Contractor Offers Recession Defense

12/28/2009


  Recent Price
$68
  Dividend
$1.52
  Yield

2.2%

  P/E Ratio
11
  Shares (millions)
388
  Long-Term Debt as % of Capital
21%
  52-Week Price Range
$70.84 - $35.28

Sales of General Dynamics’ ($68; GD) business jets lost altitude over the last year. But two parachutes — a $66 billion backlog and broad exposure to U.S. defense programs — have softened the company’s landing.

General Dynamics shares have risen 18% so far this year. The stock remains attractively valued at 11 times trailing earnings, well below the three-year average of 14. The shares also look cheap relative to historical norms for price/sales and price/cash flow ratios. General Dynamics is a Buy and a Long-Term Buy.

Defense

During wars and recessions, there’s probably no better customer than the U.S. government, which accounts for nearly 70% of General Dynamics’ revenue. However, the crunch of the federal deficit might lower the ceiling on future growth. The base defense budget is not expected to rise over the next five years, although that does not take into account wartime expenditures. Efforts to replace equipment from the Iraq war should support higher revenue over the next year or so. However, the longer view for General Dynamics will be colored by U.S. strategy in Afghanistan.

All three of General Dynamics’ defense segments have posted rising sales and operating earnings in the nine months ended September. Combat systems (30% of nine-month sales, 32% of operating income) has performed the best, with sales climbing 22%, lifted by lucrative contracts for tanks and the Stryker wheeled combat vehicle.

The marine-systems (20%, 17%) division, the Pentagon’s second-biggest military shipbuilder, produces Virginia-class nuclear submarines, destroyers, and cargo ships. Nine-month sales are up 15%, largely because of the U.S. Navy’s ship-rebuilding program.

Information systems and technology (34%, 31%) designs radios and complex electronics for weapons systems. Clients include the U.S. military, civilian intelligence agencies, and commercial businesses.

Aerospace

General Dynamics’ aerospace unit (16%, 19%) saw operating profit margins fall to 13.5% in the nine months ended September from 19% in the year-earlier period. The aerospace unit builds the Gulfstream business jet, a brand that targets the upper end of the market.

Orders for business jets, largely funded by corporate budgets, dried up during the downturn. A recent survey suggests demand could shrink further in 2010, and a full recovery could take years. However, high-end jets have held up somewhat better than the rest, and Gulfstream is partially offsetting market shrinkage with share gains.

Two new Gulfstream jets appear timed to take advantage of the recovery. The mid-sized G250 is scheduled for delivery in 2011. Customers expect to receive the G650 — billed as the largest, longest-range, and fastest business jet — in 2012. Both jets completed their first flight in the last five weeks. Upon the G650’s certification, General Dynamics will collect about $250 million in advances on future orders.

Conclusion

The stock is cheap, and Wall Street’s expectation of a 5% profit gain in 2010 seems conservative. An annual report for General Dynamics Corp. is available at 2941 Fairview Park Drive, Suite 100, Falls Church, VA 22042; (703) 876-3000; www.gd.com.

GENERAL DYNAMICS
Quarter

    Per-Share
     Earnings*

Sales
Change

      Quarterly
      Price Range

P/E Ratio
Range

Sep '09 $1.48 vs. $1.59 + 8% $65.32 -

$49.85

10 - 8
Jun '09 1.61 vs. 1.51 + 11% 61.12 - 40.78 10 - 7
Mar '09 1.53 vs. 1.42 + 18% 61.46 - 35.28 10 - 6
Dec '08 1.61 vs.

1.42

+ 4% 73.62 - 47.81 12 - 8
           
Year
(Dec.)

Sales
 (Bil.)

Per-Share
Earnings*
Per-Share
Dividend

52-Week Price Range

P/E Ratio
Range

2008 $29.30 $6.13 $1.34 $95.13
-
$47.81 16 - 8
2007 $27.24 $5.10 $1.10 94.55
-
70.61 19 - 14
2006 $24.06 $4.20 $0.89 77.98
-
56.67 19 - 13
2005 $21.24 $3.63 $0.79 61.13
-
48.79 17 - 13
             
————————————————— Quadrix Scores † —————————————————
Overall Momen-
tum
Value Quality Financial
Strength
Earnings
Estimates
Performance
94 66 91 92 83 58 47

   * Earnings exclude special items.
   † Quadrix® scores are percentile ranks, with 100 the best.


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