General Dynamics’ Virginia-class nuclear-powered USS Mississippi attack submarine.
U.S. Navy photo courtesy of General Dynamics Electric Boat
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A government shutdown is looming—but that’s no reason to avoid defense contractor
General Dynamics
.
Any politics-induced weakness would just make the stock even more attractive.
General Dynamics (ticker: GD) is as sturdy and dependable as any of the big U.S. prime contractors, alongside
Boeing
(BA),
Lockheed Martin
(LMT), and
Northrop Grumman (NOC)
.
The company is locked into long-term contracts to produce some of the U.S. military’s most iconic assets, such as the M1 Abrams main battle tank and next-generation nuclear submarines, and it has a growth kicker in its Gulfstream business-jet segment.
| Key Data | |
|---|---|
| Recent Price | $221.00 |
| YTD Change | -10.9% |
| Market Value | $60.3 B |
| 2024E P/E | 14.8 |
| Dividend Yield | 2.4% |
E=estimate
Source: Bloomberg
The stock, down 11% in 2023, hasn’t been acting like one of the steadiest growers in the market. That makes little sense. Defense spending by the U.S. and its allies shows no signs of slowing in a more geopolitically volatile world, and rebuilding stocks of munitions and equipment after large transfers to Ukraine will juice industry sales in the coming years. Gulfstream is preparing to launch a new jet, which adds to the potential upside, and the stock remains cheap relative to its own history and its peers. It also has a history of dividend increases and share buybacks.
“Unfortunately, in today’s climate, it makes sense to be long a defense contractor, and with General Dynamics, there’s the added bonus of the Gulfstream inflection coming up,” says Boyar Research President Jonathan Boyar.
General Dynamics’ defense business is strong and getting stronger. The company had a record committed backlog—orders for products and services—of $91 billion at the end of the second quarter, while its total estimated contract value was $129 billion, representing three years of revenue.
The largest share of that backlog is in the company’s marine systems segment, which builds and maintains submarines and surface ships for the U.S. Navy and its allies. Those are long-term contracts and expensive products that rank among the U.S.’s top defense-spending priorities. The Navy’s Columbia-class nuclear-powered ballistic missile submarines alone are a 15-year long program worth more than $110 billion to General Dynamics and its partners.
“Shipbuilding is one of the safest parts of the U.S. defense budget,” says Matthew Akers, an aerospace and defense analyst at Wells Fargo Securities. “China is building its fleet very rapidly, and a large number of ships are reaching the end of their useful lives over the next decade.”
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Back on dry land, General Dynamics produces the M1 Abrams tank and the Stryker armored fighting vehicle, and it’s a finalist to build a replacement for the M2 Bradley, versions of which have been in service since 1981. Recent growth has been accelerated by demand from European nations building up their ground forces and buying artillery shells and missiles, and segment revenue was up 15.5% year over year in the most recent quarter, versus 10.5% at the company overall.
Rounding out General Dynamic’s portfolio is an IT segment responsible for around 30% of revenue, which competes against the likes of
Leidos Holdings
(LDOS) and
Booz Allen Hamilton
(BAH) to design and operate computer systems for the Defense Department and other government agencies. It’s a stable but slower-growing segment with tighter profit margins.
Unlike most other defense leaders, investors also get a cyclical kicker in the form of Gulfstream, which competes with manufacturers like
Bombardier
(BBD.B.Canada) and
Dassault Aviation
(AM.France). Gulfstream has an estimated 50% share of long-range, large-cabin jets, the fastest-growing segment of the market, and its offerings are only getting stronger: Management expects the Federal Aviation Administration to complete the much-delayed certification of the G700 jet in the fourth quarter, and FAA certification of the even longer-range G800 should follow in 2024.
G700 certification and an improved aerospace supply chain should allow Gulfstream to reach around 140 deliveries for the year, heavily weighted to the fourth quarter. That momentum will continue in 2024. Gulfstream could deliver 170 aircraft next year, according to some analysts, while the consensus calls for higher sales and expanded profit margins to boost the unit’s operating income by 30%.
“The market for business aircraft should see several years of positive fundamentals due to aging fleets globally and continued post-Covid commercial air travel difficulties,” says Bill Whelan, a portfolio manager at Clough Capital Partners. “You can see that in Gulfstream’s strong backlog.”
Analysts expect General Dynamics’ earnings per share to rise 18% in 2024, to $14.93, and for free cash flow to hit a record $4.2 billion, up 12%. Yet at a recent $221, its stock isn’t getting the credit it deserves. Shares trade for 14.8 times 2024 expected earnings, a discount to their historical average. Lockheed goes for a similar 14.5 times next year’s expected earnings, but analysts forecast growth of only 4%. Northrop trades for a premium 17.5 times on expected 2024 earnings growth of less than 10%.
General Dynamics has boosted its dividend payment for 26 years straight, with its annual payout increasing by an average of 9% a year for the past decade, to $5.28, for a current yield of 2.4%. Over the same period, the company has reduced its shares outstanding by nearly 25% with repurchases.
Wall Street’s average price target for General Dynamics is $265, or about 17.5 times 2024 estimated earnings—an upside of about 20%. That’s a premium multiple to its recent history and some peers, reflecting the company’s higher expected growth in coming years.
A government shutdown may bring some near-term turbulence. If shares take another dip, investors should take the opportunity to buy. “Historically [selloffs around government shutdowns] are a pretty good chance to get in,” Akers says.
General Dynamics stock remains a solid choice for both calm and stormy seas.
Write to Nicholas Jasinski at nicholas.jasinski@barrons.com
