General Dynamics Is Heading To $166 Per Share

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About: General Dynamics Corporation (GD)
by: Sandeep Singh Ahluwalia
Summary

From March 2018, the stock has fallen from a high of $230 to a low of $144.

Interest rate risk poses a major threat to the firm’s future price performance and earnings.

Once the stock reaches the 100% Fibonacci support level, I expect it to have a bullish reversal.

From March 2018, the share price of General Dynamics (GD) has been in decline, which has resulted in the stock falling from a high of $230 to a low of $144. However, once General Dynamics fell to $144, the stock commenced a bullish ascent, which I believe has come to an end. Hence, to establish the likelihood of this, I will look at the fundamentals of the stock whilst also analyzing the chart using technical analysis tools.

Fundamental facets that matter:

Share price underperformance:

General Dynamics' share price has severely underperformed the industry over the prior twelve months. The company has lost roughly 37.35% of its value, while the industry's value has risen by around 1%. Moreover, a comparative analysis of the firm's historical EV/EBITDA ratio reflects a rather gloomy picture that will be a cause of concern for most investors. The firm's 12-month historical EV/EBITDA ratio stands at 11.31, which compares unfavorably with the 12-month median value of 13.93. Furthermore, the valuation looks stretched in comparison to the industry. Hence, due to this, I expect the stock to have a fall in the coming weeks.

Interest rate risk:

In my article on Lockheed Martin (NYSE:LMT), I had stated that one of the factors that will hamper the growth of the whole defense industry is interest rate risk. However, this notion of mine is more relevant in the case of General Dynamics. This is because the firm's interest rate expense rose to $112 million in 2018, which is a 319% increase from the prior year. Moreover, the interest expense may rise further if the Federal Reserve decides to raise the interest rates in 2019. This is because it will make the credit market very unfavorable for General Dynamics. Therefore, I believe investors who are long on the equity ought to keep an eye on this factor.

Patchy financials:

The fourth quarter results of General Dynamics were patchy as the IT and marine business lines exceeded expectations but could not offset the weakness seen in other business lines. A great example of this is the firm's Gulfstream business line whose margin came in below the analysts' estimate by more than 1%. This is due to the business line being a victim of the tensions between the governments of Saudi Arabia and Canada. In December 2018, the Canadian Prime Minister announced that he is considering backing out of a $13 billion sale of armored vehicles to Saudi Arabia. This was in retaliation to the killing of Journalist Jamal Khashoggi and Saudi Arabia's apparent involvement in the Yemen crisis. All this controversy cost the firm roughly $300 million in the fourth quarter. This in turn was enough to spoil the quarterly performance. Hence, I expect the poor financials to have a negative impact on the stock in the foreseeable future.

Weak annual growth rate:

Growth in earnings and revenue Source: Simply Wall Street

The growth rate of General Dynamics' earnings has been poor over the past one year. The earnings have risen by a mere 6.4%, which is 59.3% lower than the earnings growth rate of the Aerospace & Defense sector. Moreover, the earnings growth rate is a whopping 121.8% lower than the average earnings growth rate of the market. The earnings growth rate of the Aerospace & Defense sector came in at 10.2%, while the earnings growth rate of the American stock market came in at 14.2%. Furthermore, the same trend can be seen in the revenue growth rate as General Dynamics' revenue over the past one year has grown by 4.6% which is lower than the 5% growth rate seen in the Aerospace & Defense sector. Thus, even though the growth level of earnings and revenue is positive, it is still modest, and I would just stop short of calling it a weak performer. Hence, I believe it is a stock worth avoiding as of now, but you may keep it in your watch list.

Return on Equity and Assets:

The two areas General Dynamics is performing rather well are in Return on Equity and Return on Assets. General Dynamics, over the past one year, has efficiently utilized its shareholders' funds. The ROE of General Dynamics stands at 28.99%, which is higher than the industry's average of 13.8%. Moreover, General Dynamics over the past one year has utilized its assets more efficiently than the rest of the Aerospace & Defense sector. The firm's Return on Assets stood at 6.97% against an average of 6.5% seen in the Aerospace & Defense sector. This is one of the reasons why I believe the stock should be in your watch list. The stock may become a buy once it falls to the $166 price level.

Future outlook:

The net worth of General Dynamics puts the firm in an odd position. There is more clarity about the firm's near-term outlook than its long-term prospects. General Dynamics can meet its short-term (one year) commitments with its holdings of cash and other short-term assets. However, it cannot meet its long-term commitments as the liabilities outweigh its cash and other short-term assets. The short-term assets of the firm stand at $18,189 million, while the short-term liabilities stand at $14,739 million. However, the firm's long-term liabilities stand at $18,937 million, which outweighs the firm's cash and other short-term assets. Hence, I believe investors ought to keep an eye on this aspect of the firm in the future.

Dividend yield:

General Dynamics may not be a dividend guru, but it is doing rather well on this front. The current annual income for investors stood at 2.38% over the prior one year and is estimated to rise to 2.51% in the coming year. Thus, this is better than the bottom 25% of firms in the American stock market which pay an average dividend yield of 1.44%. However, it is less than the stock market's top 25% dividend payers who pay an average dividend yield of 3.63%. Moreover, the firm's dividend per share has risen over the past 21 years. Hence, this makes me confident enough to say that the stock will have some downwards movement in the short term but will have a steady value in the long term. I expect the stock in the long term to have a spike in the level of interest shown by dividend investors. This in turn will be favorable for the stock as dividend-seeking investors don't tend to sell, which in turn helps maintain price stability.

Technical analysis:

Weekly chart:

General Dynamics Weekly chart The weekly chart indicates that the equity is all set for a bearish reversal. The stock has formed a 'Bearish Harami' candle pattern. This pattern psychology indicates to investors that the trend has turned bearish. The second candle's real body has closed within the first candle's real body. Moreover, the pattern received further bearish confirmation as the candle has crossed below the 200-day moving average line. However, the bullish tinkle here is that the stock has presently taken support from the 50% Fibonacci support level at $166.15. Hence, if the stock does manage to hold this level, then I believe it will trade in a sideways pattern. Nevertheless, I do not expect this level to hold for long as the trend is severely bearish.

On the price target front, I expect the stock to tumble until the range between the 78.6% and 100% Fibonacci support level. The 78.6% Fibonacci support level is at $154.04, while the 100% Fibonacci support level is at $166.15. Nevertheless, once the stock does reach the 100% Fibonacci support level, I expect it to have a bullish reversal.

The big picture:

Overall, General Dynamics' future growth trajectory faces many risks that I believe will cause the stock to have a price descent in the coming weeks. However, before trading, do ensure that you utilize a trailing stop loss so that you are around for the next trade as capital protection is key. Lastly, do watch the 50% Fibonacci support level as this is a make or break point for the equity.

Good luck trading.

Disclosure: I am/we are short GD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.