FTSE 350: Strategic imperatives and a more collaborative MoD

That may seem slightly disingenuous given the Royal Navy will eventually take delivery of the two largest vessels in its history, the Queen Elizabeth II class aircraft carriers, alongside a flotilla of next-generation Type 26 and Type 31e frigates. There’s also a commitment to buy 138 F-35B Lightning II fighter jets from US manufacturer Lockheed Martin. But the reality is that a significant proportion of the £178bn that the MoD has allocated for new and replacement capital items for the UK armed services (including a £31bn commitment for renewal of the UK’s nuclear deterrent) was predicated on projected efficiency savings (a mainstay of shadow front-bench spending plans). Unfortunately, these savings have proved more difficult to find than the stealthy F-35s, so defence chiefs have been left with a £20bn funding shortfall, together with the prospect of some embarrassing trade-offs once the national security capability review is finalised this year.

Its contents are likely to further highlight the imperative for the UK to beef up its cyber defences, in response to what’s essentially a relatively low-cost, difficult-to-trace form of state-sponsored aggression. The government has created a National Cyber Security Centre (NCSC) as the hub of the UK’s cyber-security environment, although the military’s Cyber Security Operations Centre will work closely with the NCSC in the event of a significant national cyber-attack.

Some FTSE 350 contractors, notably BAE Systems (BA.) and QinetiQ (QQ.), are well placed to benefit from increased spending commitments here, having already developed key competencies in the field. And obviously companies within the UK’s rapidly expanding software sector should also profit from the intensifying focus on cyber defence (and presumably attack as well).

The reality is, however, that any realignment of the UK’s strategic objectives will be carried out amid tightening fiscal constraints, with all the attendant implications for the FTSE 350 contractors. Markets were spooked in the latter part of 2017 after Ultra Electronics (ULE) warned that its revenues would fall short of expectations following delays to the Royal Navy’s Dreadnought ballistic submarine programme. The warning undermined valuations across the sector, although groups with a high degree of exposure to MoD budgets in particular, such as QinetiQ, came under increased scrutiny.

The Ultra Electronics warning came barely a fortnight after former chief whip Gavin Williamson was appointed as the new defence secretary, following Michael Fallon’s unseemly departure. It was hardly the most auspicious moment to take up the reins, but at least the new incumbent seems to appreciate the potential for UK arms exports. To this end, the MoD now plans to take a proactive role in the way it engages with businesses in the procurement process, thereby ensuring UK contractors have a better idea of what military requirements are in the pipeline. This approach should aid their ability to develop new equipment to meet unfolding strategic objectives, while simultaneously enhancing commercial export opportunities.

Still, you get some idea of the conflicting pressures placed on UK contractors through the example of the F-35 fighter jet – by some estimates the most expensive weapons system in history. A Defence Select Committee report recently slammed the MoD response to requests for clarification on key issues, citing “an unacceptable lack of transparency”. But the committee members should balance that secrecy against estimates that put the proportion of kit produced by UK aerospace companies on the F-35, including the electronic warfare suite, at 15-25 per cent. It has also been estimated that almost £5bn of contracted work has already been placed with the UK supply chain, with FTSE 350 constituents such as BAE Systems (one of the lead partners), Cobham (COB), Ultra Electronics and Rolls-Royce (RR.) among the 100 or so UK suppliers involved in the controversial programme.