In continuation of our talks with Peter Arment of JSA Research on trends in defense, Mr. Arment comments on long-term defense spending, and areas of growth.
TWST: Let’s shift over to the defense side. What’s the longer-term outlook there? You mentioned resetting and refurbishing.
Mr. Arment: The budget continues to increase and a lot of that is tied to the global war on terror. Supplemental bills are not only funding the War, but addressing the repairing and replacement of equipment. The latter point is really focused on the Army and the Marines. Everything from vehicles, helicopters, precision weapons, ammunition, troop uniforms, body armor and other force protection equipment are on the list of receiving higher funding. Any company that has exposure to the Army is going to benefit regardless of a change in the administration in 2008. The political aspect of the defense budget will still exist, but in a post 9/11 environment, a strong national security theme still trumps social issues. A Democratic President is still seen to be weaker on defense spending by Wall Street, so some multiple compression is likely to occur. But given current valuations, the downside seems limited.
The biggest area of growth beyond 2008 is within armored vehicles. Humvees are going to be replaced along with a number of existing tactical vehicles. The Humvees that were utilized in Iraq have been found to be very vulnerable to the IEDs. As an interim step, the Army and the Marines have been buying MRAP (Mine- Resistant Ambush Protected) vehicles, which has become the Defense Department’s number one priority. This has been a very fast evolving program that started with just demand for a few hundred vehicles back in 2004 and now the request is for well over 20,000. MRAPs cost anywhere from $0.5 million to over $1 million a piece. We are talking about a $20 plus billion program that’s come out of nowhere from five years ago. There are only a handful of companies that are delivering these vehicles.
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