General Dynamics is a global aerospace and defense company. The company is organized into four operating segments. These are Aerospace and the three defense segments consisting of Marine Systems, Combat Systems and Technologies. The 2024 revenue breakup is provided in the chart below.
Source: Latest
Annual Report
Of the defense segments, Marine Systems has the best growth
prospects due to the U.S. Navy’s ship and submarine construction plans. GD’s backlog for major ship construction
programs gives the company a clear pathway to continue to generate dependable
cash flow. The Virgina and
Columbia-class submarine backlogs totaled over $27 billion running through
2032. The total backlog for Marine
systems, which also includes destroyers, fleet replenishment oilers, and one
expeditionary sea base auxiliary support ship, totaled $36.8 billion. Sixty-nine
percent of the company’s overall revenue is derived from the U.S. government
while 14% is U.S commercial with the remaining 17% of revenue coming from
non-U.S. government and commercial.
The Aerospace segment produces business jets and consists of
Gulfstream and Jet Aviation business units.
Gulfstream has about 50% market share in the long-range wide-cabin business
jet segment. Bombardier and Dassault
compete with GD in this segment. Historically,
General Dynamics has been able to operate with higher margins than these peers. The Combat systems segment’s backlog includes
Abrams battle tanks as well as the Pandur/Piranha armored vehicles. Land combat systems also have a long cycle
nature providing revenue stability like the marine segment. The M1 Abrams tank has been the Army’s main
battle tank since the 1980s. It is
expected to remain central to the Army’s warfighting capabilities. The company says the demand by NATO members
and other allied partners for the tanks and upgrades remains strong.
The Technologies segment serves military, intelligence,
federal civilian and state customers by providing technology solutions and
mission support services. The segment’s
portfolio also includes surveillance and reconnaissance solutions.
There is an obvious reason for the Defense department to
focus on the Navy. The size of China’s
navy surpassed the U.S. Navy in number of battle force ships according to a Defense and Intelligence
report available on Congress.gov.
The size of China’s navy is expected to grow to 395 ships in 2025 and to
435 by 2030. This compares to 296 battle
force ships for the U.S. Navy as of the end of September 2024. Battle force ships include major surface
combatants, submarines, and ocean-going amphibious ships, and aircraft
carriers. A bet on General Dynamics
should be a logical one for investors that assume that the U.S. will want to
keep pace with the growth of China’s navy.
General Dynamics has put up extremely dependable free cash
flow numbers for many years. Sales and
EPS growth have been in the low single digits for the last five years while
profitability metrics have been more impressive. The latest ROE, ROIC, and profit margin
numbers came in at 18.23%, 12.8%, and 8.08% respectively. This compares favorably with the other major
shipbuilder, Huntington Ingalls Industries Inc (HII) where the same metrics
came in at 12.27%, 7.11%, and 4.76% while also coming with more debt. General Dynamics achieved this outperformance
with a relatively healthy balance sheet and a debt-to-equity ratio currently
standing at 0.52. The company also
provides a 1.98% dividend yield. The five-year
dividend growth rate is a respectable 6.9% while the 10-year dividend growth
rate is slightly better coming in at 8.7%.
Another positive is the consistent reduction in the share count while
still growing shareholders’ equity.
We believe the company is currently trading below its
intrinsic value based on our discounted cash flow valuation. We considered a five-year time period and a multiple
of 25 which is below the industry average multiple of 26.27. We used the average of analysts’ annual EPS
growth estimates for the next five years of 9.95%. The company’s actual most recent quarter over
quarter and year of year EPS growth rates came in at 26.81% and 17.65%, respectively. Considering these inputs and a ten percent
discount rate, GD is currently trading at 76% of fair value. If we
instead use the current multiple, 20.46, as the PE in year five, the model
would show the company is trading at 91% of fair value. General Dynamics trades at this discount despite
being less leveraged than its peers. For
example, Northrop Grumman, Lockheed Martin and Huntington Ingalls Industries
Inc have debt to equity ratios of 1.11, 3.04, and 0.71, respectively. GD’s current debt to equity ratio comes in at
a more conservative 0.52.
With markets at all-time highs, your portfolio needs some companies
that can provide some stability. General
Dynamics, with its large backlog which provides years of almost guaranteed
revenue and its essential products, is somewhat recession resistant. Additionally, the company is working on
efficiency improvements to drive incremental margin expansion. It currently trades below its intrinsic value
despite the company’s clear path toward continued impressive cash flow
generation. We feel investors should use
the opportunity to initiate a position in one of only two major shipbuilders in
the U.S.
