Bruce: “What is this?”
Lucius: “Oh, that old thing? That is the F9JMK-3,000.”
Bruce: “What does it do?”
Lucius: “We needed something that would tunnel through the Himalayas. So we created this machine with 18 fully-rotating bits made of a titanium/krytinium alloy capable of reaching top drilling speeds of 80 mph. It tunnels you through in a climate-controlled environment while you can enjoy your beverage choice from the built-in espresso machine. And yes Mr. Wayne, it comes in black.”
Such movie moments make you wonder, are the research and development branches of our nation’s defense contractors really like that? I mean, are they seriously just sitting on a bunch of awesome prototypes that the government will never use because they are too expensive?
No, not exactly. But even so, let me say this: if you’re thinking about investing in a defense contractor, it behooves you to get to know its R&D.
The issue with defense contractors
Why get to know its R&D? I believe the annual report from Lockheed Martin Corporation (NYSE:LMT) says it better than I could:
As we write this letter, the U.S. government is in the midst of addressing significant fiscal challenges and mounting national debt…We’re closely following the government’s efforts…We know, however, that we are not immune to future budget reductions in the U.S., and that the environment for 2013 and beyond will prove challenging.
Defense contractors, no matter how well run, have one main thing outside of their control: the U.S. budget. Unfortunately for these companies, no matter how good their products or management, if the national defense budget is cut that means that defense contractor’s income gets cut. This matter is completely out of the contractor’s hands.
| Company | US Gov Income 2012 | R&D Expenditures 2012 |
| Lockheed Martin | 82% | $616 million |
| Boeing | 33% | $3.3 billion |
| Northrop Grumman* | 90% | $520 million |
| General Dynamics | 66% | $1.6 billion |
*2011. Full 2012 information still pending.
When you look at this chart, a screaming advantage for The Boeing Company (NYSE:BA) immediately hits you in the face. The company is much less dependent on the national budget than the other companies listed. That’s good news for Boeing, at least in one sense. Any potential budget cuts won’t hurt this company as much as it would one of the other guys.
What is more pressing for The Boeing Company (NYSE:BA) is their Dreamliner situation. Plagued by bad batteries and leaky gas, these planes eventually got grounded. Now Boeing is on the path to getting them in the air again. How effectively The Boeing Company (NYSE:BA) is able to fix the problems will say a lot about this company. Only 50 of these planes have been delivered to date, but there are orders for 840 more. Another setback for the 787 at this point could be devastating.
Other defense contractors, having acknowledged the risk of being too dependent on Uncle Sam, are all seeking solutions that have application outside of the military.
Cyber security
In 2008, the Pentagon got hacked. They didn’t like that too much. Since that time we have been hearing more and more about the government, and large corporations, having sensitive information compromised by hackers. Because of the increasing risks, this year’s national budget includes increases in spending for cyber security. One of the leaders in this field is Northrop Grumman Corporation (NYSE:NOC).
Northrop Grumman Corporation (NYSE:NOC) should be one of the main companies to benefit from the budget increase for cyber security. I believe that this spending increase will develop into a trend. With each passing year, the cyber threat has become greater, and I look for Northrop Grumman to benefit for years to come as the government continues to spend more to keep our nation’s information safe.
Unfortunately, this means that the main source of revenue for Northrop Grumman’s cyber security is still the government, but this technology has applications for any large corporation. Big companies, including Facebook Inc (NASDAQ:FB), Microsoft Corporation (NASDAQ:MSFT), and NBC have all been victims of Internet hacking lately. The problem keeps getting worse by the day.
As a leader in this field, I’m looking for Northrop Grumman Corporation (NYSE:NOC) to grow its customer list. However, this company needs to pursue this commercial revenue to a much greater degree than it does currently. Currently, only 1% of their cyber-security revenue is derived from commercial sources.
If you are worried about how defense budget cuts could effect Northrop Grumman, than keep an eye on how it progresses in attracting commercial clients for cyber security. This company has a long ways to go to lessen their 90% government dependence.
Harnessing the ocean
Lockheed Martin Corporation (NYSE:LMT) is looking to become the king of the ocean. It has two major oceanic projects in front of them right now.
The first is related to a product called Perforene. The company intends to use this incredibly thin and remarkably strong product as a filter for salt water. Given how thin it is, it is able to filter out the salt at about 1% of the energy output typically required to do this.
In other words, with Perforene Lockheed Martin Corporation (NYSE:LMT) has successfully made salt-water filters a viable solution to solve the world’s water needs. The company stated that i has already identified 83 countries that could use this technology now.
But sticking with the seas, Lockheed Martin Corporation (NYSE:LMT) is also looking to solve energy problems through Ocean Thermal Energy Conversion. The system uses warm surface water, and cooler deep water and turns them into clean energy. Recent deals in China prove that this technology is moving forward.
Smartphones?
Believe it or not, defense contractor General Dynamics Corporation (NYSE:GD) has inked a deal with Samsung (NASDAQOTH: SSNLF) to provide security to Samsung devices. This comes at a time when competitor Apple Inc. (NASDAQ:AAPL) has been struggling with security issues. So, do you need your phone to be a fortress? Might want to look into Samsung.
For most, security strangely isn’t a big deal. One survey found that only half of smartphone users even considered security when selecting a phone. Price and ease of use were bigger factors for the consumers. To which I say, smartphone security is still a relatively new need.
Not too many people knew what identity theft was just 15 years ago. Fewer knew how to prevent it. As people grow in their understanding, it will become a bigger issue for them. The Samsung deal with GD may prove to be a competitive advantage that no other smartphone can touch.
For General Dynamics Corporation (NYSE:GD), this is just a demonstration that even some of its government revenue streams can be converted to have commercial application. However this revenue is still a long shot from the kind of revenue they would need to soften a budget cut blow. It is a good step, but if you’re worried about budget cuts, you should wait for a little more from the company.
The winner
While all of these contractors are spending on research and development, and all of them are searching for new streams of revenue, I really believe that one is actually making big strides to be not so dependent on Capitol Hill. Lockheed Martin Corporation (NYSE:LMT) is serious about this. The company isn’t just tinkering around. The goal is to “capitalize on the market that we hope to be in five to eight years from now.” As buy-and-hold investors, a long-term vision from the company is a huge plus in my book.
Catch that phrase “the market we hope to be in.” Lockheed Martin Corporation (NYSE:LMT) isn’t sitting idly by. It is proactively seeking a solution to its 82% government revenue. I’ve highlighted two of the most promising technologies that look to accomplish this. I admit, the Batmobile is way cooler. But what Lockheed Martin Corporation (NYSE:LMT) has brewing in their R&D is almost as cool as Batman.
The article Almost as Cool as Batman originally appeared on Fool.com and is written by Jon Quast.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
