General Dynamics: A New Buy in Defense

12/04/2015 8:00 am EST


John Eade

Chairman and CEO, Argus Research Group

Our latest recommendation is a defense contractor with leading market positions, combat systems, and shipbuilding and marine systems, explains John Eade for Argus Research.

We are raising our rating on General Dynamics (GD) to a buy, as a recent modest pullback in the share price has improved valuations.

General Dynamics’ business mix is attractive compared to those of many peers, as a relatively low 62% of revenue comes from the US government, thus reducing the company’s exposure to the budget debates in Washington.

Management is focused on driving growth through modest sales increases, ongoing margin improvement, and share buybacks, and has a history of delivering positive EPS surprises.

The company is also generating solid cash flow and aggressively returning cash to shareholders through increased dividends.

Recent budget trends have been generally supportive for the industry. The budget includes modernizing investments in such areas as nuclear deterrence, missile defense, cyber security, and power projection.

The recent terrorist attacks in Paris have boosted demand for military and security-related spending.

Based on healthy backlog, new contract wins, and management’s focus on cost cutting, we are boosting our 2015 estimate to $9.00 from $8.80, implying growth of 15% from the $7.83 recorded in 2014.

We are also boosting our 2016 estimate to $9.70 from $9.50. Our five-year earnings growth rate forecast remains 8%.

GD shares have underperformed the S&P 500 over the past quarter, falling 6% while the index has lost 1%. Over the past year, the shares have also underperformed.

We think that GD shares are attractively valued at current prices near $144. On a technical basis, they are in a positive trend of higher highs and higher lows that dates to November 2012.

To value the stock on a fundamental basis, we use a peer and multiple comparison models. Based on our blended analysis, we arrive at a target price of $160 per share.

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