Will Foreign Markets Provide the Boost?
Gen. Ray Odierno, the u.s. Army chief of staff, is fond of reminding colleagues, audiences — and perhaps most importantly, the media — that the Asia-Pacific region is home to seven of the world’s 10 largest land armies, which makes his service a critical component of any strategic “pivot” to the region.
The leaders of those seven armies no doubt are paying close attention as Defense Secretary Leon Panetta jetted around the region earlier this month in a series of meetings with his counterparts to discuss regional security.
The region also is home to the world’s five largest arms importers — India, South Korea, Pakistan, China and Singapore — which together represent 30 percent of global arms sales. India alone is responsible for 10 percent of all global arms imports, according to SIPRI, the Swedish research center.
That makes the Asia-Pacific region in general, and India in particular, important for U.S. defense manufacturers looking to expand their international reach now that the domestic market is heading for some belt-tightening.
“U.S.-India defense ties are extremely important in a whole host of ways,” an American defense official told reporters on May 29. “Strategically, we see India as a partner with whom we have a lot of common interests and a lot of areas where we can work well together.”
But the global economy is volatile, perhaps nowhere as much as in Europe, where the euro crisis continues to make headlines. In assessing the global market, Byron Callan, director at Capital Alpha Partners, said that a lot can change in Europe, and with the European defense industry, depending on which way the euro goes.
“The way interest rates have surged, if anything, I imagine things in Europe will continue to slip despite the declarations at the Chicago NATO Summit,” he said. “It’s really hard in this environment to see big exports of U.S. product into Europe.”
But if the euro weakens and reaches parity with the U.S. dollar, that could provide a boost for French and German armored offerings on the international market, he said.
Elsewhere, the situation in the Middle East is a little more mixed. There are still some governments that are stable and with energy prices high, countries such as Egypt, Saudi Arabia and to some extent, Iraq, are going to be able to buy equipment to meet their needs.
Despite the hoopla surrounding Panetta’s trip to Asia, Callan said that while the region is full of populous countries, “their budgets are well below European or Middle Eastern levels.”
Perhaps the important thing from a U.S. industry standpoint is to be able to fill a capability gap or two to gain a little bit more visibility in the region and help keep domestic production lines open.
One of the platforms that has been touted as having great potential for foreign military sales is General Dynamics’ M1 Abrams tank.
But “if you’re talking about countries that can be considered contenders to buy the M1, you can probably count them on half a hand’s worth of fingers,” Callan cautioned. Since American systems are highly engineered, there will always be affordability issues, he said.
Even if foreign military sales increase for U.S.-based defense manufacturers, Michael Lewis, director of Equity Research at Lazard Capital Markets, said he doesn’t see enough gains to offset reduced spending by the Pentagon.
“Everyone is talking about the international market and that their international market sales are going to expand,” he said. “Are we going to see a material increase in actual dollar sales to international participants, or is international becoming a larger portion of a company’s sales base because the U.S. market is contracting? I think that it’s the latter.”
There hasn’t been a rise in international purchases over the past two years to offset the reductions in the Pentagon’s budget.
“If these companies are saying that they’re going to grow internationally, that implies international revenues should be in excess of what has been pulled out of the U.S. base, and we’re not seeing that,” he said.
All of this is thrown into flux if Congress fails to cut a deal to avoid the sequestration trigger in January, meaning another roughly $500 billion would be cut from the Pentagon’s budget over the next decade. If that happens, then “everything is off the table,” according to Lewis, because industry will undergo massive realignment to maintain some type of profitability.
That in turn “will have repercussions for foreign military sales, which will result in delayed deliveries, since [industry] will deliver to the U.S. before they deliver to overseas customers.”
Overall, the outlook for the U.S. defense industry is a very mixed bag, Lewis said. While some companies will likely see their market share rise, others will be hit hard.
“With regard to the optimism by companies talking about international sales opportunities,” he cautioned, “I think that should tamp down a little bit; investors have an incorrect expectation that international sales will entirely fill the hole of the U.S. defense reduction, and that’s not the case.”