BAESY - General Dynamics: A Long-Term Dividend Grower With Upside

2023-06-05 18:29:09 ET

Summary

• General Dynamics Corporation first quarter results are pressured by supply chain challenges.
• The second half of the year should show a significant improvement.
• For the long-term investor, General Dynamics stock might just be what you are looking for.

In a previous report , I assessed any impact from the decision to send main battle tanks to Ukraine for BAE Systems plc ( BAESF ) and General Dynamics Corporation ( GD ) and concluded there was little upside driven by main battle tank sales for these two stocks. In this report, I take a closer look at General Dynamics.

Supply Chain Challenges Hit General Dynamics

The overall results show that revenues rose by 5.2% while operating earnings grew 3.3%. However, virtually all of that growth was absorbed by an increase in the tax rate, leaving the company with $730 million in net earnings, which was stable year-over-year, but helped by a lower share count it was up 1.1% on per share level.

General Dynamics has four reporting segments, namely Aerospace, Combat Systems, Marine Systems and Technologies. In the Aerospace segment revenues declined by $11 million to $1.892 billion which is a decrease of less than a percent. Its operating earnings, however, declined by 5.8%, which was driven by supply chain issues. General Dynamics has been experiencing supply chain challenges for a while as have more aerospace and defense companies, but this was the first quarter in which it led to lower than anticipated deliveries. Total deliveries were three units lower than planned. Two deliveries were attributable to late engine deliveries and one to paperwork finalization being slow at customer side. Overall, due to the less attractive mix, suboptimal manufacturing efficiency due to Honeywell International Inc. (HON) driven out-of-station work, inflation, and pre-building some G700 jets the margins contracted 80 basis points.

For Marine Systems, we did see strength with sales growing by nearly 13% to almost $3 billion but also for this segment there was margin erosion leading to stable profits of $211 million. So, none of the top line growth driven by the Columbia-class submarine program translated to the bottom line, and that was driven by supply chain issues on the Virginia Class submarines.

In Combat Systems, sales grew 4.8% while profits grew 7.9%, so we saw an increase in margin from 13.6% to 14% with strength in its entire portfolio despite some forex headwinds. The Technologies segment saw 2.5% sales growth, but its profits were stable year-over-year driven by mix.

Overall, the quarter is best described as a stable quarter, where mix and supply chain issues prevented growth in operating earnings.

Strong Backlog For General Dynamics

Overall, the backlog remained strong at $89.8 billion which marked a sequential decline but an increase of 3% year-on-year. An overview from the evoX Defense Monitor, exclusively available to subscribers of The Aerospace Forum, shows that over the past five years General Dynamics has received $110 billion in contracts most of which was driven by submarine contracts. General Dynamics is one of the companies that consistently makes its way into the top 5 defense contractors. In week 21, it even was the top defense contractor as it received a $1.1 billion contract for long-lead material for two Virginia-class submarines and a $736 million contract for the detail design and construction of a replenishment oiler for the US Navy.

Is General Dynamics Stock A Buy?

With the margin pressure and supply chain issues, one can wonder whether General Dynamics is still a buy. For proper context placement, I think it is important to realize that the Q1 performance is not to be projected forward. For instance, in the first two quarters G700 jets will be built that won’t be delivered from Q3 onward and the supply chain challenges are easing according to General Dynamics. That indicates to improvement in the remainder of the year. Furthermore, General Dynamics has a streak of 27 years of dividend increases and while its 2.5% yield might not be juicy, coupled with a strong history of dividend increases it is a strong pointer that a very nice yield-on-cost can be built over time. So, I wouldn’t want to look at Q1 to tell anyone to not hold this stock because its history shows strong return to shareholders via dividends.

Instead, if we utilize the evoX Financial Analytics tool available to subscribers of The Aerospace Forum, we see that General Dynamics is undervalued compared to its peers. Using its own usual enterprise to EBITDA multiple, we see that the stock is more or less fairly valued with 2023 performance in mind or said differently: 2023 earnings are already factored in. However, compared to the industry multiple there is around 30% upside to $272 per share which is higher than the $261 per share price target that Wall Street has for the stock. Also interesting, to note is the upside towards 2025 which provides 22% upside which is close to the Wall Street analysts price target. Either way, I do believe that with the forward projections in mind General Dynamics is a buy.

Conclusion: General Dynamics Is For The Long Term Investor

The General Dynamics Corporation first quarter results were pressured by supply chain issues and negative mix, but this year we will already see some improvements as pre-built G700s will start delivering and supply chain challenges will ease modestly. Overall, General Dynamics Corporation is for the long-term investor, in my view. The company has a solid track record of increasing its dividends, and its forward earnings show upside to the stock price for all years whether you value the company in line with its peers or to its median enterprise-to-EBITDA multiple. So, I do believe that General Dynamics Corporation is a more than solid stock for shareholders to buy.

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