US defense firms reported quarterly earnings last month and the results indicate the industry continues to face revenue and operating income pressure from a customer grappling with funding uncertainties. Avascent’s defense indices show, however, that on average, the industry was able to maintain operating margin and ROIC levels for the quarter and the year. The consensus on Wall Street is that profitability levels are likely be maintained over the next several quarters, due, in part, to industry cost-cutting initiatives and divestitures of low-margins business.
The strength of the industry’s balance sheet and free cash flow generation continues to support aggressive cash deployment in the form of cash dividends and share buybacks resulting in above average payout. The current dynamics in the defense market poses significant challenges to senior industry leadership in balancing short-term budget uncertainties and shareholders’ expectations against investments the industry must now make in order to optimize long-term value creation.