Jefferies' Sheila Kahyaoglu talks 2026 defense playbook

Defense Industry Challenges & Profitability - Defense contracting is inherently difficult, with programs yielding only 10% operating margins on an accounting basis and 5% on a cash basis, making profitability challenging [1][2] - Imposing further penalties on defense primes could exacerbate these difficulties, potentially leading contractors to withdraw from programs or decline to bid [2] - Lack of clarity in 5-year budgets hinders defense primes' ability to generate proper returns on programs, creating investment uncertainty [8] Capital Allocation & Investment - In 2023 and 2024, defense primes' company-funded R&D plus capex totaled approximately $40 billion, compared to $50 billion returned to shareholders through dividends and buybacks, representing a 13% investment to return ratio [4] - The analysis suggests that defense primes generally maintain a balanced capital allocation strategy, avoiding inefficient capital use such as excessive buybacks funded by leverage [5][6] Market Dynamics & Growth Opportunities - Commercial aerospace offers growth opportunities, with aircraft needs growing at 3% and aftermarket services growing at 8-10% [7] - International growth, particularly increased NATO spending, presents an upside for defense contractors, with potential increase from 2% to 35% of GDP on actual equipment, translating to $280 billion in investment [10] - Some defense contractors are experiencing double-digit growth in international defense sales, with RTX having 44% of its defense backlog exposed to European spending [11] Geopolitical Influence & Government Support - The US administration is recognizing the importance of investing in smaller contractors to foster innovation, alongside supporting larger contracts [14][15] - The global threat environment, encompassing regions beyond the Middle East, China, and Russia, is driving investment in the defense sector [15]