A Blockbuster Quarter for Defense Companies

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July 25 (Bloomberg) -- Center for Strategic and Budget Assessments Senior Fellow Todd Harrison discusses defense company earnings and the impact of the sequester with Scarlet Fu on Bloomberg Television's "Market Makers." (Source: Bloomberg)

There were warnings that the sequestration would hurt defense companies, but so far, they're doing ok.

Boeing and lockheed martin are reporting blowout earnings this week.

The defense company index is up 30% in 2013 versus an 18% gain in the s&p 500. our guest is todd harrison, a senior fellow at the center for strategic and budgetary assessment.

He is in our washington bureau.

Good morning to you.

Does the defense sector to the nest deserve credit for adjusting well to this new reality?

Both are true.

I think the defense industry has gotten ahead of the curve.

And a lot of these companies started restructuring themselves as and they saw this was coming.

They have shed part of their workforce and closed facilities and other things to get more efficient internally.

They deserve credit for that.

The other thing going on here is that sequestration's impact from a defense industry are not going to be immediate.

There is a time lag because superstition cuts -- the department of defense budget authority depends on outlays.

There is a natural lag between when they get budget and when they spend it.

For services, they spend money more quickly.

They will spend two thirds of it in the year.

For equipment, which a lot of these companies make, it actually takes about five years before they spend all that money.

They have had time to prepare and may have been shrinking the workforce.

How effectively haven't been able to manage these costs and cuts that are coming?

You look at companies like lockheed -- lockheed martin, they shed 30,000 jobs since 2008. there got ahead of the the curve.

Other companies and industries are adjusting.

It is fair to say the industry is taking sequestration more seriously and adjusting to it faster than the department of defense itself.

The department of defense has been lagging and i think is fair to say they were caught flat- footed on march 1 20 recession actually went into effect.

They were not expecting this to happen.

The ceos gave these doomsday messages about how it would spell disaster.

That has not happened yet.

What kind of consequences doesn't have?

I think the risk here is credibility.

A lot of the ways they framed the impact of sequestration, there is a lot of ambiguity.

It gave people the impression that there was going to be immediacy on impact.

But with this and this year or this quarter.

That is not the way it works.

These countries have a huge backlog, many of them have huge backlog of orders.

That money is already obligated and it by law cannot be touched by sequestration.

I don't think that message was made quite clear.

It is a snowballing effect.

Starting now, it will build next year and a year after that.

We will eventually see the impact.

I was just don't ask you you, when specifically on timing?

General dynamics, they raised expectations for profits through the end of this year.

This is something i think we'll see more of the impact next year and more in 2015. this will gradually build over time.

The other thing to keep in mind is we are talking about overall sales and revenues going down.

Profitability within that, the margins of these companies make may not be affected.

In some cases, it may actually be able to prove the margin.

Why is that?

What happens is under superstition, the dod is forced to mr.

These cuts in a fairly blinded manner.

Across all accounts.

There are some accounts where they have entered into long-term contracts with these companies where they have agreed to buy at a certain rate in the future.

They have less money than they thought the reports have in that account.

They had to go back to renegotiate the contract with the vendor.

That gives the vendor the opportunity to come back in and improve their margins, if they feel they can.

I know some companies have been faring better cap and those that have been exposed to commercial aircraft and more of that kind of business.

How should these companies reposition and researcher themselves to make the most out of the fact the cuts are coming?

The reality is, we're in a downturn in terms of defense spending.

It started in 2010 and it is not just superstition going on.

We're seeing a reduction in the amount of funding for the wars in iraq and afghanistan come to an end.

We know we are in a drawdown and that will be less money for the defense industry.

We will have to see a reduction in capacity.

This text has been automatically generated. It may not be 100% accurate.

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