General Dynamics (GD) reported third quarter earnings (transcript) last week and missed analyst projections in several key areas. Diluted earnings per share came in at $1.70, or down 5.6 percent from the third quarter 2011. Revenues were also down 7.8 percent from last year, as uncertainty in defense spending has continued. Future earnings in defense segments will continue to be affected by the Budget Control Act of 2011, which mandates nearly $500 billion of cuts in the FY2013 budget with additional cuts to kick in if Congress cannot agree to deficit reduction measures by the year's end. According to CEO Jay Johnson, "We would hope to receive some clarifying details over the next two months as this election cycle ends and Congress returns to address the many important fiscal issues confronting our country". Said another way, don't expect much change in the fourth quarter.
But despite these apparent negatives, one subsidiary of GD added substantially to the bottom line, and that was Gulfstream Aerospace. The third quarter was the strongest yet in 2012 for Gulfstream orders. Sixty percent of orders were from North American customers, which signaled an important geographic shift in the order book from the past few years. Gulfstream's orders backlog of $16 billion represented almost 31 percent of General Dynamics total orders backlog of $51.5 billion. This backlog represents 18 months of G450 and G550 orders, and nearly 5 years of G650 orders. Revenues from the aerospace division (representing both Gulfstream and Jet Aviation, an aircraft service subsidiary of General Dynamics) were up 30 percent year-over-year, and the operating margin of this segment represents GD's highest at 14.2 percent. Put into perspective, third quarter revenues at Gulfstream Aerospace alone were more than revenues at Facebook (FB), which has a market cap almost double the size of the entire General Dynamics company.
Why the surge in revenue? Gulfstream just received type certification on two new aircraft paving the way for new orders, deliveries and more factory service income. As a personal investing rule, understanding a company's products and services can be just as valuable as reading earnings reports. I thought it was appropriate to take a closer look at the opportunities presented by these exciting new aircraft.
The G280 (specs) is currently Gulfstream's only entry in the super-midsize market. It is being billed as a "clean-sheet" design even though it is based on the G200 Galaxy, designed originally as the "Galaxy" by IAI (Israel Aircraft Industries) with production later bought by Gulfstream. In reality though the only commonality between these two aircraft is the fuselage cross-section. Gulfstream took note of many of the shortcomings in the G200 and improved in nearly every area. The G280 sports a brand new wing based on the amazing G450/550 wing, removing all leading-edge devices and adding larger blended winglets. The tail has been completely redesigned as a "T-tail" and now better fits the existing product line from both an aesthetic and operational standpoint. For additional thrust Gulfstream chose Honeywell HT7000 series engines, which also power its nearest competitor, the Bombardier Challenger 300. The result of this redesign is an aircraft with a range of nearly 3,600 nautical miles at a speed of mach 0.80 (maximum mach of 0.85). With a new PlaneView avionics suite, and the optional Heads-up Display and Enhanced Vision System, the G280 boasts one of the most advanced cockpits in the super-mid segment. The G280 received FAA type certification in the U.S. on September 4, 2012.
The flagship G650 (specs) is a completely new design that builds upon Gulfstream's experience as the dominant force in long-range, large cabin business jets. This amazing aircraft has shattered many long standing records and should continue to impress as customer deliveries begin in the fourth quarter 2012. With a maximum range of 7,000nm the G650 will be able to take 8 passengers from New York to Dubai at speeds up to mach 0.90, shaving 40 minutes off the flight time of the world's leading long range business jet, the Gulfstream G550. Even on a 12 hour flight, a 40 minute difference represents an enormous performance advantage. On shorter legs up to 18 passengers can be flown, depending on configuration, at speeds up to mach 0.925, currently making it the world's fastest civilian aircraft in production. At a gross weight of 99,600lbs the G650 will still be under the weight limits for both Teterboro, NJ and Aspen, CO, two important locations for domestic business jet operations. At nearly $65 million it is also one of the most expensive business jets in production. Currently there are over 200 orders for the 650.
Though the G650 program suffered a tragic accident during experimental flight testing in April 2011, the NTSB has made it clear that the accident was not the result of any aircraft design flaws (summary), and type certification by the FAA took place on September 7th, 2012.
Forecasts & Growth
A recent report by Honeywell (HON) outlined the projected global demand for business aircraft. In the next 10 years business jet manufacturers will deliver a total of nearly 10,000 aircraft valued at nearly $250 billion. Roughly 30 percent of operators that were surveyed indicated that they would be replacing aircraft or expanding their fleet within the next five years, which represents a huge shift in sentiment from 2009. The aircraft which are expected to see the most demand are the large cabin, long range aircraft, a segment which Gulfstream currently leads. Though Bombardier continues development of Global 7000 and 8000 aircraft, which are expected to rival the G650's performance, neither aircraft will be certified for at least 3 years giving Gulfstream a giant head start in this segment.
Gulfstream also dominates the product support and service of their aircraft. They have been voted the #1 manufacturer for product support 10 years in a row by the annual Aviation International News product survey's (link). And with new factory service centers being built in Beijing, China and Sorocaba, Brazil the worldwide Gulfstream fleet will have more direct access to factory maintenance.
General Dynamics will continue to face macro-economic pressure in the near future with dwindling defense budgets and political positioning. I don't believe the strength of the Gulfstream Aerospace unit alone is enough to warrant a "buy" for GD. I do believe, though, it's important to have a perspective on the entire product line, as many investors view General Dynamics as a pure military and defense contractor. With an exciting product line and award winning support, Gulfstream will continue to provide a strong revenue stream to the parent company until the fear of the fiscal cliff has come to pass. In the meantime, GD also offers a 3.0% yield and for those of us who currently own shares those are two good reasons to hold.