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U.S. Defense Budget Still Up in the Air

We think the most likely outcome won't have much effect on defense stocks.

The defense budget for fiscal 2018 continues to wind its way through Congress. Since the U.S. government’s fiscal 2018 began on Oct. 1 without a budget, the Department of Defense is operating under a continuing resolution that lasts until Dec. 8; this freezes funding at fiscal 2017 levels and prohibits new program starts.

We think the most likely outcome is an extension of the continuing resolution into next calendar year, and we don’t think the U.S. defense stocks we cover will react to this development.

Although a budget resolution has been passed by the Senate as well as the House, it is only a vehicle for tax reform and doesn’t have the force of law. The real budget fireworks will begin in early December, when the continuing resolution expires. We see four possible scenarios, listed in order of likelihood, unfolding for the defense budget:

(1) Congress passes another continuing resolution lasting into the new calendar year.

(2) Congress passes a full-year continuing resolution for fiscal 2018.

(3) Congress passes a budget by Dec. 8.

(4) The U.S. government shuts down.

We think option 1, an extension of the continuing resolution into calendar 2018, is a strong possibility, particularly given the current focus on tax reform instead of appropriations. A continuing resolution extension is likely to be greeted with shrugs by the market because Congress hasn’t passed the defense appropriations on time since 2009, and it can also make specific programs exempt from the continuing resolution funding restrictions.

We think high-profile programs like the B-21 bomber and Columbia-class submarine, as well as others, could make it onto such a list. Options 2 and 4 would be negatives for the defense industry. A shutdown would be the most unfavorable outcome, and while we think it is unlikely, we’re not ruling it out. We think option 3, a fiscal 2018 budget passing by Dec. 8, is unlikely.

Because both House and Senate versions of the base defense budget are above the spending caps laid out in the Budget Control Act, Republican defense hawks in Congress would need to bring both GOP fiscal hawks and some Democrats on board to pass the defense budgets currently being proposed. We forecast a Defense Department budget for fiscal 2018 (if one is passed) landing in the range of $625 billion-$645 billion, including Overseas Contingency Operations funding, which is not subject to spending caps.

The upper end of this range is roughly comparable with the Trump administration’s Defense Department budget request of $639 billion (base budget plus Overseas Contingency Operations) but below the defense spending levels under consideration in Congress.

Beyond fiscal 2018, we think U.S. defense budgets are headed higher, but we’re skeptical when we hear claims of historic defense spending increases. Including Overseas Contingency Operations funding, we anticipate average annual growth of 3% for the Defense Department budget through 2021.

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About the Author

Chris Higgins

Senior Equity Analyst
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Chris Higgins, CFA, is a senior equity analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers aerospace and defense companies, airports, and airlines.

Before joining Morningstar in 2015, Higgins spent eight years working for Airbus Group in both the United States and Europe. While at Airbus Group, he held a variety of positions, ranging from corporate development to investor relations.

Higgins began career in strategy consulting, where he consulted leading U.S. and European aerospace and defense prime contractors. During his time in consulting, he led teams that solved business challenges ranging from merger and acquisition decisions to new product launches.

Higgins holds a bachelor’s degree in economics from Rhodes College, where he graduated as a member of Phi Beta Kappa, and a master’s degree in finance from The Henley Business School in the United Kingdom. He also holds the Chartered Financial Analyst® designation.

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