The Wall Street Journal - November 30, 2011, By Ben Fox Rubin, Dow Jones Newswires
Regardless of whether Department of Defense cuts materialize as are currently planned in the coming years, Fitch Ratings said defense contractors face increasingly difficult decisions over where to spend their cash, as revenue growth moderates and free cash flow generation weakens.
Following Congress' failed super-committee negotiations, an additional $600 billion in defense cuts are currently slated for the next 10 years, starting in 2013. The cuts would be on top of large reductions in the Defense Department spending already approved.
U.S. defense firms have already been adjusting for planned reductions in defense spending, Fitch has said, though the ratings company believes those cuts could be managed by controlling costs. However, the extra $600 billion in cuts could reduce revenue growth significantly, it has said.
The current outlook of Defense Department spending remains volatile and highly uncertain, Fitch said, in light of the super-committee's failure to reach a bipartisan deficit reduction plan. In a worst-case scenario, Fitch predicted defense contractors' credit profiles and ratings would face downward pressure. But less severe spending cuts are more likely, the ratings firm said.
Congress could agree on legislation to curtail the automatic cuts, which could be as much as $1 trillion for defense over 10 years.
Fitch predicted a reduction of $700 billion. That level would not harm defense contractors' credit profiles, Fitch said, especially if the cuts came later in the decade, allowing the firms to adapt to the changes.
Regardless of how big the cuts, they will translate into slower revenue growth and profitability for those companies, Fitch said.
Fitch's outlook for the U.S. defense sector hasn't been affected by the ratings firm's negative outlook on the U.S.'s sovereign-debt rating. Fitch lowered its outlook earlier this week, saying high debt levels and a troubled economic outlook could endanger the country's top triple-A credit rating. It warned of a downgrade by the end of 2013 if a credible plan to tackle the deficit wasn't reached.
Fitch was the last of the top three ratings agencies to lower its outlook on U.S. debt. Moody's Investors Service gave the country a negative outlook in August. Standard & Poor's cut its rating on U.S. debt to double-A-plus in August and maintained a negative outlook on the debt.
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