Wagering on the War Machine of General DynamicsGeneral Dynamics (GD: Charts, News, Offers), the world’s fifth largest defense contractor, after BAE Systems, Lockheed Martin (LMT: Charts, News, Offers), Boeing (BA: Charts, News, Offers) and Northrop Grumman (NOC: Charts, News, Offers), in that order, is a diverse U.S. defense conglomerate with four divisions: Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Its primary customers include the United States Department of Defense, the CIA, Homeland Security and other “first response” agencies. The company is best known as the original creator of the F-16 Fighting Falcon and the manufacturer of the M1 Abrams Tank. The company, with a market cap of $24 billion, operates with a net profit margin of 8.03%, up from the 7.53% the previous year. It trades with a P/E of 10.17 and a hefty dividend of 0.42 per quarter. It is well below its 52 week high of $79, but safely above its low of $55.26. Is it time to invest some cold hard cash in America’s war machine, as a bet on continued world conflict focused on military expansion and protectionism?
General Dynamics, formerly known as the Electric Boat Company for much of its century-long history, rose to prominence after World War II, when the cash rich submarine manufacturer bought Canadian aircraft producer Canadair in 1946. The Cold War fueled demand for large defense contractors, and General Dynamics, with both naval and air capabilities, fit the bill perfectly. Despite trailing its larger competitors during the Cold War, those years were kind to the company, and by the time the Vietnam War broke out the company had become a force to be reckoned with. The company eventually divested its aviation holdings starting in 1976, and began to focus on land units, with its 1982 and 2003 respective purchases of General Motors’ and Chrysler’s defense divisions, which significantly boosted its tank line with well-known units such as the Abrams, LAV 25 and Stryker. In 1999 it returned to the aircraft business by purchasing Gulfstream Aerospace.
The company has consistently won diverse contracts; recent ones include $13 million from the TSA to install a new security screening system, $68 million from the U.S. Army for technical support and maintenance of Abrams tanks, and up to $544 million from the Navy for new digital modular radios. With a steady stream of contracts from permanent customers, it’s no wonder that the company’s earnings last quarter increased by 4.8% to $651 million, with a free cash flow of $414 million. The company’s most popular products include Gulfstream business jets, Stryker, LAV III and Scout armored vehicles and Hydra-70 rockets and components. It also earns a healthy revenue from its shipbuilding, information technology for intelligence, and specialized computer products.
Moving forward, the government’s increased demand of Virginia Class attack submarines to two ships a year in 2011 will benefit both General Dynamics and Northrop Grumman, who have exclusive contracts with the military to produce the 1.8 billion dollar submarines. The current submarine contract was signed in December 2008. In addition, General Dynamics was also selected by the FAA to participate in its Systems Engineering 2020 (SE2020) Program, to participate in next generation aerospace advancements. Despite high barriers to competition, General Dynamics has tried to expand its portfolio by attempting to take over Alvis Vickers, a British armored vehicle manufacturer in 2004, but was blocked by British military contracting giant BAE Systems to “keep General Dynamics out of its backyard.” It also attempted to take over Newport News Shipbuilding, a manufacturer of nuclear powered ships and a subsidiary of chief competitor Grumman but has been blocked multiple times by regulators and competitors.
General Dynamics would be good defensive play as long as America’s military arm keeps expanding, which is, to say the least, inevitable. Besides its largest competitors, the company has no clear obstacles to growth and has a nearly unassailable position in the market. The company is efficiently managed with a high ROIC and profit margin. Its strong cash flow has led to dividend increases over the last 12 years, and would be a stable, long term investment. Lastly, adding a military contractor to any investment portfolio would be a good hedge against unexpected downturns.