Defence looks to retrench

This year could see the biggest structural changes in the defence industry since the mega-mergers of the 1990s as governments on both sides of the Atlantic try to get to grips with a bloated and inefficient procurement system. The prime contractors, sub-contractors and makers of disposable items such as flares and munitions will all look nervously at the gradual winding down of combat operations in Afghanistan, a major source of income, as well as the rise of closed defence markets such as China. So, the need to crack new and rising markets like India and Brazil has become even more imperative. But at civil aerospace seems set up for a better year.

Rolls-Royce was in the news for all the wrong reasons last year after the Qantas engine blow-out, but the company should be able to contain the damage and will be bouyed by a late rush of plane orders from low-cost and asian carriers; Airbus recorded 644 orders in 2010 and should deliver between 520 and 530 planes this year. The high oil price will also impact the sector this year, with the business jet sector usually bearing the brunt - that might hit Meggitt, although the brake-maker had a generally good recession.

In the defence sector, all of the main UK manufacturers will have to decide this year how to start diversifying away from the US market. BAE Systems seems to recognise this with a push into India, where surrounded by belligerent neighbours and competing super powers, the country's defence market is expanding by 20 per cent a year. Cobham will also be a company of interest after bid rumours started to surface before Christmas. The defence contractor suffered an ignominious ejection from the FTSE 100 after investors were spooked by procurement delays in the US. It remains to be seen whether these log-jams have cleared up, or form part of a long-term trend.

Apart from the threat of a budget squeeze, the main concern for the industry this year is how the procurement systems of the US and UK will look after re-organisation. The inevitable shake-up will be led by former IC journalist Bernard Gray who, as chief of defence material and the author of a stinging report on the MoD's purchasing practices, has a very wide brief to reform the procurement system and is likely to favour outsourcing the 20,000 or so staff that buy equipment for the ministry.

BAE SYSTEMS34311,6798.44.9-6.5
QINETIQ GROUP13690011.50.0-16.1
ROLLS-ROYCE GROUP66412,41917.32.337.4
ULTRA ELECTRONICS HDG.1,7431,19816.91.926.8

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