2023-09-11 08:10:00 ET
Summary
- General Dynamics is trading below its 52-week high and is an attractive play for potentially strong total returns.
- GD has a steady and growing revenue stream from long-term government contracts, making it less vulnerable to economic downturns.
- Strong demand for military hardware and a record-high backlog support GD's near-term growth prospects.
Sleep well at night stocks should be a cornerstone for most conservatively run portfolios, and these types of holdings should be accumulated when the pricing is favorable. Such may be the case with the defense giant General Dynamics ( GD ), which, as shown below, is now trading well below its 52-week high of $256 and has recently dipped from recent highs.
I last covered GD here back in March with a 'Buy' rating and after ups and downs in price, the stock is back just below (-0.62%) the price at which I recommended it last. In this article, I discuss recent developments and GD is an attractive play for potentially strong total returns on the dip.
Why GD?
Experienced investors know that defense companies tend to be good 'all-weather' stocks to hold in a portfolio, due to them being less vulnerable to economic downturns. That's because GD, like its peers Lockheed Martin ( LMT ) and Northrop Grumman ( NOC ), has long-term revenue visibility due to government contracts that last for years and in some cases, decades.
This business model has worked out well for GD, as having a steady and growing revenue stream amidst varying economic climates has enabled strong shareholder returns. As shown below, GD has produced a total return that's more than triple that of the S&P 500 ( SPY ), double that of LMT, and trailing just behind NOC over the past 30 years.
Meanwhile, GD's near-term growth is being supported by strong demand for military hardware, pushing its backlog to a record-high of $91.4 billion as of July, an increase of 4.3% compared to the prior year period. As shown below, GD's revenue over the trailing 12 months has bounced up, and sits well above its average over the past 10 years, with Q2 revenue rising by 10.5% YoY.
This is driven in part by strong demand for GD's Marine and Combat systems and munitions stemming from the conflict in Ukraine, as the estimated potential contract value for indefinite quantity ((IDIQ)) contracts alone was $38 billion. Moreover, GD has continued to win orders, including a $488 million Army contract for artillery munitions. GD could also benefit from the U.S. DoD's plans over the next two years to deploy an extensive network of technology, drones, and autonomous systems powered by AI to ward off threats in Asia and the Middle East.
Meanwhile, GD continues to demonstrate strong cash flow conversion, with free cash flow representing 123% of net income. This enables robust shareholder returns, as reflected by $378 million in share buybacks so far this year. As shown below, GD has retired 21% of its outstanding shares over the past 10 years alone.
GD has also been strategically reducing its debt load, having reduced its long-term debt by $1.2 billion since the end of 2021. At present, it carries a safe net debt to EBITDA ratio of 2.0x, sitting below the 3.0x level generally considered safe by ratings agencies. This also supports its A- credit rating from S&P due in part to its strong revenue visibility from government contracts.
Risks to GD include supply chain issues that continue to linger and potential impacts to its labor force from COVID should infections rise during the winter season. Also, while GD is seeing strong demand from its business segment due to heightened consumer travel, this segment is more vulnerable to economic downturns compared to GD's defense segments.
Importantly for total return investors, GD is a dividend aristocrat with 28 years of consecutive annual raises under its belt. Its 2.4% dividend yield is well-covered by a 42% payout ratio and comes with a 7.8% 5-year CAGR. As shown below, it carries A and B grades for dividend safety, growth, yield, and consistency relative to the Industrials sector.
While the dividend yield isn't high enough to write home about, GD's track record of buying back shares as mentioned earlier contributes to its total return story. Lastly, I find GD to be reasonably attractive at the current price of $217.87 with a forward PE of 17.2. While this isn't cheap in the traditional sense, I believe GD is deserving of this valuation considering that demand drivers are firmly in place, including, driven by geopolitical tensions and continued modernization of naval and combat systems. Analysts also forecast robust annual EPS growth of 10-17% over the next 2 years.
Investor Takeaway
Defense stocks such as GD tend to be good 'all-weather' holdings. With its strong revenue stream visibility from government contracts and a reasonable valuation, I see the stock well positioned for attractive returns. While its dividend yield isn't particularly high, investors should be mindful that this stock should be held more for its total returns due to the added benefit from share buybacks, which are more tax-efficient for investors. As such, long-term conservative investors may benefit from taking a hard look at GD at the present level.
For further details see:
Why General Dynamics Is A Great SWAN Pick