Budget Blues for Oshkosh

While bullishness is seemingly everywhere today, there are pockets of weakness -- and President Obama's fiscal 2013 budget, which would begin on Oct. 1, provides a few. Several items have been widely expected, including raising taxes on would-be millionaires and billionaires, cuts to military spending and investing in the nation's infrastructure. With the budget proposal now available, politicians and investors alike can drill down and decide which companies are vulnerable and which are positioned to benefit from shifts in spending. Military and defense spending is in the cross-hairs; the 2013 budget proposal proposes cuts in Pentagon spending for the first time since 1998. The Pentagon's fiscal 2013 budget calls for a 7.5% drop to $179 billion for developing and buying new warships, fighter jets and other weapons. Slower procurement for several headline programs -- including the Joint Strike Fighter -- could slow the outlook for Lockheed Martin (LMT). According to the budget proposal total acquisition spending would be cut by 12.2% from last year's budget, with larger cuts in ground vehicle programs (compared to aircraft and ship spending) as the military reduces the size of the Army and Marine Corps after 10 years of war in Afghanistan and Iraq. The relative sturdiness of aircraft and ship spending bodes well for Boeing (BA) given the sharp increase in funding for the KC-46 refueling tanker from $877 million to $1.82 billion, and for Huntington Ingalls Industries (HII), a spinoff of Northrop Grumman (NOC), as the Navy added $781.7 billion for initial construction funding of a new aircraft carrier and $1.6 billion for the refueling of the USS Abraham Lincoln carrier. Cuts in ground vehicle programs are going to hurt Oshkosh Corp. (OSK) shares. Over the past three fiscal years Oshkosh derived more than 50% of its net revenues from the U.S. government, much of it under multiyear contracts and programs in the defense vehicle market. The Army has proposed buying fewer medium-duty trucks made by Oshkosh to save $2.2 billion over a five-year period, according to the budget document. More specifically, this U.S. Army proposal targets saving $100 million in fiscal 2013 and the remainder through fiscal 2017. The defense budget for fiscal 2013 shows the U.S. Army would spend $377.4 million to buy 1,471 Family of Medium Tactical Vehicles (FMTV) trucks, down from an estimated $438 million for 2,524 trucks in fiscal 2012. While this is a budget proposal, it increases the uncertainty risk associated with OSK shares and calls into question the company's ability to reverse the calendar 2012 falloff in earnings in calendar 2013, as the Street currently expects. As a point of reference, after delivering earnings of $2.39 a share in calendar 2011, the Street currently sees OshKosh's earnings falling to $1.51 a share this calendar year and rebounding to $2.30 in 2013 -- and rising steadily thereafter. Given the strong operating margins associated with the company's Defense segment and low margins at its Access Equipment and Fire & Emergency businesses, cuts in military and defense programs are likely to pressure Oshkosh earnings. Given the year-to-date rise in OSK shares, risk-averse investors should trim positions and book some profits until the dust of the budget cloud settles. One potential wrinkle: some pundits are positing that Carl Icahn may look to combine Oshkosh, of which he owns nearly a 10% stake, with Navistar (NAV), where he's also a 10% holder. For my money, I'm still inclined to trim at current levels and look to revisit the shares between $19 and $20.

Budget Blues for Oshkosh

It's far from a done deal, but Obama's proposed 2013 budget offers a glimpse of what could be in store -- and there are winners and losers throughout the defense industry.

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