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Playing Defense

CFOs of defense contractors are preparing their companies for a new era of austerity at the Pentagon.

13Nov_Subhed_p40Huntington Ingalls Industries: Projects in the Pipeline
Other defense contractors are riding the down cycle well, thanks to long-term manufacturing contracts with the government. This is the case at Huntington Ingalls Industries, which inked a 30-year contract with the U.S. Navy less than a decade ago to build aircraft carriers, nuclear attack submarines and other ships. “That gives us some stability and security,” says Barbara A. Niland, corporate vice president and CFO. “It takes four to eight years to build a ship, and we’ve got a backlog of $21 billion in contracts that were awarded.”

13Nov_PD_p40Spun off by Northrop Grumman to stockholders in 2011, Huntington Ingalls is not biding its time counting the future revenue. Like other contractors, it is maximizing its competitiveness by closing noncore enterprises and pursuing adjacent market opportunities. The Newport News, Va.-based company ($6.6 billion in annual revenues) recently announced the closure of its Gulfport, Miss.-based composites facilities, which made deckhouses for guided-missile destroyers. And in February, it opened an office in Houston to pursue opportunities in the energy infrastructure market. “We’re in discussions with several companies in the oil and gas infrastructure market to build modular structures comparable to what we do in shipbuilding,” Niland says.

Another nongovernment project in the pipeline is the possibility of building ocean carriers to move products between U.S. ports. “There is a need for Jones Act commercial ships right now, but we are being very cautious in exploring this avenue,” the CFO says. “We’d need support from the Navy, as well as a credible partner in commercial shipbuilding or the energy infrastructure business that understands this market, pricing structure and risk.” (The Jones Act restricts the carriage of goods or passengers between U.S. ports to U.S.-built and -flagged vessels.)

These and myriad other efforts by the nation’s defense contractors are predicated on remaining profitable if and when the top line falters. So far, pricing has held in the industry. “Contractors have not been terribly aggressive in their pricing to drive revenues up,” says Stifel’s Loomis. “The focus has been on operational excellence and cost cutting, as opposed to playing the market-share game. As long as margins aren’t moving much, most seem comfortable with shrinking revenue. As we go through the next few years and a tougher budget environment, we’ll see the [pricing] pressures intensify.”

Those next few years remain hard to call from a budgeting standpoint, as the recent shutdown of the federal government underlined. “At the moment, we don’t know where the cuts will be the sharpest, so diversification of portfolios, the development of specialized capabilities and investing more money into R&D make sense for defense contractors,” says Dragelin. “These small investments could have some significant legs propping up the rest of the business.”

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