Marcial: Behind General Dynamics' Soaring Stock

The defense contractor is in demand globally for its private jets. It's also landing new orders for military equipment and finding companies to buy

Big companies that don't make splashy products sometimes fly under the radar—like General Dynamics (GD), a giant corporation that the public tends to ignore. But Wall Street pros are paying attention.

The secret behind the success of the world's sixth-largest defense contractor is that General Dynamics is a military-technology-industrial company for all seasons. Also one of the biggest makers of corporate jets, the company has developed an aggressive strategy for fast growth that's working wonders for its bottom line—and its stock, which has soared from a 52-week low of 74.01 a share on Jan. 22 to 91.42 on Aug. 26. Little wonder that of the 21 Wall Street analysts who follow the company, none recommend selling the stock while 15 continue to rate it a buy. The remainder are neutral on the shares.

I usually shy away from featuring stocks that are heading higher, since the law of gravity kicks in sooner or later. But from what I see, General Dynamics is firing on all cylinders, and the stock appears to have a lot more upside.

Jon Kolb, an analyst with independent research outfit Zacks Investment Research, rates the stock a buy and has a six-month price target of 105. And analyst Brian Betts of Gamco-owned investment outfit Gabelli (GBL), which owns some shares, estimates the company is worth 108 a share. "General Dynamics' attractive mix of businesses has enabled it to grow faster than its peers," says Betts.

Global Demand for Private Jets

Some investors worry that the high price of oil, the worldwide economic slump, and uncertainty about the U.S. defense budget(, 8/23/08) with a Presidential contest under way could stymie the company's earnings and revenue growth, particularly in its aerospace unit, which makes the popular Gulfstream business jet. Among General Dynamics' diverse businesses, which range from sophisticated electronics for land-sea and land-based weapons systems to nuclear-powered submarines, the aerospace unit is a standout. Demand continues to be strong for upscale corporate planes overseas, particularly in Abu Dhabi, Saudi Arabia, Russia, and other countries rich in petrodollars.

The company's Gulfstream G650, a new private jet scheduled for delivery in 2012, has generated "super demand" around the globe, says analyst Morton L. Siegel of independent research firm Value Line (VALU). With a base price of $58 million, the G650 will fly at a top speed of 700 miles per hour and at a maximum altitude of 51,000 feet. Orders are six to seven times the company's initial expectation of 83 orders for the first 2.5 years, says Siegel, adding that production may have to be accelerated.

But the other units of General Dynamics aren't standing still. The company's Information Systems & Technology Group, which makes sophisticated electronics for weapons systems sold to government agencies, produces 35% of all sales and 32% of operating earnings. It competes with Northrop Grumman (NOC), Lockheed (LMT), and Boeing (BA) for the $70 billion U.S. government IT business. Combat Systems, the second-largest unit, makes and supports armor, threat detection systems, and electronic countermeasures and accounts for 29% of sales and 29% of operating earnings.

Aerospace, which includes jet manufacturing, accounts for 18% of sales and 26% of operating profits. Based on revenues, Gulfstream is the world's second-largest maker of corporate jets, behind Canada's Bombardier, Textron's (TXT) Cessna, France's Dassault , and Hawker Beechcraft. In 2007, the total market for private jets totaled more than $16 billion. The fourth unit is Marine Systems, contributing 18% of sales and 13% of profits, the Pentagon's second-largest military shipbuilder behind Northrop.

Growth Through Acquisitions

Richard Tortoriello of Standard & Poor's, who rates the stock a buy, sees General Dynamics over the longer term continuing to increase sales and earnings through acquisitions, growth in deliveries of business jets, strength in land vehicles and munitions needed for operations in Iraq, and overall replacement of damaged equipment, one reason he expects Congress to vote for increased military spending. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

On Aug. 6, General Dynamics won a $1.5 billion contract from the U.S. military for 615 Stryker combat vehicles. And on Aug. 20 the military awarded it a $326.5 million contract to produce mobile-gun versions of the Stryker.

Boosting the company's business through acquisitions, General Dynamics' latest deal is the $2.3 billion purchase of Switzerland's Jet Aviation. The company says the operations will boost its capabilities as a business jet-services provider and give it a global reach in expanding its aerospace portfolio alongside Gulfstream.

Zacks' Kolb cites several factors that he thinks will drive General Dynamics' results: "revenue growth, margin expansion, a growing backlog, an underleveraged balance sheet, and cash generation." He figures the company will earn $6.13 a share in 2008 on revenues of $29.7 billion, and $6.70 a share in 2009 on $31.7 billion in sales.

Some companies can make success seem downright boring, and investors may take smooth-running, profit-making outfits like the big defense contractor for granted. In these times of market volatility and uncertainty, however, it's companies like General Dynamics that could convince investors that boring is beautiful.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Before it's here, it's on the Bloomberg Terminal.