With a backlog of $82.7 billion, General Dynamics (NYSE:GD) will be able to continue to expand its business and reward its shareholders via dividends. Despite the fact that the company’s stock failed to show a meaningful performance in recent years, we believe that, at the current price, General Dynamics is an attractive investment. There’s also every reason to believe that the downside of owning the company’s shares at this stage is limited, and with the coverage ratio of over 9x, General Dynamics will be able to easily service its debt and create value at the same time. For that reason, we decided to add General Dynamics to our portfolio.
Strong Balance Sheet Makes the Company a Solid Buy
General Dynamics is the fifth-largest defense contractor in the United States and the sixth-largest in the world. The company is part of the Fortune 500 list, and the majority of its revenues come from North America. For years, General Dynamics has been one of the most important contractors of the US Department of Defense, developing various types of civil and military equipment in fields like aerospace, combat systems, information technology, mission systems, and marine systems. However, despite its systemic importance to the military-industrial complex, General Dynamics’ stock failed to perform in recent years, as it was declining since 2018 and only recently started to recover after reaching its 5-year low in March.
Earlier this year, COVID-19 disrupted General Dynamics operations, as some of its divisions were shut down during the initial weeks of the pandemic. As a result, the company disappointed its investors in Q2, since its revenues during the period declined by 3.1% Y/Y to $9.26 billion. However, General Dynamics was still able to make money, as its GAAP EPS was $2.18, and it also managed to generate $622 million in free cash flow from April to June. In addition, despite the temporary shutdown of its civil aviation business in the first half of the year, General Dynamics also managed to deliver 32 Gulfstream business jets in Q2, which is an increase of 3% Y/Y or 39% Y/Y.
Source: General Dynamics
The positive thing about General Dynamics is that, at the end of June, it had a backlog of $82.7 billion, which is an increase of 22% Q/Q, as the company was able to receive a contract to develop two submarines for the US Navy, which in total will be worth $11.5 billion. In addition, the company’s Abrams tank continues to be in high demand and Q2 was the 17th quarter in a row in which the sales of this type of tank were up. Going forward, General Dynamics has plenty of room for growth, since, recently, it has received additional contracts from the military-industrial complex to develop drones, air defense systems, and military IT solutions. Also, the biggest advantage of General Dynamics is that it operates in a business with a high barrier of entry. After establishing itself as a reputable company in the defense field, it’s much easier for the company to compete and win sizable contracts as an up-and-coming contractor. Also, having the previous Secretary of Defense Jim Mattis on its Board of Directors is also a big advantage.
While there’s every reason to believe that General Dynamics will be able to continue to expand its portfolio of military projects, there’s a risk that its civil aviation business, which develops and sells Gulfstream jets, could be underperforming in the near term. The problem with the corporate jet business is that it’s too small, and it’s nearly impossible to scale it. Every year, around 800 business jets are being delivered across the world, and with the CAGR of 1%, the growth opportunities are limited. Also, due to the COVID-19, Gulfstream business is already experiencing some difficulties, which are likely going to remain until the virus is contained.
However, other than that, General Dynamics’ other businesses will be fine. Its military projects and a sizable backlog will be able to minimize the downside of owning its shares, and the solid balance sheet will keep the company afloat. After all, General Dynamics continues to be profitable, it has $2.3 billion in cash reserves at the end of June, and with an interest coverage ratio of over 9x, it can easily service its debt and reward its shareholders along the way.
Another good thing about General Dynamics is that, while it trades in line with its peers, its operating and net margins are slightly above the industry’s median, which makes its stock more attractive than others.
Source: Capital IQ
Considering that the company has a price target of ~$168 per share and a bullish outlook, it’s safe to say that General Dynamics stock is a bargain at this price, and its downside right now is limited. As the company is about to release its Q3 earnings in the next couple of weeks week, we decided to purchase the company’s shares ahead of the conference call, as we’re confident that it will be able to create value in the long term.
Source: Seeking Alpha
Disclosure: I am/we are long GD, LMT, NOC, DUAVF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.