General Dynamics Corporation [NYSE: GD] is a global aerospace and defense company, which offers a wide range of products and services, ranging from Gulfstream business jets and combat vehicles to nuclear-powered submarines and communications systems. It operates through four segments:
- Marine Systems,
- Combat Systems and
The company’s largest operating unit, Marine Systems, designs, builds and supports submarines (Seawolf and Virginia-class submarines), destroyers and amphibious assault ships.
GD’s Aerospace segment, which delivers a family of Gulfstream aircrafts, is one of the world’s leading makers of business aircrafts.
The Combat system mostly produces land-based combat vehicles, such as the M1 Abrams tank.
The Information System segment offers a wide range of technologies, including communication, computer, defense, electronic, information, and telecommunications systems for a wide range of military, federal, and commercial customers.
General Dynamics is the third-largest defense contractor in the U.S. by sales and it deserves your attention.
The Bull Case for General Dynamics
The pandemic, and the budgeting uncertainties it gave rise to, led to General Dynamic’s stock price losing momentum for the better part of 2020. However, analysts argue that such hiccups are only temporary and unlikely to meaningfully impact the moat or secular trend of the business.
In other words, given the large size of the business, its technological superiority, scale, demand, profitability, return on capital employed, and wide moat, GD finds itself in an excellent position to capitalize on the long-term secular trend, while offering excellent growth prospects.
Diverse Product Portfolio Creates Wide Moat
As of 2020, General Dynamics was the third-largest defense contractor in the U.S. by sales. The company offers a wide range of products and services, ranging from tanks, weapons systems, munitions, submarines, warships, business jets, electronics, and technology products to the U.S. government and its allies.
The exhaustive portfolio of products and services, along with sheer technological superiority, scale, and customer relationship, makes GD an integral part of the highly lucrative defense industry.
For example, Virginia class nuclear-powered fast-attack submarines (also known as the SSN-774 class) developed by GD is the U.S. Navy’s latest undersea warfare platform.
The advanced stealth multi-mission nuclear-powered submarine for deep ocean anti-submarine warfare and shallow water operations incorporates the latest in command systems, sensors, design, propulsion, stealth, intelligence gathering, countermeasures and weapons systems technology.
The sheer magnitude of innovation and technology that has gone into this next-generation attack submarine makes it essentially a monopoly with no alternative in sight.
The expertise, scale and customer trust further adds another irreplaceable intangible asset. Additionally, in the defense industry, the exorbitant switching cost acts as a solid deterrent, which means customers are more likely to stick with a tried and tested defense contractor.
Future Growth Appears Certain
The future growth prospect of companies like GD also looks secure as increasing levels of geopolitical tension and polarization across the globe spurs more and more countries into augmenting their defense budget and upping their weapons procurement program.
The same is corroborated by data which shows that global defense budget has been increasing faster than GDP and faster than inflation for many years, and this trend is likely to accelerate further in the next 10 years. And GD, with its technological innovation, vast expertise, scale, plethora of products and, most importantly, customer trust, is strongly placed to leverage this trend.
Strong Financial Results
The company reported a strong second quarter results, generating net earnings of $737 million (up 17.9% from year-ago quarter) on revenue of $9.2 billion.
Second-quarter 2021 EPS stood at $2.61, above consensus estimate of $2.52.
Operating earnings improved 7% from $2.18 per share in the year-ago quarter.
All in all, second-quarter results were marked by strong cash flow, improved margins and significant Aerospace order activity.
In March, Gulfstream Aerospace, a wholly owned subsidiary of General Dynamics, was awarded $696 million in defense contracts from the U.S. Air Force Life Cycle Management Center for engineering services support and contractor logistics for C-20 and C-37 aircraft.
General Dynamics recorded a total backlog of $89.2 billion, up 7.9% year over year. Funded backlog at the quarter-end was $41.1 billion. With such a huge backlog, a few hiccups and interruptions here and there is unlikely to impact its cash flows at all, and there would be little uncertainty in the expected returns.
The reason for such backlog is their unique product cycle and government commitment when it comes to advanced defense products. For example, we see tech giants like Apple [AAPL] are compelled to release a new iPhone every year or so. This is certainly not the case with GD, as the product cycles for many of its products run in decades.
Let’s again revisit the example of the Virginia Class attack submarine. GD is expected to make the full delivery by 2043, and they are expected to remain in service into the 2070s. Currently, GD has 18 of them in their backlog, scheduled for delivery all through 2029 at a two-per-year rate and a unit price tag of $1.3B.
Such a unique product cycle and government commitment really provide long-term stability to the business, and also a very stable and predictable return on capital.
The GD Bull Case Wrap-Up
General Dynamics is a global aerospace and defense company and a business with perpetual growth potential, given the fact that their products are unlikely to run out of demand as they cater to an equally eternal human need just like food, energy and shelter.
GD enjoys strong support and demand from the government (nearly 60 percent of the company’s net sales coming from contracts with the U.S. government) which adds a lot of stability to the business.
Add to that its technological superiority, extensive range of products, high barriers to entry and lengthy product cycle, and investors will realize it offers excellent prospects of handsome long-term returns.
The Bear Case for General Dynamics
General Dynamics offers an extensive range of products and services, from tanks, nuclear-powered submarines to business jets. It’s a well-diversified business operating in a high-demand industry with exceptionally high barriers to entry. The company has the US government as its main customer, and a lack of competition from new entrants paves the way for high ROE and profitability.
However, one major risk, when it comes to General Dynamics, is its reliance on the U.S. government for the majority of its business.
Although the amount of sales it makes from the government (60% of total sales) is lower than that of its main competitor Lockheed Martin (LMT), which derives 78% of its sales from the government. But still depending on one source for major portion of your sales can still be problematic.
Also, there are other rivals whose dependence on the government for their sales is much lower, which means they offer all the advantages as offered by GD, but at a lower risk.
When you are dependent on a single customer for the majority of your revenue, reduced orders from that one source can gravely impact overall revenue. In the case of the U.S. government, cuts in defense budget poses a severe threat to General Dynamics. Although the defense budget has been continuously increasing, the thoughts of budget cuts is likely to keep General Dynamics worried. Also, GD’s slow EBITDA growth could be a concern.
Having said that, it is worth noting that GD also has a very profitable Gulfstream aerospace division, which diversifies the company away from its traditional aerospace/military defense programs.
Overall, GD is a fundamentally sound company with great cash flow. The financial health of the company is strong; what is missing is the consistent growth component.
General Dynamics Stock Price Forecast
12-month price targets for General Dynamics range from a high estimate of $243.00 to a low forecast of $198.00.
The average price target is $222.20, which represents around 8.5% change from the stock’s current price.
Is General Dynamics Stock A Buy?
Having suffered some turbulence during the pandemic, General Dynamics, maker of M1 Abrams main battle tanks, nuclear-powered submarines, and Gulfstream business jets, seems to be regaining its mojo.
New aerospace orders are accelerating while other segments remain stable. Private jets, whose price can range from $3 million (the most basic ones) to $100 million for the biggest and most opulent, have been recently witnessing an uptick in demand.
A record 1300 of these beauties were delivered in 2008, before the great recession delivered a ‘Muhammad Ali’ punch in the nose of the industry.
The beleaguered industry was showing some signs of recovery, with 2019, in particular, registering 15% increase in deliveries compared to the prior year.
But the ghosts of 2008 returned again in 2020 as the pandemic struck, sending deliveries tumbling southwards. The five principal builders — Bombardier, Embraer, Textron Aviation (Cessna and Beechcraft), Dassault Falcon Jet and General Dynamics’ unit Gulfstream — suffered in unison, as they were left fighting for sales from a diminished pool of buyers.
The situation, however, has finally started to look brighter for these manufacturers with the rising demand for business jets. Gulfstream’s second-quarter book-to-bill (the number of units sold compared to actual delivery to customers) increased to 2.1:1, driving backlogs over $1 billion higher than they were at this time last year.
Also, this year in March, General Dynamics’ fully owned subsidiary, Gulfstream Aerospace, secured two contracts from the US Air Force Life Cycle Management Center (AFLCMC). Valued at $696m, the contracts will see Gulfstream provide engineering services support and contractor logistics for C-20 and C-37 aircrafts.
Other than aerospace, the company’s anti-cyclical defense-related exposure due to its dealing in modern weaponry, including combat vehicles, nuclear submarines, ships, and advanced technologies makes this defense contracting giant a rewarding investment opportunity.
Quarterly Earnings Report: Flat Sales
The sales growth was more or less flat, but other than that the company had a nice quarter.EPS came at $2.61 on revenue of $9.2 billion, with net earnings registering a $112 million increase.
Thanks to a 140-basis points improvement in operating margins in comparison to the same period last year, the company was able to boost operating earnings by 15.0%, or $125 million, to $959 million.
The company also improved operating cash flow by $272 million. Due to lower capital expenditures (“CapEx”), free cash flow was boosted by more than $321 million.
First, let’s have a look at how well aerospace did in the second quarter.
Sales declined by 17.8% to $1.6 billion as a result of fewer planned aircraft deliveries. Last year, the company sliced production as the pandemic led to supply chain uncertainties and lower than expected demand. Aerospace had revenue of $1.6 billion and operating earnings of $195 million, with a 12% operating margin.
In dollar terms, Aerospace had a book-to-bill ratio of 2:1. Gulfstream alone had a book-to-bill of 2.1:1, even stronger if expressed in unit terms instead of dollars.
What this means is that orders are twice as high as production numbers. This indicates significant sales growth ahead in this (mainly) cyclical business segment. The pandemic has taken a back seat, the economy has more or less opened, and businesses are ready to invest in business jets again.
Combat systems had revenue of $1.9 billion, up 8.3% over the year-ago quarter, driven primarily by strong sales of combat vehicles. The quarter was also good for combat systems from an order perspective with a 1:1 book-to-bill, leaving a modest increase in total backlog.
Abrams main battle tank demand is also increasing and the Stryker (SYK) remains the combat vehicle of choice for multiple U.S. Army missions and operations. Marine systems reported higher sales, better margins and, as a result, higher operating income.
Overall, Marine Systems had a revenue of $2.54 billion, up $65 million over the year-ago quarter. All in all, the aerospace business is accelerating while other segment remains stable.
It is also important to note that GD is not a high-growth business. However, what should matter to investors is its products doing well, and that’s exactly the case here. The company’s growth is tied to a high defense budget and international tensions that warrant investments in military equipment and, as previously mentioned, the global defense budget has been increasing for quite some time now and is expected to accelerate further in coming years.
GD had an EBITDA of $4.0 billion in 2008. In 2022, EBITDA is expected to reach $5.3 billion. That’s roughly 1.9% per year. However, this is where the bad news ceases. The company is now able to generate close to $3.5 billion in free cash.
GD currently needs around $1.3 billion to sustain its annual dividend yield of 2.4%, which means it has plenty of room to increase its dividend.
On top of that, net debt is back below 2.0x EBITDA, which means GD can boast of a strong balance sheet.
The company hiked its dividend by 8.2% in March, and the dividend payment has more than doubled since 2012.
Moreover, the company is using excess cash at its disposal to fund its share buyback program. In 2Q21, the company repurchased shares worth $593 million.
Is General Dynamics A Good Stock To Buy?
General Dynamics is a great stock to buy despite slow EBITDA growth.
The company offers a very stable business model, has plenty of cash flow and offers a good dividend yield.
GD also is poised to benefit from rebounding aerospace demand. It may not be a high-growth stock, but it is definitely a stock of choice for investors looking for a fairly valued stock with a sustainable dividend and a decent dividend yield.
General Dynamics Investment Thesis Conclusion
General Dynamics delivered a stellar Q2, marked by strong financials and a growing backlog.
Revenues more or less remained unchanged year-over-year at $9.22 billion against $9.26 billion in Q2-2020. This did not ruffle many feathers as year-over-year marginal revenue variances are generally the norm amongst large defense contractors.
EPS & Operating Margins Expand
EPS jumped around 20% to $2.61, gaining strength from General Dynamics’ margin expansion, lesser operating and interest costs, as well stock buybacks.
Every single division of the company saw expanded operating margins, with the operating margin for the entire company expanding to 10.4%, 140 basis points higher year-over-year.
The defense contractor expects its operating margins to keep expanding, and hence it has lifted the FY2021 EPS outlook to $11.50.
Backlog Suggests Future Revenues Will Grow Well
General Dynamics recorded a total backlog of $89.2 billion, up 7.9% year over year. This is an important figure as it ensures the company’s future revenues and hence profit generation. The company has received significant contracts in the last few quarters, with Aerospace and Marine Systems leading in terms of aggregate dollars.
The Navy, in November of 2020, awarded GD a $9.4 billion contract to begin construction work for the new nuclear-powered Columbia class submarines. It is the first class of ballistic missile subs the Navy has begun since the 1970s, and will eventually replace the current fleet of Ohio class boats when that fleet reaches its retirement age decades from now.
Army Selects General Dynamics, Finally
For more than a decade, the United States Army has been looking for a new armored personnel carrier to replace its aging lightly armored, fully tracked Bradley Infantry Fighting Vehicles (IFV).
The Army has picked up five companies, including General Dynamics, for the new armored vehicle, tentatively titled the “Optionally Manned Fighting Vehicle. The robotank, capable of medium and long-range firepower, is to be equipped with medium-caliber guns, anti-tank missiles and, more interestingly, directed energy weapons aka laser guns. And, most important of all, it will be “optionally manned”, meaning capable of being driven by a robot.
Last time the Army had floated the tender, only General Dynamics remained in contention, but it failed to win the multi-billion-dollar contract to build Bradley’s replacement.
Now General Dynamics is America’s foremost producer of armored vehicles, including M1 Abrams main battle tank. The fact that it failed to win the contract despite all its expertise means the Army was less than impressed with its offering.
The winner will be finally announced by 2027 and full-rate production is expected to begin by 2030. However, the wait should be worthwhile, as the company to come out on top is likely to be awarded a $45 billion contract for production of around 3,800 new armored vehicles. It means it will be a windfall for the company and its investors that wins the multi-billion dollar contract.
Does General Dynamics Pay A Dividend?
General Dynamics has grown its dividend annually for the past 30 years, thus rightfully earning the sobriquet of Dividend Aristocrat.
The company recently announced $1.19/share quarterly dividend, thus further cementing its strong dividend growth record. The dividend yield is currently around 2.43%.
GD Stock Buybacks
The strong cash flow position of the company allows it to indulge in stock buybacks, and the global aerospace and defense company has been incredibly consistent in repurchasing its shares.
Over the past twelve months, it has allocated around $1.44 billion in stock repurchases, accounting for around 2.7% of its current market cap.
Can I Buy General Dynamics Stock?
Due to its long-standing existence, technical expertise, and generous government contracts, GD is a solid business. In all probability, military budget will keep growing in the coming years, which means companies like GD can keep rewarding shareholders.
To sum it up, GD’s sizable and diversified backlog of around $89.5 billion, a 30-year record of consecutive quarterly dividend increases, the potential for greater defense spending and a host of new contracts makes it an attractive long-term play.
The financial health of the company is strong, and with its current backlog, the company is likely to generate solid revenues for at least around 6 quarters at its current rate of deliveries.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.