Japan Tired of Playing with Toys; Buys Fighter Jets Instead
Japan has announced that it has selected the Lockheed Martin (NYSE: LMT) F-35 to use for its next generation of jet fighter planes. The F-35 program has been implemented as collaboration between the US and its allies in an effort to develop a low-cost, but capable fighter jet. Jet fighters have been a source of controversy during US defense spending cuts over the past few years, as the highly advanced F-22 Raptor fighter has been deemed too expensive to produce large quantities of.
News of Lockheed Martin's contract originally broke through Benzinga Pro. Check it out here.
The F-35 competed with the Boeing (NYSE: BA) F-18 and Eurofighter Typhoon for the jet fighter contract. Japan ultimately deemed the next generation fighter's stealth capabilities as the winning factor, as the ability to avoid radar detection will be one of the defining characteristics of warfare over the next few decades. The F-35 is also designed to be flexible in that many countries will outfit them to support their needs, which allows each jet to be sold for $114 million.
The F-35 program has faced criticism from US officials with regards to development costs and limited international interest. As lawmakers look to trim hundreds of billions of dollars from the defense budget, Lockheed Martin has struggled to find enough willing partners to amortize work loads and production costs. An investment by a technically advanced country such as Japan is seen as a much needed validation for the program. "This program badly needed an endorsement like this. But there are still many complications, especially price tag and work demands," said Richard Aboulafia, an anlyst with the Teal Group.
The F-35 decision is unique in that Japan did not have an opportunity to adequately test the aircraft in real world situations, given its development status. The country also took a gamble in that its fleet of F-4s are rapidly aging and in desperate need of replacements. Any delay in F-35 production could mean problems for Japan's air force. However, Japan clearly valued the next generation capabilities of the F-35 over the aging F-18 and modern Eurofighter Typhoon. Given the country's willingness to stretch the lifespan of its fighter fleet, the decision could pay dividends a few decades from now.
The decision was informally made well before news of Kim Jong-il's death, which has heightened tensions in the Asia region, as there is very little information or guidance on how North Korea's new leader, Kim-Jong-un, will handle the transition. It is a reflection of Japan's recent stance on expanding diplomatic relations with the US, as minor tensions had flared in 2009 when the new Democratic Party of Japan had taken power and sought a more equal relationship with its diplomatic partners.
The decision is clearly positive for Lockheed Martin, as the company faces potential issues with future revenue streams. The US decision to pull out of Iraq, as well as a possible end to the Afghanistan war a few years down the road mean that the company will need to find new revenue opportunities.
Bullish:
Traders who believe that Lockheed Martin's F-35 program will continue to generate new orders should consider the following options:
- Purchase shares or call options in Lockheed Martin. If the company can grow revenue from the program, shares could be poised to climb.
- Short shares of Boeing or consider put options. The only fifth generation fighters, the F-22 and F-35, are both produced by Lockheed Martin, and Boeing's failure to adequately replace the aging F-18 could mean the company's jet fighter program is in jeopardy.
- Go long an aerospace and defense ETF. If foreign countries decide to follow Japan's lead and purchase new fighters, the sector could have financial upside for investors.
Traders who believe that countries will cut jet fighter orders will want to consider these trades:
- Go short Lockheed Martin and Boeing, or consider put options. As the US looks to cut defense spending and end its wars in the Middle East, military equipment producers could see their revenues fall.
- Short an aerospace and defense ETF. Even if Lockheed Martin can see gains in the F-35 program, the industry as a whole could suffer if the US continues to cut its defense budget.
