General Dynamics: Business Jets to Combat Systems

05/25/2020 5:00 am EST

Focus: INDUSTRIALS

Prakash Kolli

Founder and Author, Dividend Power

General Dynamics Corporation (GD) is one of the major prime defense contractors. The stock price is down approximately 23% year-to-date and a little over 26% in the past six months, notes income expert Prakash Kolli, editor of Dividend Power.

The stock prices of most of the company’s defense contractor peers were down as well due to COVID-19 but some have regained much of their losses. For comparison, Northrop Grumman (NOC) is down about 4.9% year-to-date and 7.5% in the past six months.

General Dynamics’ stock is trading at prices last seen in 2014–2016. The main difficulty for General Dynamics is the business jet market.

On the defense side the company is arguably a market leader in land combat systems. It makes the well-known M1-series of tanks and the Stryker vehicle. General Dynamics is also one of two manufacturers of nuclear submarines including the Virginia-class and the Columbia-class submarines.

The company also makes surface combatant and support ships, and oil tankers and cargo ships. Plus the company produces Gulfstream business jets. Other business segments focus on command and control, cyber, communications, and IT.

Its main challenge right now is the Aerospace segment. Travel by airlines in general is down. This includes travel by business jet, where private flights have reportedly declined by as much as 40%. This will negatively impact the aviation services business in the near-term.

On the other hand, U.S. defense spending is robust, and it is likely to remain so for the next few years. The companywide backlog is healthy at $85.7B driven by the large Virginia-class contract award, orders for Gulfstream jets, and IT contract wins. This bodes well for future earnings.

or investors interested in income and dividend growth the stock is yielding approximately 3.2% at the moment. The yield was higher during the depths of market downturn, but still it is much higher than the ~2.0% offered by the S&P 500 index. The yield is also higher than some of its prime defense contractor peers.

General Dynamics is also a Dividend Aristocrat, having raised the dividend for 29 straight years. The dividend is safe from a forward earnings perspective based on the payout ratio of ~39%.

On a negative note, leverage is up for General Dynamics due to the CRSA acquisition. At end of Q1 2020, short-term debt and the current portion of long-term debt was $5,047 million. Long-term debt was $12,951 million.

Debt is offset by about $5,330 million in cash at end of Q1 2020. The cash position has increased by $4,428 million since last quarter. It is likely that the company is building liquidity to handle potential disruptions due to COVID-19.

In addition, the company has $2,000 of fixed rate debt maturing in May 2020 and $500 million in floating-rate debt maturing in May 2020. The cash on the balance sheet will likely be used in part to pay off the maturing debt.

The stock is possibly undervalued even after accounting for downward adjustments in earnings for expected weakness in the Aerospace segment. It is currently trading at a forward price-to-earnings ratio of ~12.1. This is much lower than the average multiple of the S&P 500 at ~21X. The current valuation is also lower than trailing 10-year average of approximately 14.0.

The company’s defense segments are performing well. The business jet market for General Dynamics will eventually recover as the U.S. economy recovers and airline travel returns to a more ‘normal’ footing. This may take many months to a couple years and the timing is, of course, uncertain. However, I view the stock as a long-term buy.

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