With a $750 billion national defense budget proposal for 2020,1 the US Defense Department is the primary customer for US defense companies. At Invesco Unit Trusts, we believe this unique business relationship offers compelling opportunities for investors in two ways. First, by providing investors a potential sense of security in a time of heightened geopolitical and economic uncertainty through dependable government revenue streams and significant barriers to entry. Second, by promoting innovation as the Department of Defense demands state-of-the-art technology and solutions to respond to the ever-evolving global geopolitical landscape.
Reason No. 1: A potential sense of security in uncertain times
Government contracts reduce the guesswork when it comes to how and when a company earns its revenue. The Department of Defense awards contracts with clear timelines, product/service expectations, and transparent pricing. This predictability makes US defense companies less susceptible to the macroeconomic backdrop, which is especially notable now as we face higher economic uncertainty in the tenth year of the current expansion. Importantly, the Under Secretary of Defense (Comptroller) forecasts continued growth in the national defense budget for several years (Figure 1).
Figure 1: National Defense Budget Authority forecast
We don’t yet know what final adjustments Congress may make to the $750 billion defense budget proposal; however, regardless of the final figure, many US defense companies still anticipate healthy growth as the Department of Defense has prioritized military modernization efforts (Figure 2), which include procurement, research, development, testing, and evaluation.
Figure 2: “Modernization” budget authority
The US defense industry also has significant barriers to entry considering many leaders in the space have strong brand reputation, regulatory expertise, proprietary technologies, extensive experience with government contracts, and limited foreign competition (for US security reasons). Security clearances, specialized accounting rules, and substantial capital spending requirements also limit the number of incumbents. Since the government is particular about who does business with the military, its extensive procurement regulations and procedures can be daunting to navigate. These barriers can help protect the existing firms’ revenues and profits.