The Contrarian

“In the investment markets, what everyone knows is usually not worth knowing.”

US War Industry Shifts Into High Gear

One of my favorite sectors (as written about in our latest Wellington Letter) is what is called the “aerospace and defense.” The new president will challenge many nations opposed to the US, and aid others who are our allies. That means the war industry will shift into high gear.

It’s already doing well. In 2015, it sold $33 billion of weapons just to the Gulf oil countries. That’s pretty good for such a thinly populated area that probably no one seriously wants to attack, unless they need sand for their own beaches. But it would be cheaper to buy that sand.

The excerpt of an article in Fortune Magazine below discusses those sales. You can bet that they will be substantially higher in 2017.

U.S. Sold $33 Billion in Weapons to Gulf Countries in the Last Year

Clay Dillow

If war is a nasty business, it’s also a lucrative one. New figures released by the State Department show that the United States has sold $33 billion worth of weapons to its Gulf allies since May of last year, with more deals in the works as the business of bombing the Islamic State continues to boom.

“Consistent with the commitments we made to our Gulf partners at the Camp David summit last May, we have made every effort to expedite sales,” State Department spokesman David McKeeby told Defense News.

In the eleven months since, the State Department has helped with the export of everything from attack helicopters to ballistic missile defense systems to precision guided munitions to Gulf Cooperation Council states—that’s Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.

The Gulf spending spree is two-pronged. Sales of higher-end weapons systems—things like advanced naval frigates, attack helicopters, and defensive missile batteries—stem in large part from the U.S.-Iran nuclear accord. GCC states, and Saudi Arabia in particular, worry that a resurgent Iran unencumbered by economic sanctions will move to bolster its ailing military, upsetting the regional balance of power.

But where munitions are concerned, the twin bombing campaigns against the Islamic State in Iraq and Syria and against Houthi rebels in Yemen are driving sales of precision weapons and “dumb” bombs alike. In 2015, the U.S. delivered 4,500 precision guided munitions to GCC states, McKeeby says, including 1,500 taken from the U.S. military’s own inventories.

In December, Air Force chief of staff General Mark Welsh said the U.S. was “expending munitions faster than we can replenish them,” warning of a shortage of precision-guided Hellfire missiles and other munitions. Air Force Secretary Deborah Lee James put it somewhat more bluntly, stating “we’re in the business of killing terrorists, and business is good.”

Business certainly is good. In a note to investors, Guggenheim Partners defense analyst Roman Schweizer noted this morning that precision munitions makers like Lockheed Martin (LMT, +0.91%), Raytheon (RTN, +0.53%), Boeing (BA, +1.19%), and General Dynamics (GD, +0.99%) all stand to benefit from the uptick in overseas sales.

Lockheed alone has already received $18 million to bump its Hellfire missile production from 500 to 650 missiles per month, Schweizer writes. The company has also quadrupled production of Paveway II laser-guided bombs, a favorite of the Saudi Royal Air Force (the State Department cleared a sale of 1,000 Paveway II bombs to Saudi Arabia in November of last year).

All that’s on top of the $1.8 billion the Pentagon is asking for in its fiscal 2017 budget request to fund the production of 45,000 smart bombs to replenish its own stores.

Meanwhile, Department of Defense spending on missiles rose 14% from fiscal 2015 to fiscal 2016, and another 7% increase is included in the fiscal 2017 request, according to Schweizer’s note (ammunition spending is also slated to rise 12% in fiscal 2017 over the year prior, though that’s a broad category encompassing both high- and low-end munitions).

But as the State Department continues to help with the export of copious amounts of expendable munitions to America’s Gulf allies, a couple of major deals remain in arms-export limbo. Kuwait and Qatar have been waiting for two years for State Department approval to purchase, respectively, 40 F/A-18 Super Hornets and 72 F-15 Silent Eagles (both aircraft are manufactured by Boeing, which could use the business).

Sources in Kuwait and Qatar have vocally complained to media that pressure from Israel is holding up the sales, though State Department officials have explicitly denied those claims.

As the campaign against the Islamic State in Iraq and Syria as well as the conflict in Yemen persist, Schweizer doesn’t see the demand for weapons slowing anytime soon.

But while the pace of bombing in those countries may slow or even cease, the military buildup in the Middle East in response to the Iranian nuclear deal shows no sign of abating. Meanwhile, U.S. allies in Europe and Asia are quietly—though no less aggressively—looking to upgrade their own defenses in light of new high-tech regional threats like Chinese and Russian ballistic and cruise missile technologies.

“We have been bullish for the better part of a year that the Pentagon and its European and GCC allies will have to refill their stocks of missiles and munitions due to the current campaign against ISIS in Iraq, Syria, Yemen, and even Libya,”  Schweizer notes.

“While this is taking place, we think there is also a different trend emerging in U.S. weapons and munitions purchases (which will probably follow with European and Asian allies over the next several years) of accelerating the fielding of next-gen weapons targeting high-end threats.”

The above article was from last year. We used it to let investors know which countries get the hardware, and which US companies get the business. Here is an update from this year (February 8) on what the new President is doing. He obviously wants to create a coordinated opposition to the strongest power in the region, Iran, which will have nuclear weapons in the future.

It is now speculated that Saudi Arabia has made a deal with Pakistan to purchase nuclear weapons from them, in preparation for the day that Iran will have them. Furthermore, the leader of Saudi Arabia had a recent meeting with top Gulf states to create a group to combat Iran if and when necessary. That means more arms sales to that region.

Here is an excerpt from zerohedge.

The bottom line, however, is that in Trump the Saudis have managed to land a very near and dear friend, one who will provide them with any weapons they need, for a price.

Sources close to the government in Riyadh told the WashTimes that Saudi Foreign Minister Adel al-Jubeir is “very, very up” on the Trump administration and believes it will pursue a significantly different policy from the Obama administration, particularly toward Iran.

Other U.S. officials, speaking on background this week, noted that the Trump administration already moved during its first days in office to approve roughly $1 billion in sales for America’s Gulf Arab allies, including some $400 million in air-to-air missiles and helicopter parts for Kuwait and a $500 million-plus package that included Aerostat observation balloons for Saudi Arabia.

The Saudis in particular are likely to see billions of dollars in more defense sales in the coming years.

And there we have the next war. That’s why the stocks in the aerospace and defense sector should do very well over the next several years. Furthermore, a conflict with China is a possibility as well. Money will be poured into the war machine.

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