Defense shares gain on spending boost in U.S. budget

(In Feb 1 story, corrects $159 million to billion in first paragraph, and corrects name of defense secretary in paragraph 6)

Shares of major U.S. defense contractors rose on Monday after the Obama administration unveiled a defense budget for fiscal 2011 that seeks a 3.4 percent increase in the Pentagon's base budget and $159 billion to fund missions in Iraq, Afghanistan and Pakistan.

The Standard & Poor's Aerospace & Defense Index <.GSPAERO> gained about 1.5 percent on Monday.

In general it was better than we expected, across the board in terms of the increases in the base budget as well as weapons procurement spending, said Craig Fraser, aerospace and defense analyst for debt rating service Fitch Ratings.

Among big names, industry leader Lockheed Martin Corp gained 37 cents, or 0.5 percent, at $74.89 while aircraft maker Boeing Co rose 1.8 percent to $61.70. Northrop Grumman Corp , a provider of ships and unmanned spy planes, rose 2.3 percent to $57.92.

Sanford Bernstein analyst Douglas Harned said in a note to clients that Lockheed was likely to face near term margin pressure as it is forced to take on more development risks tied to the F-35 Joint Strike Fighter, the world's largest military aircraft program.

Defense Secretary Robert Gates said he would dock Lockheed $614 million in performance fees because the F-35 program's performance had not met expectations over the past two years. Gates also replaced the Pentagon's manager in charge of the program.

General Dynamics Corp was up 3.9 percent at $69.43. Sanford Bernstein said the maker of tanks and ships stood to benefit from increased spending on the war in Afghanistan outlined in the budget.

Defense stocks were overshadowed in 2009 by U.S. defense program cuts and concern that spending growth will slow in coming years as the Obama administration looks to devote more resources to equip soldiers to fight insurgents.

With the very large federal deficits that we're seeing over the next few years, there will continue to be some concern about defense spending, Fraser said.

Among other defense contractors, missile maker Raytheon Co gained 1 percent at $52.96, while L-3 Communications Holdings , a provider of systems that monitor and gather intelligence, rose 1.6 percent to $84.64.

Shares of Harris Corp , which has seen rising demand for its tactical radios that distribute voice and data in an encrypted form, climbed 4.2 percent to $44.74.

(Reporting by Karen Jacobs; Editing by Richard Chang)