3 Thorns in General Dynamics’ Side

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It’s been a pretty good month for defense/aerospace giant General Dynamics (NYSE:GD). The company landed billions of dollars in contracts, and its third-quarter earnings, released Wednesday, beat Wall Street expectations. But GD’s revenue fell by 2%, and that speck of doubt could temper the otherwise positive buzz.

General Dynamics lifted third-quarter earnings to $652 million ($1.81 per share), up from $650 million ($1.71 per share for the same quarter last year). Although that reflects a razor-thin 0.3% increase, analysts were expecting net income of only $1.77 per share. General Dynamics’ income has beat the Street in each of the past four quarters.

But revenue fell for the second straight quarter to $7.85 billion from $8 billion in the third quarter of 2010; analysts had expected revenue of $8.31 billion. This marks GD’s second quarter of declining revenue and reverses three consecutive quarters of revenue growth.

The company’s strongest growth area was the aerospace segment, which includes the Gulfstream aircraft business. Aerospace revenues rose 9.4% to $1.41 billion; earnings rose 9% to $217 million. Strong performance there could help offset some of the revenue lost from future defense cuts.

For now, General Dynamics still has some good news to crow about. It received three recent contract awards from the U.S. Navy: an $89.9 million contract from for advanced submarine technologies, a $429 million contract for nuclear submarine technical support and engineering and a $134 million contract for the onboard repair of the amphibious assault ship USS San Diego.

The company also won an $86 million network support contract from the Defense Intelligence Agency and a $243 million contract from the U.S. Army to build another 115 Stryker Combat vehicles. GD’s most interesting deal this month was a $1.04 billion contract from the Canadian government to upgrade the country’s armored vehicle fleet.

Despite the good news, here are three reasons General Dynamics still could slip:

  1. Election-Year Politics: With a sluggish economy and a ballooning federal deficit, politicians of all persuasions are in deep trouble heading into the 2012 election. As President Barack Obama pins his re-election hopes on fixing the deficit crisis with a half-trillion dollars in defense cuts, General Dynamics and other contractors are holding their collective breath. The fact that Tea Partiers are cool with putting defense programs on the chopping block adds to the anxiety. With GD’s huge exposure to the defense sector, any cuts approaching that number will have a big impact on its stock.
  2. Loss Of Nuclear Training: General Dynamics recently lost a U.S. Navy nuclear propulsion-training contract to rival Huntington Ingalls Industries (NYSE:HII). While a single training contract is not a big deal, the company’s Electric Boat Division had held the contract for the past 24 years and laid off the 165 workers associated with highly sensitive contract. The big deal here: Defense contractors usually work hard not to lose the unique expertise of nuclear workers.
  3. Stryker’s Future in the U.S. Army. Despite the fact that GD has sold more than 4,000 of its Stryker wheeled armored fighting vehicles, it will face a couple of tough battles in the near future. First, Stryker has been a key asset in Iraq, but with Obama’s announcement that all U.S. troops would be out by year’s end, the platform might need to find a new mission. The Army is looking to replace its M113 armored personnel carriers, but GD faces a tough battle from BAE Systems’ refurbished M2 Bradley Fighting Vehicle, which, unlike Stryker, runs on tracks instead of wheels.

Bottom Line

General Dynamics remains a strong defense contractor, as well as one of the world’s largest manufacturers of business jets. With a market cap of $23.77 billion, the stock has a price/earnings-to-growth ratio of 1.17, indicating that it’s slightly overvalued. At $65.79, GD has risen 22% above its 52-week low of $53.95 in September. The company reliably pays its dividend; the current yield is 2.9%. Still, falling revenue and relatively flat earnings are a concern — the company will have to rely more on business jet sales and information technology to make up the difference from hefty defense cuts.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.


Article printed from InvestorPlace Media, https://investorplace.com/2011/10/3-reasons-general-dynamics-gd-stock-could-slide-hii/.

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