The possibility of a smaller Department of Defense budget would hurt Lockheed and its rivals.
NEW YORK (TheStreet) -- Defense-industry stocks such as General Dynamics(:GD) and Lockheed Martin(:LMT) may suffer a double whammy if Congress fails to pass a budget for the Department of Defense and the so-called Super Committee trims costs.
FBR analyst Patrick McCarthy said there's a chance the Department of Defense may operate under a "continuing resolution" next year, meaning funding would remain little changed or fall. That's never happened before.
The Super Committee is preparing to unveil a plan next week to cut government spending, which has been weighing on defense stocks. Since the start of June, the S&P 500 Aerospace & Defense Index, a proxy for the stock performance of the defense industry, has declined 8%.
According to McCarthy, the Department of Defense has never operated under a continuing resolution, but at the same time no budget for the department has been provided. He wrote in a note that "some services are entirely unprepared to alter budgets in fiscal 2012 if a continuing resolution is in place for the entire year."
There's no clear sign which contracts would be hurt most if the Super Committee cuts costs or a continuing resolution is put in place, making it hard to determine which companies would be affected. Thus, investing in the defense sector should be avoided -- despite attractively valued stocks -- until a budget is passed.
Companies such as General Dynamics, Lockheed Martin, Raytheon(:RTN) and Northrup Grumman(:NOC) receive a big slice of their revenue from the Department of Defense (see chart below). Investors would be wise to steer clear of those companies.
Lockheed Martin, a maker of satellites, aircraft and missile-defense systems, was the No. 1 supplier to the U.S. Department of Defense in 2010 and is on track to claim that title again this year based on data from USASpending.gov. In fact, the government has paid more than $8 billion to Lockheed in 2011 for aircraft. About 60% of revenue was derived from the Department of Defense in 2010.
The other company largely reliant on contracts from the Department of Defense is Raytheon, which manufactures air-, marine- and missile-defense systems. The government's top awards to Raytheon have been for guided missiles, with contracts worth $2.8 billion so far in 2011. For Raytheon, things could get even worse if President Obama pulls troops from locations overseas.