Sometimes market, economic, and other forces work on a global scale to turn against an industry in such a way that even long-term forecasts remain uncertain. The Aerospace industry is a good example of what I mean; the global spread of COVID-19, which as of this morning has now taken more than 900,000 lives brought the entire commercial side of the industry to a screeching, grinding halt. Even optimistic forecasts don’t see demand for air travel, on either a consumer or business level returning to 2019 high levels until 2023, which means that this side of the Aerospace business is likely to remain under pressure for an extended, long-term period of time. That should make the entire industry radioactive, right? Not necessarily – because another critical piece of this industry is Defense – which means long-term government contracts for a wide range of products and solutions for everything from jet fighters to tanks and submarines.
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The Defense portion of this industry can also be volatile, because it is intrinsically tied to government spending, which can obviously ebb and flow with changes in political sentiment. That’s why many companies that have historically operated major portions of their operations on this end of the business, like Raytheon (RTX) and General Dynamics Corp (GD) also put a lot of emphasis on business and commercial Aerospace; that usually acts as a useful counterbalance against variations in government spending.
The world we’ve been forced to become used to living in this year has flipped that script. The pandemic has grounded air travel across the board, not just for popular commercial airlines, but also for all kinds of business travel, which is one of the reasons that GD’s business has continued to seen pressure on its bottom line, driven largely by a decline in the commercial Aerospace side (GD makes the popular Gulfstream jet). At the same time, the company has been able to use significant new defense contracts brought in during the year that have helped to buoy the business at large. Does that mean that GD, which touched a bear market low in March below $110, but has since rebounded to hover in a new consolidation range between $143 and $157? Maybe – despite its rally since March, the stock is still more than -22% below its pre-pandemic peak at around $190. Are the fundamentals strong enough to still offer attractive upside despite the fact that Aerospace is still likely to keep seeing bearish pressure for the foreseeable future?
Fundamental and Value Profile
General Dynamics Corporation is a global aerospace and defense company. The Company offers a portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions, and shipbuilding and ship repair. It operates through four business groups: Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. Its Aerospace group offers aircraft design; cockpit and cabin systems, and product service and support. Its Combat Systems group offers combat vehicles, weapons systems and munitions. The Information Systems and Technology group provides technologies, products and services in support of various programs. The Marine Systems group is a designer and builder of nuclear-powered submarines, surface combatants and auxiliary and combat-logistics ships. GD has a current market cap of $42.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings were -21.3 lower while sales declined -3%. In the last quarter, earnings where -10.29% lower compared to the same quarter a year ago while sales increased almost 6%. Not surprisingly, GD has seen its operating margin show signs of deterioration this year; over the last twelve months Net Income was 8.52% of Revenues, and dropped to 6.75% in the last quarter.
Free Cash Flow: Over the last twelve months, GD’s Free Cash Flow is a little more than $2.6 billion – marking an increase from the beginning of the year (before the pandemic) of $1.9 billion. The current number also translates to a modest, but healthy Free Cash Flow Yield of 6.31%. The fact this number has increased, rather than decline during the pandemic as might normally be expected is a sign of strength.
Debt to Equity: GD has a debt/equity ratio of .75, which is a generally conservative number. Long-term debt in the last quarter was $10.7 billion – which marks a decline from $12.9 billion at the beginning of the year. At the same time, cash and liquid assets have increased significantly, from $902 million at the beginning of the year to $2.3 billion in the last quarter. That does mark a drop from the of the first quarter, when cash was more than $5 billion. Servicing their debt is no problem, but continued deterioration in Net Income could put pressure on the company’s liquidity.
Dividend: GD pays an annual dividend of $4.40 per share, which at its current price translates to a dividend yield of about 2.98%. Even at that attractive level, GD’s dividend payout is also only a little more than 50% of the stock’s earnings per share over the last twelve months – a conservative figure that actually helps bolster the company’s balance sheet strength.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $195 per share. That means that GD is significantly undervalued, with about 33% upside from its current price.
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line defines the stock’s downward trend from September 2018 to its low point in March at around $100. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. From that low, GE rallied to a short-term peak at around $165 in June before falling back to form a consolidation range over the last three months, with support sitting around $143 – a little below the 50% retracement line and resistance at around $157.50. The stock is currently sitting near to support at a little below $147; a push above the 61.8% retracement line at $157.50 offers additional upside to the June peak near $165. A drop below support at $143 could see the stock fall to around $136, in line with the 38.2% retracement line.
Near-term Keys: GD’s fundamentals have largely managed to remain healthy, despite the ongoing headwinds in its Aerospace business. Continued pressure on Net Income, along with reductions in cash and liquidity remain concerns; however the fact that Free Cash Flow has improved, while debt has dropped are also strong counter-elements in its favor. I also really like their value proposition, but don’t ignore the stock’s exposure to broad market-based volatility right now. I believe the stock is likely to remain under pressure as long as commercial air travel demand remains low. If you prefer to work with short-term strategies, there are a couple of signals that could be useful. The stock is currently bouncing off of support, so continued bullish momentum could offer a good opportunity to buy the stock or work with call options, using $157.50 as a useful profit target, and $165 from there if bullish momentum continues. If the stock drops below $143, consider shorting the stock or working with put options, with $136 acting as an attractive exit target on a bearish trade.
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