General Dynamics (NYSE:GD) is primarily known as a producer of defense equipment. The company has an aerospace division, combat division, marine division, information technology division, and a mission systems division. Each one complementing each other in enhancing technology and offerings to provide superior products. As a producer of military equipment, the company benefits from strong defense budgets and awarded military contracts. However, the stock can be swayed if the defense budget is viewed as being cut. While some investors would consider the stock an industrial, I consider it less so due to the need for its products no matter the economic state of the country. As the shares trade closer to their 52-week lows, I believe now is the time for investors to add some to their portfolio.
Performance
General Dynamics recently reported earnings that beat on both the top and bottom lines.
Source: Seeking Alpha
The company saw growth in every operating segment showing it can continue to produce results. Earnings per share increased 14% from the prior year. Quite a nice number. "Aerospace" saw growth of 8.4%, "Combat Systems" saw a nice increase of 13.1%, "Information Technology" saw revenue grow a slight 1.9%, "Mission Systems" grew 2.5%, and "Marine Systems" saw a nice gain of 11.7%.
Operating margins continued to expand which helps drive profitability growth faster than revenue growth.
Source: Earnings Slides
These strong results would usually lead a stock to new highs and certainly create strong stock performance. The company is seeing growth of high double digits, thanks to many contract wins and a strong backlog. In fact, the backlog is a record $86.9 billion. This type of consistency and order log gives the company confidence in the future. This allows management to use its strong free cash flow to enhance shareholder returns.
As the company continues to produce strong results, it issued guidance representative of earnings growth of around 5%.
Source: Earnings Slides
This guidance, however, doesn't take into account any share repurchases. The backlog at $86.9 billion should give investors the confidence that even with a lower contract win rate, the company can still deliver excellent results. The company has announced several contract wins in the last few months, which I expect to contribute to the growth in backlog.
Taking a look at the summary of operations, we can see the company has been steadily reducing the shares outstanding.
Source: 10-K
GD repurchased over 7.6% of the shares outstanding since 2015. This helps enhance earnings growth as well and thus increase the share price. The cash position has been steady and debt has declined slightly. As the company continues to generate record cash flows, it should be able to continue to return cash to shareholders via share repurchases and dividends.
The company continues to maintain excellent debt levels as we can see below.
Source: 10-K
Long-term debt now stands at $9 billion, and total debt stands at almost $12 billion. This debt is mostly fixed rate, and much about 25% of it is due in the next two years.
We saw the company announce a 7.8% increase in the quarterly dividend to $1.10 per share.
Source: Seeking Alpha
This is the 22nd year of consecutive dividend raises, making it an attractive dividend aristocrat for dividend investors. Additionally, the new 10 million share repurchase program is good for another 3.5% of shares outstanding. With the recent swoon in the share price, it will be interesting to see how much management took advantage of this.
Arguably 2019 was a very strong year, and repeating that would require expanded capacity which the company may not currently have. This puts the forward multiple at a bit under 13x. So let's review if the valuation is fair at this time.
Valuation
Compared to peers, General Dynamics does not appear expensive.
Data by YCharts
Compared to peers, the company has the lowest forward P/E, the second highest yield, and the lowest forward P/S ratio. With shares trading below most peer valuations and fundamentals showing strong momentum, shares may be offering some value.
Taking a look at the five-year historical trading averages for shares, we can further see if they offer a good value.
Source: Morningstar
From what we can see above, it appears shares are trading at a discount compared to their average for quite a few metrics. Currently, shares trade less than they have for P/S, P/E, P/B, and forward P/E. We also see the company is offering a lower PEG ratio than normal alongside a higher earnings yield. This would make shares appear to be undervalued compared to their own history. I typically look for a discount of about 10% from the average to become interested; currently, this is more than present.
Lastly, I check to see if shares offer a higher-than-average yield. This would imply undervalued shares, especially from a dividend aristocrat which just reported a record year of results.
Source: YieldChart
Since 1995, the average yield has been about 1.96%. Currently, with a yield of 2.75%, shares are offering an above-average dividend. The new raise is not yet reflected in the above chart. This has happened less than 10% of the time in the last 24 years. Investors should recognize this as a potential opportunity to pick up shares at an opportune time. With 22 years of raises, it is likely the company will continue to raise the dividend in the future, which more than makes up for the relatively small yield.
Conclusion
General Dynamics' shares seem to offer value compared to peers. While the market has been falling due to Coronavirus fears, GD's shares have too. Investors can take the opportunity to start a position, and should the shares fall further, they can add to the position. The company should be largely unaffected by the economic impact the virus may have. With below-average valuations, record earnings, and an above-average yield, shares seem to be offering value. I typically look for a higher dividend, but am willing to wait given my time frame and the company's dividend history. Going forward, the company will be reliant upon a strong defense budget and a favorable political environment. That being said, for investors looking for a defense play for their portfolio, General Dynamics seems to be the way to go. I have recently added more shares to my portfolio.
