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What Sequestration Means for Defense

Looming budget cuts make us cautious on the sector.

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The Budget Control Act of 2011 outlined cost reductions to offset U.S. debt ceiling increases of as much as $2.1 trillion in multiple steps: $400 billion immediately, $500 billion a bit later, and the remainder after Congress enacts further reductions. The initial tranche of spending limitations totaled $917 billion over 10 years, which would cover the first two boosts to the debt ceiling. The final advance would require further cuts that could total $1.2 trillion-$1.5 trillion. Since the bipartisan supercommittee tasked with identifying the reductions announced its failure to come up with a compromise in late November 2011, the law currently on the books will require across-the-board cuts of $1.2 trillion to begin Jan. 2, 2013--otherwise known as sequestration. In our previous article, we examined the impact of the cuts to the defense budget and emphasized aspects of the sequestration cuts that are set to hit the defense sector in a meaningful way. In this article, we take a closer look at the effect the cuts could have on the defense companies we cover.

Potential Outcomes
We think there is some likelihood that Congress will delay the impact of the sequestered cuts into the future, perhaps by three or six months, following the fall election. We think a delay would represent a victory of sorts for the defense industry because companies are currently unable to plan for any significant cuts; therefore, the status quo doesn't pressure revenue or operating margins for some time. Many companies have reduced workforce and facility exposure where possible, but plenty of "unknown unknowns" remain outside the planning purview.

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Neal Dihora does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.