NEW YORK--(BUSINESS WIRE)--Fitch Ratings has published the first edition of its Defense & Security Handbook, which provides an overview of the current global defense spending environment and contains profile reports for 22 U.S. and European companies. The report also highlights the U.S. Department of Defense budget, and provides detailed spotlights on the F-35 Joint Strike Fighter program and defense contractors' pensions.
Global defense spending has stabilized, and should rise in 2017, with the global threat environment serving as a tailwind. The U.S. remains by far the largest defense market. Cash deployment actions, M&A, and pension deficits continue to pressure some defense company ratings. Program details remain essential to the analysis of specific credits.
Fitch expects the relevant parts of the addressable global defense market to rise between 3% and 5% over the next three years, which is more than Fitch's global GDP forecast. Fitch estimates this market in 2016 is approximately $400 billion-$425 billion. Fitch's defense spending estimate excludes off-limit markets, such as China and Iran. The U.S. budget accounts for 45%-50% of the addressable market by Fitch's estimates, but its growth is less than in non-U.S. markets.
Higher U.S. defense spending in fiscal year (FY) 2016 has supported Fitch's credit outlook for the defense and security sector. Investment spending turned up this year after a three-year trough, and Fitch expects continued solid spending levels in FY2017 and beyond, assuming budget caps are overridden. Although it has not yet been enacted, Fitch views the FY2017 budget request as a conservative indicator of spending trends. Fitch expects there could be upside as a result of the recent elections.
Projected U.S. spending beyond FY2017 is above enacted budget caps, so caps remain a risk through 2021. Fitch bases its defense ratings on the assumption the caps will continue to be overridden, and Fitch expects this assumption is stronger as a result of the recent U.S. elections. Fitch believes temporary continuing resolutions (CRs) for spending are still a risk, but less than in the past decade, also as a result of the elections.
The F-35 Joint Strike Fighter is the largest program in the global defense industry, and it is also one of the most international programs, with 12 customer nations and a geographically diverse supplier base. Nine countries partnered in the development of the F-35. Deliveries could almost double over the next two years, helping revenue growth throughout the defense industry.
Fitch views the defense industry as a specialized technology sector fed by significant R&D expenditures. The industry continues to pursue warfighting advantage through innovation, including cyber and third offset technologies. However, Fitch does not believe the sector is as exposed to disruption from new entrants as other industrial sectors.
Fitch sees little evidence of shareholder-focused capital allocation ebbing, and M&A activity has exceeded Fitch's expectations in 2016. Discretionary pension contributions for some U.S. defense companies could rise in the next two to three years. Capital allocation and M&A continue to nullify many of the benefits of positive defense budget trends.
Risks to the outlook include cost overruns or delays on key programs; currency fluctuations in non-U.S. markets; the impact of oil and commodity prices on government budgets; the budget cap overhang in the U.S.; additional CRs; and political disruptions. Affordability and cost reduction are also key themes in the global defense sector, and companies unable to lower costs will be at a disadvantage in program competitions.
Additional information is available on www.fitchratings.com
Related Research:
Fitch: US Defense Industry to Benefit from Trump Victory https://www.fitchratings.com/site/pr/1014870
U.S. Defense Spending Review Update (Upturn Supports Sector, but Budget Caps and Continuing Resolutions Risks Persist) https://www.fitchratings.com/site/re/890575
Defense Contractors' Pension Deficits on the Rise https://www.fitchratings.com/site/re/890629
Aerospace and Defense: Ratings Navigator Companion https://www.fitchratings.com/site/re/804088
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Defense & Security Handbook
https://www.fitchratings.com/site/re/891321
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