Do favorable winds justify its assessment?

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General dynamics (GD) is one of the few leading aerospace and defense companies in the United States, specializing in the development, engineering, and high-end manufacturing of advanced solutions, primarily for the U.S. government and its allies.

Specifically, 70% and 10% of the company’s consolidated revenue last year came from US government and US non-government customers (allies), respectively. The remaining 12% and 8% came from US and non-US business customers respectively.

General Dynamics’ broad portfolio of products and services includes business aviation, shipbuilding, ground combat vehicles, weapons systems, munitions, and technology services.

The company’s competitive advantage, in addition to its proprietary technologies in the above products and services, is that each of its business units is responsible for optimizing its own operating results. As a result, the business operates with minimal friction and considerable flexibility with respect to each division’s capital requirements and capital allocation.

On the one hand, the company has several other qualities, including an exceptional record of return on capital and creation of value for shareholders. Additionally, as a defense contractor, General Dynamics stands to benefit from the current unfortunate war in Ukraine.

On the other hand, with the stock’s valuation hovering at relatively high levels, investors’ total return prospects going forward may be somewhat limited. Accordingly, I am neutral on the title.

Current business landscape

Aerospace and defense contractors like General Dynamics are currently experiencing strong tailwinds due to the unfortunate ongoing war in Ukraine. As Western governments continue to supply Ukraine with all types of relevant weapons and equipment, space companies are poised to increase their arrears and future revenues.

The current situation should not be a temporary event, as Western allies will eventually have to restock their arsenals due to constant deliveries, which in military terms could mean years of delays for contractors. In fact, in his fourth quarter earnings call (before the outbreak of war), the CEO of General Dynamics had noted that demand for combat vehicles in Eastern Europe had been at high levels for some time now. .

It just goes to show that defense contractors typically benefit before, during and after conflict, which means the current war could mean prolonged tailwinds for the company.

Recent performances

General Dynamics’ most recent results once again demonstrated the company’s mastery of successfully meeting its backlog and producing resilient financial statements.

Quarterly revenue was flat at $9.4 billion, though earnings per share rose 5.6% year-on-year to $2.63. Note that since General Dynamics is a defense contractor, revenue growth isn’t really a meaningful metric. Investors should especially pay attention to General Dynamics’ ability to expand its order book and its overall capabilities to meet it.

As the backlog grows, the company’s revenue and profitability should gradually do the same, as it has historically.

Indeed, General Dynamics’ backlog growth momentum remains quite strong, with the company posting a book-to-bill ratio of around 1.7x. This means that General Dynamics’ cash flow over the next 1.5 to two years should be relatively secure from its customers, provided, of course, that the company carries out these projects.

Overall, as long as General Dynamics’ backlog growth recedes from its shipping volumes, the book-to-bill ratio should remain healthy. Thus, the company’s medium-term revenues should also remain fairly predictable. With the ongoing war in Ukraine likely to lead to increased military budgets in the future, this will most likely continue to be the case.

Dividends and valuation

Given that General Dynamics’ order-to-bill ratio remains historically healthy, as I mentioned earlier, the company’s performance exhibits little to no volatility. This allowed General Dynamics to gradually increase returns on its capital over time. In particular, the company has an impressive history of dividend growth, boasting 27 consecutive years of annual dividend increases.

This places the company among the elite constituents of the S&P 500’s Dividend Aristocrat Index. The company has a five-year dividend growth CAGR of 9.13%, which is quite remarkable given the maturity of General Dynamics’ dividend growth record. The most recent dividend increase was also quite substantial, raising the quarterly payout rate by 5.9% to $1.26. The title is currently yielding nearly 2.15%.

Management did not update its guidance, which targets annual revenue of between $39.2 billion and $39.45 billion. EPS is also expected to range between $12.00 and $12.15 for fiscal 2022. The midpoint of management’s ESP outlook suggests the stock is currently trading at a forward P/E of 18.8x at its current price levels. On an NTM basis, that figure drops to less than 18x.

While this seems like a relatively fair valuation given the aerospace and defense macro environment that looks quite promising, the current multiple is at the high end of the stock’s historical P/E range.

The Taking of Wall Street

On Wall Street, General Dynamics has a Strong Buy Consensus Rating based on seven buys and two holds awarded over the past three months.

At $275.67, the average projection for General Dynamics shares implies 21.5% upside potential.

Carry

On the one hand, Mr. Market is likely forecasting above-average EPS growth in the coming years due to continued tailwinds benefiting the industry. Market enthusiasm is confirmed by the stock’s premium valuation and confident price target, implying even noticeable upside potential from here.

On the other hand, as we mentioned earlier, the company’s results derive from its order book and its ability to meet it. So, even if the backlog increases in the future, which is certainly good news, General Dynamics’ production capacities are only expected to increase at a slower rate each year.

Based on the company’s historical growth rates and valuations, current business environment, most recent results and outlook, I would view the stock as more reasonably valued at a forward P/E of around 17. .

So while General Dynamics remains a quality company with a strong case for its ability to continue to generate strong shareholder value creation over the long term, investors should consider that its short-term upside potential could likely be reduced. exhaust at the current share price.

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