**General Dynamics Corp. (NYSE:GD)** operates in Aerospace/Defense Products & Services industry. I think this stock undervalued by up to 26% or even more. Below are my calculations using FCFF model, multiples comparison and other interesting facts and threats.

**Discounted Free Cash Flow Valuation**

In this article I will run you through my DCF model on GD. In particular I will be using free cash flow to the firm FCFF model to evaluate the stock. Feel free to share your opinion regarding the assumptions I made for this valuation.

Let's start with the top line. GD recorded $32.67B revenue in 2011, which represented 0.65% growth Year/Year. In 2010 revenue grew by 1.52% compared with 2009. In 2012, however, I predict that the company will record the same revenue as in 2011, and modest 0.2% recovery in 2013. I predict 1% growth for the next 4 years.

Coming down to the cost side I predict 12% EBIT margin for the projected period. Interest expense should stay at around 5% of the long-term debt. I forecast taxes to be 31% on average for the projected period.

Then I subtract increases in working capital and capital expenditures. I model working capital to increase 20% of the revenue increase per annum. Capital expenditures should stay at 16% of the total revenue.

This model uses WACC to discount FCFF backwards to find out the present value. Beta of this stock is 1.26. I project the WACC to be 9.26%. However, I believe in reality WACC could be higher on average in the long term so I will do further calculations with 10% WACC.

To get the value of the firm we need to discount the projected FCFF by WACC and add the terminal value at the end of the 5-year period by calculating a perpetuity with growth of 1% and 10% WACC.

I get the value of equity by subtracting the market value of debt and adding back current cash and marketable securities.

Equity value per share is $82.77, which means the stock is 26% undervalued.

**Multiples Valuation**

GD is also undervalued in terms of P/E (9.66) compared with the industry (14.71). It is also undervalued to the biggest direct competitors: The Boeing Company (NYSE:BA) has P/E of 12.57, Lockheed Martin Corporation (NYSE:LMT) - 10.10 and Textron Inc. (NYSE:TXT) - 21.36.

In terms of P/S, GD has lower (0.73) ratio than the industry average (0.95) and similar to BA - 0.74.

**Analyst ratings**

The median analyst target price for GD is $81, which shows more than 23% upside potential. It is relatively close to my DCF valuation. In the last 30 days two analysts have increased the EPS revisions for the current year and one analyst for the next year.

**More positive facts**

- I projected the long-term growth of the company quite conservatively. Some brokers are forecasting up to 7% long-term growth, which of course would mean ever more upside for the stock. If military spending is increased because of any U.S. actions, it may boost company's growth.
- The company also has 2.9% trailing annual dividend yield and 3.1% forward looking dividend yield.
- GD net profit margin is consistent at approximately 7.3%.
- Low capital expenditure ratio (under 20% in the last four years).
- Consistent and significant cash flow growth during the last 10-year period (except for 2009).
- The company has also repurchased 4.82% stocks in 2011 and has been repurchasing stocks for the last four years.
- Excellent and consistent return on equity at approximately 20%.

**Threats**

- Large portions of business is generated by the U.S. government, and within the budget deficits. If military spending is cut, it may threaten the company's revenue.

*Financial data taken from Yahoo Finance.*

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.