The market, at first glance on Wednesday, seems to indicate that there may be some shakiness in the sector over future budgets or contract awards, as well as the resignation of Defense Secretary Donald Rumsfeld. Shares of major defense contractors slipped slightly–Northrop Grumman Corp was down more than 2% to close at 64.98, Lockheed Martin Corp fell a point to $86.45, and SAIC was down nearly 4% to $19.18.
But smaller federal services companies such as SRA International, ManTech International Corp, and CACI International–firms that do most of their business in IT and project management work for the defense and intelligence agencies–all gained yesterday.
A research note from Robert W. Baird & Co, however, predicts that the divided government could lead to further delays in passing the federal budgets, which could lead to funding problems for contracting projects for these services specialists. All civilian agencies other than the Department of Homeland Security are currently operating under continuing resolution in light of these delays. The perception that Democrats in Congress may scale back increases in the defense budget also contributes to what Baird says are near-term challenges in the sector.
The note states that SRA would be most exposed to budget delays, with 30% of revenue coming from the affected civilian agencies, nearly twice that of CACI.
The likelihood of funding delays of course depends on the willingness of both parties to craft compromise budgets. And it’s too early to tell whether the Democrat’s return to congressional power will be on of reconciliation or gridlock.
And while it’s true that the Democrats owe a good part of their victory to the public’s growing disapproval of Bush’s handling of Iraq, this doesn’t mean that they’ll be looking to slash defense budgets straight away. In fact, many Democrats have been calling loudly for refocusing the war on terror to other areas, abroad and at home for issues such as port security. And all of these initiatives require plenty of funding, which means there should be new opportunities for defense services companies.
