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Military Market Report

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Metals on the Defensive The U.S. defense budget may never be as big as in the past. Metals suppliers need to adapt to a shrinking market, say the experts. By Myra Pinkham, Contributing Editor Government defense spending has a widespread effect on the U.S. economy and on the thousands of suppliers to government contractors, including many metals producers and distributors. Calls for austerity in Washington have produced steep cuts in the U.S. defense budget—a trend almost certain to continue, say the experts, barring some unexpected political calamity that escalates military activity. The aerospace and defense industries account for about 2 percent of U.S. GDP. They directly employ a million workers and support over 3.5 million jobs nationwide. Innovations in defense R&D not only reduce casualties on the battlefield, they also improve the lives of all Americans as the new technologies carry over into the commercial marketplace. But government spending on national security has been on the decline and there is no sign that will change, says James Callan, vice president-aerospace at Castle Metals, Oak Brook, Ill. Cuts by government agencies hurt businesses that depend on the defense sector, including suppliers of airframe materials such as aluminum sheet and plate, titanium and nickel bar, as well as suppliers of steel plate for Humvees and Mine Resistant Ambush Protected (MRAP) vehicles and other military ground equipment. The Obama administration and Congress have slashed the U.S. defense budget in the last several years. Spending is forecast to decline from $850 billion in 2010 to $750 billion in 2015. Last year was "a virtual disaster" for anyone who relies on the defense industry, and not just metals producers and distributors, but companies making parts, as well, says Rich Carbone, president and chief executive officer of Tech Steel & Materials LLC, Holbrook, N.Y. Automatic spending cuts resulting from government sequestration took about $100 billion out of the defense budget, idling workers and machinery at processors and fabricators across the country. Some of the sequester cuts were reinstated at the end of last year, at least until 2016, so there may be some marginal improvement this year and next, he adds. "But don't expect the market to go like gangbusters. We are no longer involved in two full-out wars and we are no longer at the height of terrorism." Another threat to military spending is the possibility of further across-the-board spending cuts through sequestration in 2016, if Congress cannot achieve a budget compromise. Meanwhile, Department of Defense spending costs are undergoing intense scrutiny, says Pat Able, general manager of the government business unit at Exton, Pa.-based TW Metals Inc. Military contractors got spoiled by the surge in government spending following the 9/11 attacks, sources say. Since then the psychology has changed. “Americans have been getting tired of war, especially at this type of skyrocketing debt,” says Jerry Bashir, president and chief executive officer of Falcon Aerospace, Weston, Fla. Turmoil in Iraq, Russia, Ukraine, Syria and the rest of the Middle East could increase the pressure on Congress to slow cuts in military spending. But that depends on how heavily the United States gets involved, and whether that involvement includes troops on the ground or just air support. “Given the current push to balance the budget, it is my belief that the only way defense spending will go up would be if someone attacks the homeland again,” Bashir asserts. The effect of the cuts on the metals industry has not been as severe as it could have been, notes Todd Zyra, president and chief executive officer of Klein Steel Service Inc., Rochester, N.Y. “Many of the cuts have been in non-metal-consuming areas, such as the closure of certain military bases and the reduction of personnel.” One goal of military leaders is to reduce the number of boots on the ground, so they have taken to the air. Some tasks formerly performed by ground troops are now handled by unmanned aerial systems, more commonly known as drones, as well as satellites and other types of surveillance technology, says Bill Sales, senior vice president for nonferrous operations at Reliance Steel & Aluminum Co., Los Angeles. Production of such sophisticated equipment consumes the latest high-tech materials, including aluminum alloys and titanium. The Department of Defense has more than 7,000 unmanned aerial systems today. Growth in the use of drones for both military and civil use will nearly double spending on the technology in the next decade to an estimated $11.4 billion a year. Currently, about 90 percent of drones are used for military purposes, though commercial applications for small drones are expected to explode. Metal suppliers have not yet felt the full effect of budget cuts due to the long lead times of most military programs, says James McAleese, principal of McAleese & Associates, Sterling, Va. “Metal procured today is for programs that were funded in 2012-14. The funding cuts set for 2015 will not hit them until 2015,” he says. Even then, the impact will vary depending on what branch of the military and what specific programs a given supplier supports. Companies that sell to the Army, which is essentially going on a procurement holiday in 2015, will feel it the most, McAleese says. With the Army’s exit from Iraq and drawdown in Afghanistan, its numbers are expected to shrink from 520,000 active troops this year to 490,000 in 2015 and 450,000 in 2017. “That means there is much less of a need for ground vehicles,” he says. In fact, about 25,000 MRAPs and Humvees are either being salvaged overseas and offered at no cost to U.S. allies or being refurbished, often with new armored steel or aluminum plate, before going into Army stockpiles until they are needed. The only new ground vehicle program currently proceeding is for the Joint Light Tactical Vehicle. Once a design is chosen, production will commence within 12 months. The JLTV will be followed by the Armored Multipurpose Vehicle program, which is meant to replace some Vietnam-era M113 vehicles. The AMPV is going under development in 2015-17, but will not start procurement until 2018-19. Armored personnel carriers represent an opportunity for metals suppliers. Designers are seeking ways to use aluminum, titanium and high-strength steels, as opposed to the traditional carbon and alloy plate, to make the armor plating thinner and lighter, and the vehicles more nimble, without compromising the safety of the troops. “As long as the plate has the same ballistic properties, lighter is better,” says Zyra at Klein Steel. Procurement for military aircraft peaked three to four years ago and has since been cut by about a third, says Richard Aboulafia, vice president of the Teal Group, Fairfax, Va. The wind-down of legacy programs has exceeded the startup of new programs, magnifying the change. Air Force procurement will grow only modestly for the next few years, McAleese says. Spending is expected to increase from $11 billion in 2014 to $12 billion in 2015 and $16 billion in 2016. The F-35 Joint Strike Fighter is among the few programs that have escaped the budget cutters, though it has been slowed by some technological hiccups. Aircraft are being built at an annual rate of only about 30, rather than the 100-plane pace hoped for by next year. Still in research and development, the KC-46 tanker aircraft appears to be moving ahead quickly, though it is unlikely to go into production until next year, McAleese says. The next big program, the Long Range Strike Bomber, is just entering the research and development funding stage. Suppliers of aluminum, titanium and carbon fiber composites won’t begin receiving orders for that plane for at least another decade, Aboulafia predicts. Production of the C-17 Globemaster III, a big consumer of aluminum and titanium, is expected to come to an end sometime next year. At the same time, the F-22, F-15, FA-18 and F-16 are in their last few years of production, at this point largely relying on export sales, Aboulafia says. Likewise, the helicopter market is still descending, although Sikorsky Aircraft Corp. was awarded a contract late in June to produce up to 118 Combat Rescue Helicopters. Military rotorcraft procurement is down about a quarter from its 2011 peak and will decline further in the coming decade, Aboulafia says. Meanwhile, the Navy has been shifting funding from aircraft to shipbuilding, which has been fairly healthy. Navy procurement will total about $14 billion in 2015 for carriers, submarines and destroyers, which contain a lot of carbon steel, aluminum plate and corrosion-resistant piping. Suppliers of aerospace metals to the military have been forced to reinvent themselves, says Bashir at Falcon Aerospace. That means either looking for sales outside of the United States or increasing their focus on the growing commercial aerospace market. Competition for materials with the commercial sector has lengthened lead times for military orders. “We have seen some sporadic shortages for precipitation hardening stainless steels, as well as for some aluminum and titanium aircraft alloys,” says Tech Steel’s Carbone. With mill lead times extending out two to three months, it is hard for distributors to keep them in stock. No doubt, the U.S. government will always be one of the metals industry’s biggest customers. But suppliers to its military can no longer count on demand on an upward trajectory. As Bashir says, “The defense industry will never be the same as in the past. There just isn’t sufficient funding.”