Problems and Solutions for investing in the Defense industry

 

Some disadvantages in defense investing may include percentage of completion accounting, changes in politics and also security, delays, mistrust or mismanagement and problems with equipment possibly between defense companies or other partners and canceling defense programs.

Percentage of completion accounting. This is meant to calculate and keep track of the flow of sales in a long term contract. This can affect a company’s profits whenever there’s not enough reserves in place.

For example, in 2008 there were delays in building the LHD-8 Makin island. Because cost estimates change due to the delays and unexpected problems, Northrop Grumman had to take in additional charges in order to follow percentage completion accounting

Unforeseen Changes in Security or Politics. In 1999 the Subcommittee on Defense of the House appropriations committee pushed for the removal of procurement funding for the Lockheed Martin F22 fighter aircraft program from the 2000 defense budget which was a big surprise for investors.

Delays and mistrust maybe between defense companies. This could be a big problem because when this happens, there is a possibility of companies wanting to end partnership with each other.

Earlier this month Boeing posted their net loss from the first 3 months of 2021 along with setbacks with their 737 Max jetliners. Boeing’s current CEO Dave Calhoun also mentioned suing GDC TECHNICS and accusing it of missing deadlines for work Air Force 1 related and causing millions in damages to Boeing company. The termination of contract between these 2 companies has cause GDC to lay off employees. On April 19^th, 2021, GDC retaliates by countersuing Boeing and blaming the company for mismanagement that caused delays and also a breach in contract.

Other problems may also include, defense programs being cut and inability to manage work force.

Solutions/ Recommendations to avoiding these risks

Below are possible recommendations to solving these problems.

1.      Unexpected security and political events -To avoid this risk contractors can avoid being surprised by keeping up on currently political and security issues internationally and nationally and understanding about how the DOD or Congress might be thinking on these important defense issues.

2.      Defense programs being cancelled could be when programs may be having some technical issues or possibly going over the planned budget. To avoid this risk, Investors should watch out for these types of risk by keeping up with how well these defense programs are doing and contractors should especially watch out for over budgeted defense programs and also look into the reasons behind why those programs exist in the first place also comparing to other programs that may have succeeded or failed in the past.

3.      Percentage completion accounting-   Since this is one of the most common issue for defense companies to have, contractors should be aware of this issue being a possibility and try not to overreact to positive earnings surprises. Investors should also stay in contact with management and pay attention to cash flow.

4.      Inability to Manage Work Force: Sometimes companies put in a certain percentage growth rate for earnings revenue, management hired in those companies will hire employees they feel will make the growth rate percentage. And there would be certain risks with the type of people hired at these companies. A solution to this is investors must be aware of this type of risk by knowing the amount of people hired to achieve growth and also their skills.

 

Sources

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 https://www.cnbc.com/2021/04/08/boeing-sues-cancels-contracts-with-air-force-one-supplier.html

 https://www.bizjournals.com/sanantonio/news/2021/04/26/gdc-technics-sued-by-boeing-closing-sa-facility.html

https://research1.ml.com/Archive/11514178.pdf?q=YB2Gjvw-ycBRti876lbNjA&__gda__=1620922305_dabc7be6c4ca73aa1a1cff7a746377f7