The recent cancellation of military exercises involving the Israel Defense Forces and the Turkish army ratcheted up tensions with Turkey. Nine months after Prime Minister Recep Tayyip Erdogan harshly criticized Operation Cast Lead in Gaza, the Turkish military has opted against joint maneuvers with the IDF. A continuation of the cold wave could eat into the business of Israeli defense firms like Elbit Systems.

Elbit Systems has been involved in three major projects in Turkey. The company was a subcontractor to Israel Military Industries from 2004 to 2008 in upgrading the M-60 tank, a $780 million job of which Elbit Systems' share was worth $183 million. Sources say the work has been completed and Elbit has been paid. Currently Elbit System's major Turkish project involves a pilotless drone deal worth $200 million signed this year; the company partnered with Israel Aerospace Industries.

Another Turkish project involves Elbit's electro-optics subsidiary, El-Op, and IAI's Elta unit to provide Turkey's air force with integrated visual surveillance equipment, mainly for aerial photography. The overall price tag is $141 million over the four years ending 2012. El-Op's share of the deal is $87 million.

Analysts Gil Datner and Gilad Alper of Excellence Investments say Turkey is a major European market for Elbit, adding that there have been concerns since Cast Lead about how relations with Turkey would affect Israeli defense contractors. The Turkish military is seen as agreeing with the government when it comes to relations with Israel.

Datner and Alper say two other factors helped convince them to downgrade their recommendation for Elbit Systems to underperform: an erosion in profitability from a fall in short-term orders and stiffer competition due to the entry of major U.S. firms into Elbit's market niches. These include the manufacture of drones as well as control and command systems.

Datner and Alper say this risk is particularly large because of the growing prospect of defense cuts in the United States and Europe, particularly in Britain.

On August 13, Datner and Alper lowered their price target for Elbit Systems to NIS 220, then 14% below and today 12.5% below the company's share price. Sources close to Elbit say all the firm's projects in Turkey are proceeding as planned, and some analysts are not very worried about business there.

"The cancellation of the exercise renews concerns about continued cooperation with the Turkish army and the cancellation of existing deals between the Turkish army and Israeli defense companies," said Yoav Burgan, an analyst at Leader Capital Markets.

Burgan, however, says these concerns have been blown out of proportion. "Despite the crisis atmosphere, the prospect is low that Elbit Systems' and Israel Aerospace Industries' latest joint deal in Turkey will be canceled," he said. "In any case, it doesn't involve substantial risk to Elbit Systems' overall work load, which stood at $5.1 billion at the end of the second quarter."

Burgan said Turkey's annual military budget is currently at $21 billion, of which $7 billion goes to procurement. The defense budget is expected to increase 6% annually over the next two years. Although Turkey is a major customer of Israeli defense contractors, Burgan says the Turks are not a substantial client of Elbit Systems. Turkey is considered part of Elbit's European division, which represents 25% of the company's sales.