As Standard & Poor’s was defending its decision earlier this month to downgrade the U.S.’s creditworthiness, another ratings agency—Moody’s Investors Service—released an unsettling report about the aerospace/defense industry’s outlook that seemed to go all but unnoticed.
It spoke of potential ratings downgrades for some contractors, particularly those with underfunded pension programs, based on pressure on earnings and cash flow if defense budget cuts exceed 10%. Indeed, a draconian reduction in defense spending will take place if a Congressional super-commission of six Democrats and six Republicans by Nov. 23 fail to agree on ways to reduce the federal budget deficit by $1.5 trillion over the next 10 years.
With industry margins already under pressure and at a modest average of just 10%, Moody’s pointed out, increased competition for a less robust market will pressure profits further. As a consequence companies are likely to reduce payrolls and may be forced to undertake other restructuring-related actions as specific programs are identified.
Even if the super-commission sensibly succeeds in removing the sword of Damocles that hangs over Congress, the supplier base, from top to bottom, faces the requirement to achieve unprecedented levels of efficiency and performance, starting in the near term. Everyone working in A&D knows all too well the extent to which government customers themselves contribute to inferior program performance. Both Congress and the Pentagon share equal blame. And the truth of the matter is that almost certainly will not change very much, if at all. Period.
As exasperating as that thought may be, it is irrelevant, since the only thing that matters is the end result—can a prime contractor deliver what was promised at the contractual price and when it was initially promised. The primary focus for companies, therefore, has got to be on doing a better job of managing what they are able to control. Either systems integrators will figure out how to achieve dramatic improvements in productivity through a combination of technology and process improvements, or they will see their business base erode. My hope is that the dire warnings issued by Moody’s turn out to be false alarms.