GKN Aerospace in Yeovil, Somerset, which makes airframes for Royal Navy helicopters, said the potential loss of the contact puts 230 jobs at risk.
Leonardo, which assembles the Wildcat helicopter in the town, has told GKN it plans to take production in-house.
The firm said the current arrangement was "no longer sustainable".
The union Unite said it was a "massive blow".
GKN has begun formal consultations with the unions regarding potential job losses in Yeovil.
The firm said in a statement that the move by Leonardo "puts at risk the long term viability of our Yeovil site".
GKN added: "Having completed a thorough assessment of the business, we have regrettably concluded that GKN Yeovil, as it stands today, is no longer a sustainable business and will have to be significantly downsized or fully closed.
"We will now enter a period of consultation with nominated employee representatives."
Andy Soughton of the Unite union said talk of a potential site closure was a "bit of a shock".
"We've had quite a few redundancies over the years, and work has dropped off a little bit," he said.
"So I think people were expecting something to happen. But not a closure."
More than 250 jobs were lost at GKN's car manufacturing branch in Telford in Shropshire in August.

Hythe Ferry runs between Hythe and Southampton, serviced by a train which runs along a 640m (2,000ft) pier.
The presenter lent his support to a community group's aim to take over the management of the pier and train.
Its current operator said numbers using the ferry had been falling.
Earlier this year, Hythe Ferry Ltd warned staff about possible redundancies, having suffered a "year-on-year decline" in passenger numbers and faced with higher operating costs.
More than 9,000 people have signed a petition calling for the service to be saved.
Peter King, of the Hythe Hythe Pier Train and Ferry Action Group, said members wanted to create a "viable modern ferry" by a charitable trust taking over the management of the Victorian pier and "relieving" the ferry operators of the costs of maintaining it.
He said a redevelopment project could cost £2-3m but a trust would be able to access other sources of finance, including lottery grants.
Mr Snow said: "This train is the oldest running pier train anywhere in the world, so I'm campaigning to keep it open. We need to do everything we can to keep this extraordinary piece of our past running."
Hundreds of aerospace jobs could be lost if a factory is forced to "significantly downsize" or close, it has been claimed.
[NEXT_CONCEPT]
A Hampshire pier and ferry service facing an uncertain future is a "national treasure" which should be saved, television historian Dan Snow has said.