The Unique Relationship Between the Defense Industry and the U.S. Government

The defense business is unique in its reliance on one massive customer: the Pentagon. The Motley Fool's Nick Sciple and Fool.com Contributor Lou Whiteman discuss the pros and cons of that relationship, including the risk to the industry from infighting in Washington and the impact of the recent shutdown, on this segment of Industry Focus: Energy.

A full transcript follows the video.

This video was recorded on Jan. 31, 2019.

Nick Sciple: First, Lou, before we dive too deep into that, I want you to talk about, how significant is the government as a customer for these defense contractors? How important is what's going on in Washington D.C. to their bottom line?

Lou Whiteman: This is the trade-off of this industry. The good news is, you have a customer who, so far, for 200 years in, has been able to pay its bills, and it's pretty reliable on that. However, you are reliant on that one customer, and increasingly in recent years, there has been erratic behavior with that customer. In this case, the Pentagon was not shut down, which certainly helps these defense contractors, but they do a lot more than just serve the Pentagon. They do a lot of the IT work for different agencies that were shut down. They do a lot of work for NASA and Homeland Security, who were involved in the shutdown. So, yeah, this adds a huge layer of uncertainty to a business that is, as you say, very reliant on that one customer.

Sciple: Just to give you some numbers on the shutdown, obviously it was the longest one in history at 35 days, and we're still not 100% sure whether it's over for good. We've got this continuing resolution in place that's going to keep the government temporarily open until Feb. 15, but there could be another shoe to drop. Definitely some uncertainty for these defense contractors.

One way that these defense companies were impacted during the shutdown was the ability to follow through on some foreign arms sales that had been taking place recently because the Department of State and Department of Commerce were both shut down. Can you talk about the effects of that on some of the defense contractors in the U.S.?

Whiteman: Sure. As you say, for all these foreign sales, there's a few different programs that we do foreign sales. Some through the State Department, and some just need approval from Commerce. But they do need to be rubber-stamped. Sometimes, it can be controversial.

International sales are a big push of this administration, and it's expected to grow. It was over $55 billion last year. They're hoping for more this year. This is a significant chunk of revenue that did shut down. The good news is, it was early in the quarter. We're mostly talking about the first quarter of 2019. There's a lot of time to play catch-up. The State Department officials really believe that it won't mess up the year. It could have a small effect in the first quarter of 2019, but hopefully, they're back at work. Most of what was in the pipeline was pretty non-controversial, so it should be a matter of just getting it out the door. But that's certainly a huge risk, more for the first quarter of 2019, but a huge risk for these companies and their numbers.