Pentagon Cuts Haven’t Hurt Arms Industry On Wall Street

Defense contractors sing a heartbreaking ballad about an industry left desolate by savage Pentagon budget cuts. But Wall Street warbles a happy tune about an industry that beats the market year in and year out.

The happy tune plays on in 1996. In the first three quarters of the year, the defense industry again handily bested the Standard & Poor’s 500-stock index of the largest U.S. companies. The S&P’s aerospace and defense index, consisting of eight of the biggest U.S. military contractors, rose 16 percent in the first nine months, compared with the S&P 500’s gain of 10.7 percent. In the five years before that, from 1991 to 1995, the S&P defense and aerospace index went up 153 percent, while the S&P 500 rose 89 percent.

What gives? The companies were indeed mugged by severe budget cuts by the Pentagon and National Aeronautics and Space Administration. This coincided with one of the U.S. airline industry’s worst recessions, as many air carriers delayed orders for new jetliners.

But in the investing world, beating expectations is all. And many Wall Street investors all but wrote off the defense business as a historical irrelevancy after the Berlin Wall fell and the U.S. military began hacking at its bottom line in the late 1980s.

Now some investment experts acknowledge they failed to anticipate that defense contractors - which over the years had come to resemble the slow-moving military bureaucracy on which they depended - would have the creativity to work their way out of difficulty.

But many of these businesses learned how to become more entrepreneurial, to cut costs faster than their work disappeared and to find new efficiencies by merging with one another.

“Investors and Wall Street just didn’t understand the ability of this industry to cope with down markets,” said Paul Nisbet, a defense analyst with JSA Research. “Defense industry management was looked at (by Wall Street) as a bunch of Neanderthals able to communicate only with generals. But they’ve turned out to be astute at managing, and at acting as investment bankers able to swing acquisitions.”

Indeed, some of the companies whose stocks are flying highest are those born of mergers. The stock price of Lockheed Martin Corp. - the offspring of the combinations of the Lockheed and Martin Marietta corporations last year, and of Loral Corp. this year - grew 14 percent in the first nine months of 1996, and was up 82 percent in 1995.

Wall Street analysts say they’re impressed by the company’s record so far in finding synergies among its predecessor firms, paring redundant operations, and hustling for business in such non-defense areas as computer integration.

Northrop Grumman Corp., itself reborn after several acquisitions, appeals to investors for similar reasons, analysts said. Its stock has increased 20 percent this year, and rose 54 percent in 1995

Shares of Hughes Electronics Corp. - a division of General Motors Corp. that trades as GM’s H class of stock - increased 17 percent in the first three quarters of this year, and 38 percent in 1995. The market apparently approves of its defense and commercial satellite acquisitions, as well as its blossoming satellite-dish television service, DirecTV.

Hughes’s stock surged in January after AT&T announced big investments in that TV venture, but sagged when Hughes lost a large Pentagon missile contract in June. Howard Hughes’s old company has now diversified so successfully from its aerospace heritage that executives say they’re considering spinning off its defense components to focus on its more lucrative telecommunications and television business.

Other firms that have aggressively diversified into commercial work also have experienced a sharp rise in share prices. Raytheon Co. stock rose 15 percent through September this year, and was up 49 percent last year. United Technologies Corp. increased 27 percent this year, and rose 49 percent in 1995.

General Dynamics Corp. hasn’t diversified, but its investors have prospered - their shares went up 13 percent in the first nine months of this year and were up 38 percent in 1995. This year it’s won a huge Marine Corps contract - to build amphibious vehicles - that could eventually be worth $6 billion, and it’s all but won a lawsuit over the A-12 jet that is expected to yield a $750 million award.