution and optimism. Military spending is about to hit bottom and is projected to inch up over the next several years. With Ashton Carter as defense secretary, the Pentagon gains a leader who has been an ardent critic of budget cuts and will again be on the front lines of that fight.

But industry CEOs still face a rough road ahead as the Pentagon slows down arms purchases and military spending remains caught in the crossfire of partisan battles on Capitol Hill.

The industry heads into the fifth year of the defense downturn with some assurance that the “worst is behind,” said defense analyst Robert Stallard, of RBC Capital Markets. “We are seeing the trough in U.S. defense spending, and the next step is a return to growth,” he told investors. It remains to be seen, though, whether modest growth in the budget will boost contractors’ bottom lines. Investors also will be watching the Pentagon’s other budget, the “overseas contingency operations” fund that pays for ongoing wars.

Fiscal year 2016 is the last year of the trough according to the profile laid out in the 2011 Budget Control Act. The cap is scheduled to inch up in 2017 by about 2.6 percent, from $499 billion to $512 billion. But despite projections of 1 to 2 percent growth starting in 2017, “We think the fiscal situation will require the Department of Defense to live within its current means,” Stallard said.

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