General Dynamics: A Strong Value Investment

Jul.30.10 | About: General Dynamics (GD)

General Dynamics Corporation (NYSE:GD) is the fifth largest defense contractor in the world. It is a conglomerate active in four main business segments: Aerospace, Combat Systems, Marine Systems, and Information Systems & Technology. The company is a conglomeration of varied businesses built up through acquisitions and divestitures. In the 1990s the company started expanding beyond its core businesses of shipbuilding and land combat systems into information technology and passenger jets. The company’s 2009 revenues were $31.98 Billion.

The Aerospace group comprises Gulfstream Aerospace Corporation, Jet Aviation and General Dynamics Aviation Services (GDAS). In 2009 the Aerospace group contributed to 16% of the company’s total revenues with sales of $5.2 billion. This was a decline of about 6 percent from 2008, but expected given the difficult economic environment.

The Combat Systems group is involved in the production and service of land and expeditionary combat systems. The group supplies and supports wheeled and tracked combat vehicles, guns, ammunition & ordnance, reactive armor, mobile bridges, and components for aerospace systems. The group is further made up of 4 business units: Armament & Technical Products, European Land Systems, Land Systems, and Ordnance & Tactical Systems. With sales of $9.6 billion in 2009 (18% over 2008) and operating earnings of $1.3 billion, the Combat Systems group had the highest revenue growth and the highest operating earnings of all the four business groups.

The Marine Systems group is also made up of four business units. The Bath Iron Works (BIW), Electric Boat, National Steel & Shipbuilding Company (NASSCO), and American Overseas Marine (AMSEA). In 2009, the Marine Systems group grew 15% over the previous year to post revenues of $6.4 billion and operating earnings of $642 million.

The Information Systems and Technology (IS&T) group caters to the information technology requirements of US defense, intelligence and homeland security. The IS&T group is the company’s revenue leader with sales of $10.8 billion in 2009 and operating earnings of $1.1 billion.

Current Year Performance

The first six months of 2010 has pretty much been a continuation of General Dynamics’ long record of past performance in terms of profitability and management’s ability to respond to changing business conditions. The company-reported net earnings for the first six months of 2010 are $1.25 billion which is a 3.5% increase over the same period last year. Top-line revenues, however this year are either stagnating or under pressure.

Table 1.

First-half Earnings Data as Reported by General Dynamics (Unaudited)

($ millions except earnings per share)

2010

2009

% Increase or (Decrease)

Revenues

15,854

16,364

(3.1)%

- Aerospace

2,740

2,870

(4.5)%

- Combat Systems

4,113

4,812

(14.5)%

- Marine Systems

3,276

3,294

(0.5)%

- IS&T

5,275

5,388

6.3%

Operating Costs and Expenses

13,951

14,514

(3.9)%

Operating Earnings

1,903

1,850

2.9%

- Aerospace

451

415

8.7%

- Combat Systems

564

579

(2.6)%

- Marine Systems

328

331

(0.9)%

- IS&T

602

573

5.1%

Net Earnings

1,245

1,208

3.1%

Earnings per Share (Diluted)

3.20

3.12

2.6%

Click to enlarge

While revenues this year are under pressure the company reports that it has managed to reduce costs at a faster rate in order to preserve earnings growth. The company has managed to defend operating margins for the most part. The company reports that the Aerospace group increased operating margins from 14.5% in the first half of 2009 to 16.5% in the corresponding period this year. First half operating margins for the Combat Systems group also report an increase from 12% in H1 last year to 13.7% in H1 this year. The operating margins for the Marine Systems and IS&T groups remain unchanged from the same period last year. Both Aerospace and Combat Systems report a drop in revenues this year from the same period in 2009. While Marine Systems is largely unchanged, the IS&T group increased revenues by 6.3%.

Other Things Considered

The United States remains embroiled in conflicts in Iraq and Afghanistan that continue to require the presence of American ground troops. Meanwhile, from a long-term perspective, the US military continues to upgrade its navy, air and ground forces with a mind toward maintaining technological dominance. The unrelenting terrorist-threat perception and the need for continued development of newer systems for the intelligence, homeland security, and law-enforcement communities mean that the demand for products and services from companies like General Dynamics Corporation will remain high into the foreseeable future.

Given the companies long track record of association with and provision of technologies and equipment to, the US government there is little reason to believe that this will be undermined in the medium-term.

To Buy Or Not To Buy?

  • General Dynamics has a P/E ratio of about 10 for the trailing twelve months and a forward P/E ratio of 9.25 based on management projections

  • The company has a long history of dividend payouts for over the past 15 years with the 15 year dividend growth rate over 11%

  • Uninterrupted profits for the past 10 years with continuous profit growth for the past six years (up to year-end 2009). 2003 saw a fall in annual profit

  • With a book value of 33.75 and current share price of $61.80 the PE ratio x Price to Book Ratio = 18.30 (< 22.5)

  • The Current Ratio = 1.34 and the Debt-to-Equity Ratio = 30%

  • Going out on a limb I would estimate the company’s intrinsic value between $95 to $110

  • Continuing conflicts that involve the US military, and ongoing tensions with Iran and N. Korea mean that demand for hardware and technology from the US military will remain strong.

Given the strong performance record of General Dynamics in terms of dividend payouts, long-term record of profit growth, and satisfactory showing in most value-investing parameters (it fails the Current Ratio test) I would recommend General Dynamics as a good defensive investment and a strong value stock.

Disclosure: I currently own no positions in this company