3 Aerospace Stocks For Profits Now

Includes: GD, LMT, TXT
by: Vatalyst

General Dynamics (NYSE:GD) shares are trading around $72 at the time of this writing. This is above the company's 52 week low of $53.95 and under its 52 week high of $78. The company just increased its annual dividend to $2.02/share for a 2.9% payout. This was about an 8.5% increase from the previous $1.88/share. The payout ratio based on the new amount will put the payout ratio near the 30% range.

General Dynamics operates in four segments: Information Systems & Technology (IS&T), Combat Systems, Aerospace, and Marine Systems. These segments make up 36%, 27%, 16%, and 21% of sales respectively. Only one of these segments isn't tied to the defense industry, and that is the aerospace segment-- better known as Gulfstream business jets. Here GD competes mainly with Textron (NYSE:TXT). This is also GD's fastest growing segment because it isn't impacted by global defense spending cuts.

GD's smallest plane can carry four passengers and travel 3,000 nautical miles, while its largest can carry eight and travel 7,000 nautical miles. Textron's smallest Cessna can carry five for 1,150 nautical miles, while its largest can carry up to twelve passengers for 3,400 nautical miles. I think General Dynamics has the lead here because it has more aircraft that can travel a longer distance. If I'm a multinational corporation in the private jet market, I need a company that can get me to all my overseas locations, which Cessna cannot do.

The IS&T segment handles many different IT and communications solutions. GD built itself a significant moat in this segment, to secure providing contract services for its systems throughout their life. It keeps certain "proprietary" information, system configurations, or updates so that they can only be implemented or installed by GD personnel. Despite the military or other customers having operators completely capable of installing the upgrades themselves, this helps guarantee GD a revenue stream for the entire life of the system with each customer.

Within IS&T lies the biggest battleground for all defense contractors. Since traditional building of combat platforms, weapons, etc… is suffering a huge slowdown, companies need to replace those revenues with cyber solutions. Cyber is the one area where government and military spending will continue to grow rapidly over the coming years.

GD currently contracts with the Department of Homeland Security (DHS) for the US-CERT mission. Another company, Lockheed Martin (NYSE:LMT), owns one of the few labs that can test and wireless security capable of passing classified information. This is big for General Dynamics because GD is the current major provider of the Warfighter Information Network - Tactical (WIN-T) to the U.S. Army. This system is currently in the first increment, which allows command posts to quickly setup anywhere in the world and be connected to military networks via satellite.

The next increment is supposed to increase capability to allow connectivity on the move. This means commanders will have the capability to access classified information from their vehicles with these systems installed. The third increment is supposed to allow complete on the move capability, so that the leader on the ground can have classified access in a smartphone type device. One of the main reasons this is not out yet is because the Army is still working on securing the information as it goes through the air to its intended recipient.

Lockheed partners with the DoD for its cyber-crime center. It is the largest accredited digital forensics lab according to Lockheed's website. GD does a lot with critical infrastructure protection and border protection. As you can see, just between these two there is intense competition to become the preferred provider for cyber security services. These companies need not only to retain their current contracts, but to attempt to secure additional contracts in order to keep growing. I think Lockheed will give GD a good fight, because Lockheed has a lot more government revenues to replace with cyber contracts than GD does.

Several recent press releases on its website show that the company has received several intelligence and cyber related contracts. Despite the defense spending cuts, these two areas have already been pledged to receive increased spending because of their importance. I think General Dynamics can help replace other lost revenues by working on these areas, developing new technologies and securing new contracts. These increases, coupled with increasing the aerospace segment, should help keep the company stable until the next wars start and defense spending picks up again.

The combat systems segment depends on the U.S. Army and Marines being involved in active ground combat. With the war in Iraq over and Afghanistan coming to an end, this segment is going to take a huge hit. GD won't be replacing vehicles, weapons, or making munitions in the same volume that it has been since the September 11th attacks. The marine systems segment is similarly tied to the U.S. Navy. The navy is still engaged in combating pirates, but that is about it. Both segments will see declining orders over the coming years.

I am also still waiting to hear more on the outcome of the SEC's information request from September that was briefly mentioned in GD's fourth quarter 10-Q. It is never a good day when the SEC comes knocking and asking for documents.

I like the increased dividend and think it's a buy for the dividend now and hold till the next war for any major growth. It is a solid stable play because it's working on the cyber areas and it is able to mitigate lost defense revenues with increasing Gulfstream revenues. I think the stock could see $75-$80 by the end of 2012, and possibly even another small dividend increase before the end of the year.

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