With European economies slumping anew, investors have been
figuring out ways to trim their exposure to that region. Business
conditions are weak and could spiral even lower in coming quarters
before an eventual rebound. That's why I wrote
, which says that you should revaluate holding
of U.S. companies that derive more than one-third of their revenue
from Europe, as it may see sales fall below forecasts in coming
Yet Europe isn't the only concern. In roughly eight months, another
major source of revenue may experience real trouble. Of course, I'm
talking about the U.S. government, which is on the cusp of a major
pullback in spending so that it can get the federal budget into
Defense contractors will feel the pain
If legislators fail to
out more agreements on when and where to cut, then automatic cuts
will begin. For example, the Department of Defense is scrambling to
adapt to the possibility that a cumulative $492 billion in spending
cuts will take place through 2021. Lawmakers may decide to instill
less draconian cost-cutting, but it's increasingly clear that
defense contractors will probably be chasing a smaller pie of
These defense contractors have been scrambling to line up foreign
customers, but have only made moderate headway:
Northrup Grumman (NYSE:
Lockheed Martin (NYSE:
L-3 Communications (NYSE:
all derive more than 80% of their revenue from Uncle Sam.
Meanwhile, investors have poured back into defense stocks, figuring
they are inexpensive based on 2012 sales and
forecasts. But with zero or even
prospects, they aren't a bargain at any price.
As of now, the Department of Defense looks set to shrink 3% to 4%
in each of the next five years. This doesn't even include spending
drops associated with the U.S. troop withdrawal from Afghanistan.
Whether these cuts are more focused on personnel or equipment
remains to be seen, but the leading defense contractors are
vulnerable because they are counting on expensive plane and ship
programs that may get the budget ax.
Health care spending will plunge
It's not just defense stocks that will feel the pain of reduced
government spending. As of now, Uncle Sam will make an equivalent
$492 billion in cuts in other parts of government as well. Again,
lawmakers may manage to come to an agreement, averting these
massive cuts, but investors should expect at least some degree of
At least 40% of the currently planned $984 billion of cumulative
spending cuts through 2021 will be borne by the health care
industry. Regardless of how the Supreme Court rules on the issue of
President Obama's health care plan, spending cuts are coming.
A decade of rising costs has been great for drug companies,
insurers, hospital operators, software supplier and many other
players in the industry. The coming decade should represent a
reversal of fortune for them as pricey drugs, six-figure surgical
procedures, diagnostic testing services and extended patient stays
within facilities are just some of the areas slated for cutting.
Companies at risk: Insurer
derives roughly 75% of revenue from
and Medicaid reimbursement; Dialysis services firm
gets 66% of revenue from the government, while this figure stands
between 40% and 50% for
Tenet Healthcare (NYSE:
United Healthcare (NYSE:
And there's more...
The for-profit education sector is hugely vulnerable in light of
the growing debate of whether these institutions are delivering a
sufficiently robust education for the tuition they charge. Some
lawmakers hope to see reduced government support for student loans,
which would lead to drops in enrollment for these institutions.
DeVry (NYSE: NYSE: DV)
, for example, has 80% of its revenue base tied to
government-sponsored student loans. This figure is more than 30%
Washington Post (NYSE:
, which runs the Kaplan Education services division.
Lastly, companies that sell products to government research labs
are quite vulnerable to a spending drop as well. These include
Life Technologies (Nasdaq:
Sigma Aldrich (Nasdaq:
Risks to Consider:
As an upside risk, government cuts won't be nearly as severe if
lawmakers instead decide to largely focus on tax increases to close
the budget gap, which looks awfully unlikely.
Action to Take -->
Many of these companies lack visibility into the long-term
ramifications of a smaller government, and instead are relaying
what business conditions look like right now. Investors would be
wise to exit any government-focused stocks before the topic becomes
more widely discussed in investment circles and share prices
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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