General Dynamics Corporation
) posted mixed results for the March quarter, surpassing the Zacks
Consensus Estimate on the top line but missing the forecast at the
bottom. Looking forward, key drivers include the improving business
jet market, its stable business of U.S. military vehicles, a
backlog of over $55 billion, an ongoing share repurchase program
and strong cash flow generation.
However, the company is largely tied to the U.S. defense budget,
where the threat of budget cut is looming. Also, we have turned
slightly cautious about the company's steadily dropping order
backlog, and risks related to the execution of key projects.
Headquartered in Falls Church, Virginia, General Dynamics
engages in mission-critical information systems and technologies;
land and expeditionary combat vehicles, armaments and munitions;
shipbuilding and marine systems; and business aviation. The company
operates through four segments: Information Systems &
Technology (IS&T), Combat Systems, Marine Systems and
General Dynamics was the third largest U.S. defense contractor
in terms of revenue in fiscal 2011, after
The Boeing Company
Lockheed Martin Corporation
). The company is one of two contractors equipped to build
nuclear-powered submarines in the U.S.
General Dynamics continues to benefit from strong congressional
support for its programs in the 2012 defense budget. The U.S.
defense budget for 2012 was $645.7 billion, with the base budget at
$530.6 billion and $115.1 billion approved for Overseas Contingency
Operations ("OCO") as supplementary defense spending, mainly to
fund ongoing wars.
In February this year, the Department of Defense (DoD) requested
a Pentagon base budget of $525.4 billion for 2013, which is
approximately $5.1 billion or 1% less than what is approved for
fiscal 2012, with $88.5 billion earmarked for OCO spending.
The significant reduction in OCO funding is mainly due to the
decline of U.S. military operations in Iraq in 2011. Going forward,
OCO funding is expected to continue to decline as troops redeploy
out of Afghanistan.
For the future, the company's focus will be on revival in the
business jet market (Gulfstream) along with programs such as the
Warfighter Information Network Tactical (WIN-T) program and Joint
Tactical Radio System (JTRS) in the IS&T division.
Similarly, the Combat Systems and Marine Systems segments will
receive a boost from higher volumes in the U.S. military vehicle
business (Stryker combat vehicles and Abrams tanks) and ship
programs DDG-51, Virginia class submarines and the Mobile Landing
General Dynamics has one of the strongest balance sheets among
its peers with a low long-term debt-to-capitalization of 20.5% at
the end of the first quarter of 2012 (Zacks Industry Average was
44.3%). Earlier, General Dynamics' free cash flow from operations
reached $2.8 billion in fiscal 2011.
Management returns a substantial portion of its free cash flow
to shareholders through share repurchases and incremental
dividends. The company repurchased 18.9 million shares during
fiscal 2010 and 20 million shares during fiscal 2011. Also, in
March 2012, the company raised its regular quarterly dividend by
8.5% to $0.47 per share.
General Dynamics' total order backlog steadily decreased to
$55.2 billion at the end of the first quarter of 2012 from $59.6
billion at fiscal-end 2010. Going forward, the U.S. economic
fundamentals are basically being kept on a leash as the Euro-crisis
continues to cast its spell over the financial markets, keeping
risks of further cutbacks in future defense budgets at a high
Our apprehension is fueled by $15 trillion of national debt and
an unemployment rate hovering around 8.1% which would lead to the
Budget Control Act's dictum of automatic cutbacks across the board
Going by the pulse of the economy and given the pros and cons,
we prefer to maintain our long-term Neutral recommendation on the
stock. Moreover, General Dynamics holds a Zacks #3 Rank that
translates into a short-term Hold rating.
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