GD - General Dynamics: Buy The Dip On This Wealth Compounder

Summary

• General Dynamics has a strong track record of market-beating returns.
• It has a very strong backlog and recently won a number of contracts with the U.S. military.
• The recent dip in price presents an opportunity for long-term dividend growth investors.

General Dynamics ( GD ) has been one of my best performing picks over the past 2 years. Since I recommended the stock back in early 2021, it's given investors a total return of 69% , far surpassing the 5% return of the S&P 500 over the same timeframe.

With the uncertainties looming around a potential recession in 2023, defense contractors may be a safe haven for investors, much like how cashflow-rich pharmaceutical companies like Merck ( MRK ) and Amgen ( AMGN ) outperformed the market in 2022. In this article, I highlight why General Dynamics is a solid choice for long-term dividend growth investors at the present level.

Why GD?

General Dynamics is a leading aerospace and defense company that has a long history of delivering innovative solutions to its customers. The company operates through four main business segments: Aerospace, Combat Systems, Information Technology, and Marine Systems. Over the trailing 12 months, GD generated $39 billion in total revenue.

One of General Dynamics' key competitive advantages is its diverse portfolio of products and services. This allows the company to weather economic downturns and shifting customer needs in different segments of the market. In addition, the company has a strong track record of delivering on contracts and maintaining positive relationships with its customers, which helps to secure future business.

This diversification helps GD to avoid the pitfalls of having too many eggs in one basket, as was the case for Boeing ( BA ) when their 737 Max problems unraveled in the public eye, resulting in operational turmoil in recent years. As shown below, GD's diversified business and tilt towards defense spending has done well for investors, producing a 324% total return over the past decade, far surpassing the 226% return of the S&P 500 ( SPY ).

Meanwhile, GD is executing to plan, with revenue growing by 4% YoY to $9.98 billion during the fourth quarter. This was driven by growth in 3 of GD's 4 segments, including Aerospace and Marine Systems, which grew their revenues by 14% and 5%, respectively.

Importantly, the Aerospace segment is seeing best order performance in over a decade, and saw operating margin improvement of 60 basis points YoY to 13.3%. GD recently received EASA certification for its Gulfstream G700/G800 engines and the Aerospace segment has seen robust order backlog over the past 2 years, as shown below.

Looking forward, GD has significant tailwinds, as its three defense segments recently received significant awards, including $1.4 billion from the U.S. Navy for the construction of an additional auxiliary support ship and two additional fleet replenishment oilers, as well as a $1.1 billion contract to produce Abrams tanks. Just last month, GD also won a significant $5.1 billion U.S. Navy contract modification for a missile, with production line of sight until 2028.

Risks to GD include defense spending decisions by Congress, as reflected by a current deal being negotiated in the House of Representatives to cut 2023 defense spending by $75 billion from previous estimates. While this sounds like a big number, if implemented, U.S. defense spending for 2023 would still be $782 billion, which would be in line with 2022 levels.

Moreover, GD has plenty of backlog to work through, which stands at $88.8 billion, and total potential contract value including options and IDIQ contracts (indefinite delivery, indefinite quantity) stands at a staggering $126 billion. This gives GD revenue line of sight for many years to come.

Notably, GD maintains a very strong A- rated balance sheet. While its dividend yield is just 2.1%, it's well covered by a 41% payout ratio. GD is also a dividend aristocrat with over 25 years of consecutive raises and has an 8.7% 5-year dividend CAGR. As shown below, GD scores mostly A grades for dividend consistency, safety, growth, and yield.

In addition, like its defense peers, GD has a strong track record of returning capital to shareholders in the form of share buybacks. As shown below, GD has retired 21% of its share count over the past 10 years alone.

GD stock has recently fallen to $240 with the market reacting negatively to the aforementioned House negotiations. However, the stock is still not a bargain at a forward PE of 19.8. However, I believe GD is deserving of this valuation considering the overall quality of the enterprise and the 14% annual EPS growth that analysts expect over the next two years. As shown below, this has the effect of potentially pushing the forward PE down to an attractive range.

Investor Takeaway

General Dynamics offers a diversified portfolio of defense assets with significant growth potential, and should benefit from its very strong backlog in the coming years. It's track record of steady and growing income streams has contributed to market-beating returns over the past decade. Moreover, it pays a well-covered dividend and has a history of share buybacks. As such, growth investors may want to take advantage of the recent dip for the stock's long-term potential.

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