We have maintained our Neutral recommendation on the defense
General Dynamics Corp.
) on Sep 6, 2013.
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Why the Reiteration?
General Dynamics is one of the largest U.S. defense contractors
whose revenue exposure is spread over a broad portfolio of
products and services that help it to keep the overall growth
momentum steady. The company is one of the two contractors
equipped to build nuclear-powered submarines in the U.S.
The company posted strong second-quarter results with the top and
the bottom line easily surpassing the respective Zacks Consensus
Estimate. Earnings were up year over year, while revenues showed
a marginal decline of 0.1%. The results reflect a steady flow of
orders and an efficient cash deployment strategy.
In order to counter the decline in revenues from European Land
Systems, a unit of Combat Systems, General Dynamics is
restructuring the business. The restructuring plan would
remove excess capacity and bring the size of its European
business in line with future demand.
Again, General Dynamics has one of the strongest balance sheets
among its peers. Management returns a substantial portion of its
free cash flow to shareholders through share repurchases and
incremental dividends. It repurchased 6.6 million shares in the
second quarter, and still intends to deploy all of the free cash
flow for dividends and buybacks this year. Earlier in the year,
the company boosted its quarterly dividend by 10% to 56 cents per
share, marking the 16th consecutive annual increase. This carries
a dividend yield of 2.58%.
However, the threat of budget cuts from the Department of Defense
(DoD) keeps us on the sidelines. A large percentage of General
Dynamics' business is generated from the U.S. DoD. Hence, cuts in
defense spending could hinder growth in operating segments. The
company has now factored in the impact of sequestration on Combat
Systems revenues. For 2013, the company now expects revenues to
decline 15% versus the earlier estimate of down 8%. In fact, the
second-quarter performance was driven by stronger-than-expected
margins from Aerospace, Combat and Marine. Hence, the scissor in
the defense budget could adversely impact the Combat Systems
segment, thereby rendering the company vulnerable at large.
Other Stocks to Consider
General Dynamics presently carries a Zacks Rank #3 (Hold). Other
better-placed operators include Zacks Ranked #2 (Buy)
Northrop Grumman Corp.
Lockheed Martin Corp.
B/E Aerospace Inc.