US defence companies’ generous buybacks make for an easy target
For a monopsonistic buyer such as the Department of Defense, profitability looks like an opportunity in disguise
Donald Trump is not a man to give something away without getting something back. Hence, the US president’s call for a 50 per cent increase in the country’s military budget next year — to $1.5 trillion — comes with a stern warning to “underperforming” defence contractors to rein in their generosity to shareholders and executives.
Restricting private companies’ ability to pay dividends, buy back stock and remunerate their senior employees may horrify those who believe in the power of free markets. But, for his latest squeeze, Trump seems to have identified a target with some juice.
Big US defence companies tend to be more profitable than their European rivals. On average, in the decade to 2024, the operating margins of Lockheed Martin, Northrop Grumman, General Dynamics, RTX and L3Harris were well above 12 per cent. By contrast, European companies BAE Systems, Thales, Leonardo and Rheinmetall barely managed to get above 8 per cent.
There are various reasons for this gap — including that US defence contractors have been busy for the past 10 years, while Europe’s military spending slowed to a trickle. The two sets of companies have started to converge, and Rheinmetall in particular benefits from German rearmament.
But, for a monopsonistic buyer such as the US Department of Defense, that profitability must look like an opportunity in disguise. So must a look at where the companies have chosen to deploy their cash.
Over the decade to 2024, US companies’ capital expenditure was equivalent to about a quarter of their cash flow from operations according to Lex calculations using S&P Capital IQ numbers. Shareholder returns, in the form of dividends and share buybacks, were more than three times greater than these investments.
In Europe, meanwhile, capital expenditure was about half of cash flow from operations. And they returned to shareholders, mostly through dividends rather than share buybacks, only about half as much as they invested.
How companies deploy their war chests is their own choice in normal times. Investing more in the business depends on what’s already there in the way of facilities, as well as varying levels of visibility on future contracts and revenue streams. Should the aim be to get better pricing or faster deliveries, there may also be more market-friendly ways to achieve it than via executive order.
But Trump’s push underscores the fact that defence is an odd market to begin with: for larger or more sophisticated products, there is often only one seller and one buyer. That is a recipe for friction. But an alliance is probably more productive than a tug of war.