Earlier this month, ACG National Capital hosted the President and CEO of BAE Systems, Inc., Jerry DeMuro, for the July monthly meeting held at the Ritz-Carlton in Tysons Corner.
BAE Systems, Inc. is a global, U.S.-based defense, aerospace, and security company with approximately 35,000 employees that last year generated approximately $11.8 billion in annual revenue. Mr. DeMuro, who has had 36 years of experience in the world of security, technology, and aerospace, shared some insight into the latest trends in the defense industry, which has been facing new and emerging challenges over the past few years.
“The aerospace and defense investment budgets are in approximately the sixth consecutive year of decline, and it would appear that that decline has several years left to run” said DeMuro.
But the reasons for the continuing decline are clear-cut according to DeMuro: “We have the winding down of two wars, a nation that’s grappling with its debt, budget constraints, the ever-present threat of sequestration and program cancellations, and an industrial base in defense that is clearly in decline.”
After six consecutive years of decline, DeMuro doesn’t see a rising tide on the immediate horizon. The Budget Control Act of 2011, which among other things, led to sequestration, “is scheduled to provide almost $500 billion worth of savings from prior budgets in defense alone. And that’s over a ten-year period. So we’re barely three years into that sequestration period and the severity really is only beginning to be felt.”
But DeMuro is quick to point out that current cuts are not the result of a decline in threats around the world; these cuts are financially and fiscally dictated, and “they come at a time when world tensions, unrest and instability are, in fact, increasing.”
So what has the industry done to adjust to these big changes in government spending? “We’ve been forced to make difficult downsizing choices. We’ve reduced headcount, consolidated facilities, and reduced sizes in structure to handle the business that we have.”
But DeMuro is actually optimistic about the overall outlook. Based on his years of experience, he strongly believes that this industry has shown “the ability and agility to adjust, and this is not the first time that we’ve been through such a cycle. And that’s what it is, really, for the most part. It’s a cyclical vs. structural change.”
Looking at the historical pattern of government defense spending, it’s clear that markets are indeed cyclical in nature. “We operate most akin to a capital goods industry. After every trough the industry goes through, it marches back up. Another thing we should note is that we’re not very good at predicting the catalysts that lead to an increase in spending.”
DeMuro also highlights one of the defense industry’s biggest advantages: customers that actively advertise their requirements and their purchasing intent. “We have tremendous visibility into the budget priorities and the requirement and programs of our government. Federal budgets are debated and then published in detail. This guidance helps us discern what the winners and losers are going to be.”
As long as companies are performing solidly during a down-cycle and can show discipline, they can outperform the competition in an up-cycle. “For me, the underpinning of any value creation is a strong performing business.”
Mr. DeMuro also shared his three basic principles for solid and sound investment:
- Smart capital allocation
- Focus on sustained value
- Prudent capital deployment
Although he has a positive outlook on the future of the industry, DeMuro remained refreshingly honest and blunt about the current environment: “I don’t predict that we’ve seen the last of the budget reductions. Our industry is going to face more difficult decisions moving forward.”
But having said that, he once again emphasized, “After a period of tremendous uncertainty, and in the shadow of sequestration and shutdowns, we do have some certainty and we do have some visibility emerging, and that’s why I think this is a good time to position for growth.”
“By taking current global instability into account, which provides an upside for our business, and the historical cyclicality of the defense and aerospace business, I’ve come to the conclusion that now is the right time to plant the seeds for growth.”