Military budget under fire hits defense stocks

WASHINGTON -- Once bulletproof, the defense budget now looks like a softer target.

Lately, even some Republicans have started to question whether federal outlays can cover the dramatic increases in military spending called for by the Bush administration amid growing deficits. Such talk has gotten Wall Street's attention, helping drive down an index of major defense stocks by 4 percent since the start of the year. That's four times the decline in the Dow Jones industrial average over the same period, while the Standard & Poor's 500 index has risen 1.4 percent.

Nobody forecasts a decline in military purchases, but the rate of increase may slow as leaders of both parties weigh military goods against deficit reduction. And while it may be years before such changes affect the bottom lines of defense contractors such as Lockheed Martin Corp. or Raytheon Co. of Waltham, even talk of cuts in defense spending has contributed to the share declines, said Jon Kutler, chief executive of Quarterdeck Investment Partners LLC, a Los Angeles investment bank.

''Investors are starting to shy away from the sector in anticipation of more reductions," he said. While many investors bought into defense stocks following the attacks of Sept. 11, 2001, many now want an exit strategy. ''They go in when there's uncertainty and trouble, but they prefer not to be in the area in general because they don't understand it," he said.

Officially there's no cause for concern. Under the Pentagon's proposed budget, defense spending would rise to $487.7 billion in fiscal 2009 from $401.7 billion in the fiscal 2005 budget. More important to defense contractors, money for procurement would rise to $114 billion in 2009 from $75 billion in 2005.

Out-of-power Democrats have generally been more critical of defense spending, though they haven't stopped controversial programs such as National Missile Defense.

But lately some Republicans, who control both houses of congress, have echoed the critical sentiment, for budgetary reasons. This month,for instance, members of the House and Senate budget committees called for reducing the administration's defense requests by $2 billion and $7 billion, respectively.

Representative Jim Nussle of Iowa, the House committee's Republican chairman, at the time cited concerns about deficits, according to an aide, Sean M. Spicer. ''Everything's on the table," Nussle said at the time.

Party leaders managed to deflect those proposals, but even their suggestion was noteworthy, said Steve Ellis, a vice president at Taxpayers for Common Sense, a budget watchdog in Washington.

''These budgets are not sustainable," he said. ''The fact people are talking about cutting the budget in wartime is significant."

Said US Representative Martin T. Meehan, the Lowell Democrat who sits on the House Armed Services Committee: ''Clearly we're seeing that some Republicans are beginning to come to terms with the idea that we just can't throw money at defense."

Concerns about slowing military outlays have already had an impact on defense stocks, reinforced by the Army's cancellation of its big-ticket Comanche attack helicopter last month. Since Jan. 1, the Standard & Poor's 500 aerospace and defense index, a composite measure of stocks of the largest defense contractors, has lost 4 percent of its value, and declines in some companies have been even more dramatic. Shares in Lockheed Martin of Bethesda, Md., the country's largest defense contractor, closed at $44.47 yesterday, 14 percent off their high of $51.60 this year.

Shares of Raytheon, the largest defense contractor in Massachusetts, closed at $30.06 yesterday, from a high of $32.22 this year.

This week, Credit Suisse First Boston analyst James M. Higgins downgraded Raytheon and Lockheed Martin to ''neutral" from ''outperform," mainly because of concerns of slowing defense spending.

''The crux of the downgrade is a concern that defense spending will start to peak within a few years, darkening prospects for the defense business that is about 85 percent of RTN's [Raytheon's] revenues," Higgins wrote in a note to investors. As for the overall defense sector, he wrote, ''We see a scenario of flattening and perhaps even falling defense spending in coming years, unless there is wholesale change in the prevailing mindset in Washington."

Thomas M. Culligan, Raytheon senior vice president, said such shifts wouldn't necessarily be bad news for Raytheon since it doesn't make many big-ticket items such as aircraft or ships that are vulnerable to outright cancellation.

Meanwhile, it makes many of the electronics used to keep older military systems in service, such as the Navy's F/A-18 fighter jet. Such orders will increase if the most modern weapons are canceled, he said.

''It's not all black-and-white, that the sky is falling," Culligan said. He acknowledged broader pressure facing the sector, though he said events like last week's bombings in Spain will generate pressure for more defense dollars.

''Right now our expectation is that, given world events, we'll continue on a path to growth. We hope it will be what the administration has in its multiyear plan, but we know there are other pressures out there that will lean heavily on the defense budget," he said.

Ross Kerber can be reached at kerber@globe.com. Stephen J. Glain can be reached at glain@globe.com