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Strong U.S. defense firm profits defy regular gloomy warnings

Workers can be seen on the moving line and forward fuselage assembly areas for the F-35 Joint Strike Fighter at Lockheed Martin Corp's facto
Workers can be seen on the moving line and forward fuselage assembly areas for the F-35 Joint Strike Fighter at Lockheed Martin Corp's facto

By Andrea Shalal

WASHINGTON (Reuters) - U.S. arms makers complain regularly that lower Pentagon spending on ships, jets and other hardware will hit their earnings, but a string of better-than-expected results this week show that layoffs and cost-cutting have kept profits flowing, and growing.

Defense majors Lockheed Martin Corp , General Dynamics Corp , and Northrop Grumman Corp have all reported higher profits this week and raised their full-year forecasts. In response, the Dow Jones index that tracks the 10 biggest aerospace and defense companies <.DJUSDN> rose 2.2 percent on Wednesday.

Weapons makers turned to workforce cuts and other efficiency efforts as early as 2007 to shore up their profits, and have also concentrated on stock buybacks and strong dividends, said defense consultant Loren Thompson.

"The gradual decline in military spending has given the companies fewer opportunities to invest in new programs, so they

are returning their cash flow to shareholders," said Thompson, who runs the Virginia-based Lexington Institute.

He said the crisis in Ukraine and other emerging threats could strengthen demand for military equipment in the United States and overseas, and help stave off an expected decline in defense shares as spending cuts further erode revenues.

Company executives say the budget environment remains tough,

since mandatory federal cuts are due to resume in 2016. Still, work on big-ticket items like ships, planes and satellites would shore up revenues since those orders are either already on the books or part of multi-year agreements being negotiated now.

Lockheed shares were up 3.3 percent at $161.94 after Australia announced plans to buy 58 more of the company's F-35 fighter jets in coming years.

Lockheed, the Pentagon's No. 1 supplier, had on Tuesday reported a 23 percent jump in first-quarter net profit and raised its 2014 earnings-per-share outlook by 2.5 percent.

Lockheed, General Dynamics and Northrop all reported higher operating margins in the latest quarter, and said they would continue efforts to reduce costs and improve efficiency.

Northrop, which makes unmanned planes, the B-2 bomber and electronic equipment, on Wednesday reported higher-than-expected quarterly profit and raised its full-year outlook by about 2 percent, to a range of $8.90 to $9.15 per share. Northrop shares rose 1.8 percent to $121.96.

CEO Wes Bush attributed the rise in Northrop's EPS in part to share repurchases; the company had about 9 percent fewer shares outstanding during the latest quarter.

"While the U.S. budget environment continues to be challenging, particularly for our short-cycle businesses, we have a good long-term set of opportunities that includes ... potential for continued growth in international sales," Bush told analysts on an earnings call.

He said the sale of Global Hawk unmanned planes now being negotiated with South Korea could lead to additional foreign sales of unmanned systems for the company.

General Dynamics, which makes Gulfstream business jets, tanks and U.S. warships, raised its guidance for 2014 earnings per share by nearly 4 percent after posting higher-than-expected earnings and revenues in the first quarter. Its shares were up 3.6 percent at $111.90 in late trading.

Chief Executive Phebe Novakovic told analysts that U.S. weapons spending had "troughed," or hit a low point, and that a big rise in backlog showed the company is well-positioned. She said the firm planned to return "most, if not all" of its free cash flow to investors via stock repurchases or dividends.

Novakovic described "blocking and tackling" to lower costs. "I don't think you can ever get away from the absolute requirement to improve your operating performance quarter over quarter," she said. "You are never done."

General Dynamics' combat systems division, which posted a quarterly operating loss, would show improved sales, earnings and margins over the course of the year, Novakovic said.

The marine division also has "considerable upside" given that it expects to get a multi-year contract for more Virginia-class attack submarines from the U.S. Navy, and is working on a new submarine to replace the current Ohio-class submarines that carry nuclear weapons, she said.

(Reporting by Andrea Shalal; Editing by Ros Krasny and Nick Zieminski)

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