General Dynamics Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

General Dynamics is a global aerospace and defense company, primarily focused on business aviation, ship construction and repair, land combat vehicles, weapons systems and munitions, and technology products and services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

General Dynamics operates through four distinct segments:

  • Aerospace: This segment is the world’s leading manufacturer of business-jet aircraft, specifically the Gulfstream line. The segment provides design, engineering, manufacturing, and support services. Revenue is recurring due to maintenance and support contracts with existing customers, particularly for airframe parts and component repair. They are also focusing on developing new aircraft models and technologies.
  • Marine Systems: As a leading designer and builder of nuclear-powered submarines and a surface combatant and auxiliary ship, the Marine Systems segment is vital to the U.S. Navy. It also provides maintenance, modernization and lifecycle support services for Navy ships, along with constructing and delivering commercial vessels for both U.S and international customers. The division provides design, engineering, planning and project support services for strategic and attack submarines, surface ships, and naval nuclear engineering.
  • Combat Systems: The Combat Systems segment is a premier manufacturer and integrator of land combat solutions worldwide, including wheeled and tracked combat vehicles, weapons systems and munitions. It produces weapons and ammunition, military vehicles, and provides services including engineering, armaments, and logistics support to US and international forces.
  • Technologies: The technologies segment is involved in intelligence, surveillance, and reconnaissance systems as well as secure communication and command and control systems. The segment focuses on cloud-based offerings, cybersecurity, and IT services and infrastructure.
  • Market Share: The defense market is very oligopolistic. General Dynamics has high market share in several segments, like submarines and tanks.
  • Customer Base: General Dynamics has strong long-term relationships with their customers, the largest of which is the U.S. government. They also have a large installed base of equipment which is expensive to replace.
  • Pricing Power: The nature of their contracts, particularly within Defense, gives them some pricing power with long-term contacts. The company also produces a product that is of critical importance, which also increases their pricing power. However, when the company acts as a sub-contractor to a prime government contractor, then they have much less pricing power.
  • Operations: The company’s focus on efficiency and innovation has allowed them to achieve great results over the decades. The management is also focused on creating lasting relationships with its clients.

Financials

  • The company’s revenues were 10.7 Billion for the first 3 quarters of 2023, a 7.5% increase YOY, primarily due to higher sales in the marine segment.
  • Operating margin expanded 90 basis points.
  • Diluted EPS of $11.67 a 13.4% increase YOY.
  • The company expects an increased margin in the future as contracts are completed. This will improve profitability further.

The company has good organic growth from a mix of new products, demand for legacy products and acquisitions, like Jet Aviation.

  • Aerospace: Strong demand for new aircraft models with growth in both aircraft manufacturing and services. The segment continues to benefit from the new G500, G600, and G700 programs, which continue to ramp up production. This segment continues to benefit from aftermarket revenue from the G400, G450, G550, G650, and G700. This also includes Jet Aviation services.
  • Marine Systems: They are working on the Columbia-class submarine project, in addition to the Virginia-class submarine projects, and various shipbuilding and repair programs for the U.S. government. They also produce commercial ships for various clients.
  • Combat Systems: The segment revenues are driven by increased demand for Stryker combat vehicles and ammunition. This is also influenced by new and emerging weapons and missile systems. It also includes international contracts for products and vehicle upgrades.
  • Technologies: The technologies division focuses on IT, intelligence, and information management. The focus of this division is on providing network solutions for governments, commercial firms, and other agencies.
  • Margins : - The margins within defense are consistent and have stayed in range of 13% - 14%. - The Marine segment’s margins have been less consistent, but overall have a good positive trend with a range between 6-8%. - The Aerospace segment’s margins have been more volatile over time, as they are more sensitive to production issues and the timing of deliveries with a range between 11 and 14%. - The Technology segment is the worst with much lower margins at about 9 - 10%.
  • Revenues: 70% of the revenues are obtained from US government spending, with the rest from international and commercial sales. This implies that the company is sensitive to US government policy and spending habits. Revenue is derived primarily from aircraft manufacturing and services, US Navy ship construction and engineering, and land vehicle systems and munitions.
  • Cash Flow: The company is producing healthy cash flows which they use to return capital to shareholders through share buybacks and dividend payments. The company currently has $2.9 billion in cash and equivalents. Their current free cash flow is $3.4 billion. Their capex is $600-700 million per quarter
  • Debt: Net debt is around 11.1 Billion. However, they have an AA- credit rating. This means there is not too much concern for default risk and they are in a place where they can take on additional debt.
  • Buybacks The company repurchased shares worth $454 million, and declared $335 million in dividends for the last quarter.

Moat Assessment: 3/5

General Dynamics has several characteristics that form its economic moat:

  • Switching Costs There is high customer retention in many of their products and segments. This happens due to close working relations with their customers, the highly specific nature of contracts with US government, the difficulty of integration with customer’s existing workflow and processes, and the long-term nature of product development.
  • Intangible Assets: They have strong brand names like Gulfstream, which commands a premium and loyal clientele. They also have patented technologies and unique technical know-how. Their relationship with the US Navy is very powerful, and leads to recurring and predictable revenue.
  • Cost Advantages: Some segments, such as Marine and Aerospace benefit from significant scale. The company is a large player and has many long-term contracts. They also operate several production facilities and have developed efficient manufacturing and supply processes. Their size also makes them harder to compete against due to the high barriers of entry in certain industries.
  • Barriers to Entry: It is very hard for new entrants to enter in any of the segments. There is regulation, heavy capital required and specialized skills and expertise.

Even though, all of these attributes confer a competitive advantage, they are not sufficient to guarantee an extremely wide and sustainable moat. Competition is intense in several of the industries, and new technologies are challenging existing business models. This is why the moat rating for General Dynamics is a 3 out of 5.

Legitimate Risks to the Moat

The major risks to the company’s competitive advantage can be summarized into these main points:

  1. Government Dependence: General Dynamic’s heavy reliance on government contracts makes it susceptible to changes in government spending and policies. Decreases in U.S. defense spending can directly harm the company.
  2. Project Delays and Failures: Their long-term projects are difficult and often subject to substantial modifications and can end up being terminated, delayed, or running at heavy losses.
  3. Technology Disruption: There is always a chance that new technologies can disrupt legacy and outdated systems in place, thereby weakening the company’s competitive advantage. This is particularly valid for the Technology segment.
  4. Economic Volatility: Unfavorable economic conditions and supply chain disruptions can lead to higher costs, or lower sales, thus harming the overall company performance. The company operates globally, which also exposes it to fluctuations in different world economies.
  5. Loss of Key contracts: Loss of a major contract in US Defense will have major repercussions. The company is heavily reliant on the US government, and if the US government decides to pull its long-term contracts, that would be a major blow.
  6. Intensified Rivalry : Increase in competition in any of the segments could diminish profits. This could be caused due to innovation, increased capacity or companies trying to pursue similar strategies, lowering prices to win contracts, which could cause a significant decrease in profitability.

Business Resilience

Despite the risks identified, General Dynamics demonstrates resilience:

  1. Strong Backlog: Their diversified business model leads to strong and recurring revenues, with a strong backlog of $137 billion which protects from short-term negative impacts.
  2. Diversification: The company benefits from being a diversified enterprise which mitigates the losses of one segment with the gains of another segment.
  3. Market Position: The company occupies leading positions in segments with high barriers to entry, which makes the company more resilient to competitors.
  4. Financial Flexibility: They have very manageable debt level with a good credit rating which increases their financial flexibility and resilience to financial downturns.
  5. Long Term Contracts: Long-term contracts make their revenue predictable and stable. They also guarantee revenue in the future.

Understandability: 2/5

General Dynamics is fairly easy to understand at a high level, but delving deep into the details and understanding where it creates its advantages are rather difficult. The multitude of products and services, coupled with the financial statements that are separated into the different segments, makes for a complex picture, hence a 2/5 rating for understandability.

Balance Sheet Health: 4/5

The balance sheet is strong and has a good asset-to-liability ratio with a strong cash flow and low short term and long-term debt. Even after a buyback program of 1 Billion, their cash flow is still above 2 billion. The main negatives of the balance sheet are the presence of significant amount of goodwill, long-term debt, and employee benefit obligations. For this reason, a 4/5 rating for balance sheet health.