The defense sector is on the march again after Congress beefed up spending for the nation’s armed forces. That should translate into good news for General Dynamics Corporation (NYSE: GD) investors, who’ve seen GD stock underperform against the Standard & Poor’s 500 index over the past year.
That scenario could change as General Dynamics is reporting a better-than-expected quarterly earnings picture, bolstering the stock price before a late April price decline. Earnings moved upward thanks to a sales boost in the company’s tank and weapons system (up 11.9 percent), as Uncle Sam looks to boost defense spending.
But the aerospace sector is soft right now and General Dynamics’ aerospace division, the biggest at the company, was down 12 percent for the quarter. Toss into the mix a new merger that has investors questioning GD’s prospects going forward, and the outlook on GD lands on the positive side mostly, with several caveats attached.
General Dynamics stock at a glance. The aerospace and defense giant’s stock is trading at $203 per share with a one-year target estimate of $248 per share.
The generally positive first-quarter earnings news gave GD stock some buoyancy, with the stock rising to $224 per share before falling back toward the $200 level, as traders brooded about the U.S. defense sector’s cash flow woes.
For the quarter, General Dynamics reported earnings per diluted share of $2.65 on revenues somewhat in excess of $7.5 billion, operating earnings of slightly more than $1 billion and net earnings of $799 million.
Company management says it likes what it sees so far in 2018.
“Compared to the first quarter 2017, revenue was up $94 million, or 1.3 percent, and operating earnings were down $38 million, or 3.6 percent over the prior year’s quarter,” says Phebe N. Novakovic, chairman and chief executive officer at General Dynamics. “The operating margin in the quarter was 13.4 percent, was very good, but did not compare favorably to last year’s stellar first quarter of 14.1 percent.”
On the other hand, net earnings of $799 million were up $36 million, or 4.7 percent, on the strength of a lower provision for income taxes. Earnings per share of $2.65 were 17 cents, or 6.9 percent better than the year-ago quarter and 15 cents better than consensus. “We estimate that about half of that 15-cent beat was from operations in the form of higher-than-expected operating margin, and the remainder came from a lower-than-expected tax rate,” Novakovic says.
Aside from the earnings report, investors are still mulling over General Dynamics’ $9.7 billion deal to purchase CSRA, a cybersecurity and data analytics company that works closely with defense industry firms. Analysts estimate that CSRA will add $3.6 billion in revenues to the company’s newly-redesigned General Dynamics Information Technology division (GDIT).
Wall Street observers state it’s too early to speculate on the CSRA deal and its impact on GD stock, but so far, the reviews are positive.
“Even though General Dynamics is assuming all of the debt of CSRA the acquisition looks good overall,” says Jonathan Maula, an investment manager at Castle Hill Capital, in York, Pennsylvania. “GD is a fundamentally sound company at the moment with great cash flow and that shouldn’t be impacted going forward.”
Pros of buying General Dynamics stock. Ask a Wall Street professional about the prospects for General Dynamics and you’ll likely hear a lot about investors getting impatient about the company’s stock price.
“Although the quarter was an improvement, our outlook for GD is neutral, as we would like to see a sustainable growth story to be more positive on its outlook,” says Joseph Smith, director at the investment banking firm Cassel Salpeter & Co. “As a diversified aviation/military conglomerate, their revenue and operating profit growth over the past few years have been flat.”
Smith says his firm likes GD’s aerospace division, as the Gulfstream Jet and Jet Aviation FBO brands are well regarded and growing, but the majority of GD’s business; the military/defense, consisting of combat and marine systems “has not seen noteworthy growth” over the years.
“The buyout of CSRA should have some very positive benefits in 2018 and beyond, as it can add approximately 15 to 20 percent to overall revenues, raise the information system’s divisional revenues by over 50 percent and more than double the IT systems revenue component to approximately $10 billion, which should be a positive diversifying asset and revenue stream for the overall company moving forward,” he says.
Other positive attributes include GD’s “sizable and diversified” backlog of more than $63 billion, a 20-year record of consecutive quarterly dividend increases, the potential for greater defense spending by the current administration, corporate tax relief and the CSRA buyout (which diversifies GD further into IT systems).
“Notwithstanding, we would like to see more sustainable growth over the next few quarters to be more positive on the outlook,” Smith says.
Cons of buying General Dynamics stock. Investors kicking tires on General Dynamics need to take a close look at the company’s revenue situation, Smith says.
“The good news is that all of GD’s segments have the capability to grow or contract,” he says. “Their government programs seem to have a pretty good current tailwind, but the migration from backlog to revenues needs to be aggressively managed and executed upon.”
A general consensus is forming that existing shareholders should avoid selling the stock, aside from some moderate profit-taking opportunities. But new investors may want to remain on the fence with General Dynamics.
“We would advise new investors to look elsewhere based on current valuations,” Maula says. “Investors that invested at a lower price and have large gains might want to consider locking in some profits, but not exiting the position entirely since the stock is a good core holding.”
The bottom line. Market watchers say that it’s high time for General Dynamics to stabilize its core divisions and to harness a healthy financial picture into share price growth.
“The financial health of the company is strong, what is missing is the consistent growth component,” Smith says. “This acquisition, which pushes the company further into IT systems and services, is positive in that it further diversifies the company away from its traditional capital-intensive aerospace/military defense programs.”
“Perhaps this is the catalyst towards a greater growth story,” he says. “We will have to watch and wait and see.”