Big Defense Budget Boost For Sonobuoys To Grow Sparton's 'Razor Blade' Business

Sparton Corporation (NYSE: SPA), a $231MM LTM revenue company that designs, develops and manufactures complex electronic and electromechanical products and subassemblies (and provides related services) for the Medical, Military & Aerospace, and Industrial & Instrumentation markets, is one of only two manufacturers for US and Allied navies of a special kind of anti-submarine warfare sonar device known as a Sonobuoy. Sparton’s sonobuoy business is likely the beneficiary of the recently released President’s Budget for FYE 2014 which calls for a huge 72% increase in sonobuoy expenditures from the adjusted FYE 2013 budget.

As US military strategy transitions to an Asia-Pacific and more Navy-centric emphasis, anti-submarine warfare gains greater importance to counter both growing tensions in the South China Sea and a growing Chinese submarine threat. (See also my Seeking Alpha article entitled, “Sparton: Ready to Cash In on the Naval Arms Race.”) While heavy durable military equipment, made by companies like Oshkosh Corp. (OSK), is scheduled for cutbacks from the wind down of Afghanistan war spending, sonobuoys are relatively inexpensive and consumable devices that are essential for the protection of multi-billion dollar carrier battle groups that carry thousands of sailors, marines, and aviators. Sparton is the only US-owned company making such essential devices and shares annual Navy procurement contracts with a US-based subsidiary of a British-owned company via a joint venture known as ERAPSCO.

The ultimate “Razor Blade” dropped by the dozen and whose useful life is less than 8 hours

Sonobuoys are the ultimate “razor blade” in the Navy’s anti-sub arsenal due to their relatively low cost and short lifespan of only a few hours. While these devices are deployed via multiple platforms (e.g. air, ship, etc.) they mostly are air-dropped by plane over a wide matrix using multiple buoys seeking their prey. Sonobuoys are “consumable” in that they are dropped in front of an advancing battle group of ships with batteries programmed for eight hours or less life. While in use, the buoys transmit signals back to hunter/search aircraft, providing information on the location or absence of hostile submarine contacts. Shortly after the carrier battle group passes through the area, the buoys scuttle themselves to the bottom of the ocean to prevent recovery by adversary forces.

FYE 2014 President’s Budget – Sizable Increase For Sonobuoys And A New Delivery Platform

Coincident with this past week’s submission of the President’s Budget request to Congress, the Department of Defense publishes a non-classified summary of its procurement programs (P-1) for the DoD oversight committees of the Congress. This summary obviously does not contain supplemental amounts requested that are Classified and “Dark” programs. The FYE 2014 P-1′s Navy budget on page N-28A proposes a huge 72% increase for sonobuoys from the adjusted FYE 2013 budget. Note, as illustrated on page N-28 that the 2013 budget, as adjusted, is also up 4.2% from FYE 2012 sonobuoy expenditures.

The platform that has commonly delivered sonobuoys for the US and other allied navies to their desired location is the soon-to-be-replaced Lockheed (LMT) P-3 Orion, a propeller-powered aircraft. A new jet-powered aircraft, the Boeing (BA) P-8 Poseidon will not only fly longer missions, but also do so from a much higher and safer altitude. Afterrecently delivering its 7th new P-8 on its initial low-rate production contracts, Boeing has ramped up its production rate to roll out a new P-8 every month. Eventually, the US Navy plans to replace its entire P-3 Orion fleet with the purchase of 117 P-8As. Even in tightened defense budget circumstances, the P-8′s ASW mission remains a high priority for the Navy. The FYE 2014 P-1′s Navy budget, on page N-4A, proposes a 28% increase for new P-8 purchases vs. the adjusted FYE 2013 budget.

Sparton and ERAPSCO has already received millions in cost-plus research and development contract work to modify current and future sonobuoy designs for the P-8′s new high altitude anti-submarine warfare (HAASW) mission, after which there will be a need to provide the initial inventory of the new sonobuoys as well as re-supplying annual consumption needs, similar to what Sparton provides today.

Note finally, the US Navy’s replacement of the P-3 Orion with the P-8 Poseidon does not mean the end of the versatile P-3′s ASW mission or its need for Sparton’s sonobuoys. Hundreds of P-3′s are in service with the armed forces of many of our allies throughout the world and serve as a ready market for both newly retired US Navy P-3s as well as incremental Sparton/ERAPSCO sonobuoy sales and technical support.

In Conclusion

Our country’s growing national security demands for anti-submarine protection and a new improved delivery platform provide a sustainable, somewhat predictable, stream of high-margin cash flow and profits to Sparton’s bottom line for the foreseeable future.

Additional disclosure: At time of writing, author and/or funds author manages hold a long position in this issuer. Author and the funds may buy or sell securities of this issuer at any time.

http://seekingalpha.com/article/1337231-big-defense-budget-boost-for-sonobuoys-to-grow-sparton-s-razor-blade-business