Aerospace and defense contractor General Dynamics Corporation (GD, Financial) reported earnings results at the end of January that missed Wall Street analysts' estimates. Weakness in two of the company's largest segments due to Covid-19 was the primary culprit that the company claimed responsible for its underperformance and lukewarm guidance for 2021.
Despite this, shares of General Dynamics are higher by more than 7% since then compared to just a 2% return for the S&P 500 over this period of time.
However, the stock still appears undervalued ever after this gain, in my view. The company's backlog has reached a new record, showing that its overall businesses remain strong. Shares also provide a dividend yield that is almost twice that of the S&P 500. Even with challenges in certain areas, General Dynamics has a lot to offer investors.
General Dynamics reported fourth-quarter and full year earnings results for 2020 on Jan. 17. For the quarter, the company's revenue decreased 2.7% to $10.5 billion year-over-year, which was $284 million lower than expected. Net earnings of $1 billion, or $3.49 per share, were essentially flat compared the prior-year quarter's net earnings of $1 billion, or $3.51 per share. On a sequential basis, net earnings and earnings per share both improved approximately 20%.
For full year 2020, General Dynamics' revenue fell 3.6% to $37.9 billion. The company had net earnings of $3.2 billion, or $11.00 per share, which compared unfavorably to net earnings of $3.5 billion, or $11.98 per share, for 2019.
Much of the decline in both the quarter and full year can be assigned to the company's Aerospace segment. Revenue was down almost 17% for the quarter and 17.6% for the year. Aerospace has felt the most impact from the pandemic as customers delayed or canceled orders for the company's Gulf Stream product line.
However, General Dynamics did deliver 40 aircraft in the quarter, including 34 large cabin aircraft. Though this was three less than the company had anticipated, this was the largest number of deliveries in 2020. This helped drive 23% growth from the third quarter of 2020, providing some evidence that there remains pent up demand for aircraft. Aerospace has a backlog of $11.6 billion, though this is down slightly from the prior quarter. On the plus side, operating margins expanded 10 basis points to 16.5%
The other segment to suffer a decline was Technologies. This segment fell 2.3% and 7.6%, respectively, for the fourth-quarter and full year. The company sold its SATCOM business in the first half of 2019, so this negatively impacted comparable numbers, but the Covid-19 related delays in projects also took a toll.
That said, revenue was lower 1% sequentially as Technologies did show strength in certain areas. The Space, Intel and Cyber businesses improved. The backlog reached $13.3 billion, but the total estimated contract value grew 46% to $41 billion. The operating margin of 10.9% was flat from the previous year, but improved 120 basis points from the third-quarter.
Marine Systems was the strongest performer as revenue increased 11.4% for the quarter and 8.7% for the year. Volume growth for the Virginia-class Block V and Columbia-class submarines remains robust. In fact, this segment received a $9.5 billion award from the U.S. Navy for construction of Columbia submarines. The backlog of nearly $50 billion is almost 14% higher than the prior year. The operating margin improved 80 basis points to 8.6%.
Revenue for Combat Systems was down 0.6% in the fourth-quarter but increased 3.1% for the year. This followed 12.3% growth in 2019, so full year results look slightly more impressive considering that certain businesses were shut down due to the pandemic.
This segment's U.S. business performed well. The Army awarded General Dynamics an Abrams tank modernization contract worth up to $4.3 billion and made an additional order for Stryker vehicles that could be worth as much as $1.2 billion. International is beginning to pick up as well, with Canada purchasing $200 million worth of ammunition. The backlog of $14.6 billion was 2.3% lower than the prior year. Margins expanded 140 basis points to 15.8%.
The company-wide backlog grew 9.8% to a new record of $89.5 billion. The backlog would take more than two years to work off using revenue totals for 2020. Nearly two-thirds of the backlog is funded. The book-to-bill ratio of 1.8-to-1 was strong in the fourth-quarter, helping the book-to-bill ratio reach 1.1-to-1 for the year even as Aerospace was a headwind. The total estimated contract value is approaching $135 billion.
General Dynamics finished the year with $51.3 billion of total assets, including $21.5 billion of current assets and $2.8 billion of cash and equivalents. This compares to total liabilities of $29.8 billion and current liabilities of almost $16 billion. Total debt is $14.4 billion, with current debt of $3 million. Much of the debt due within a year will mature in the second quarter of the year.
The company had free cash flow of $2.9 billion in 2020, which more than covered $1.2 billion of dividend distributions, $587 million of share repurchases and $441 million of debt repayment.
The company provided guidance for 2021 as well. General Dynamics expects earnings per share of $11.00 to $11.05 for the year, which would be a fractional improvement from the previous year. Revenue is expected to increase 3% to $39 billion.
With a current share price of $163.47, General Dynamics trades with a price-earnings ratio of 14.8 using the company's midpoint for guidance. This compares to the stock's average price-earnings ratios of 14 and 16.7 for the last five- and 10-year periods, respectively. Compared to the historical performance, shares trade at a discount to their medium-term average valuation.
The GuruFocus Value chart also estimates that there is more upside in the name:
General Dynamics has a GF Value of $183.98, giving the stock a price-to-GF Value ratio of 0.89 using Friday's closing price. Reaching the GF Value would provide shareholders with a 12.5% return.
In addition, shares offer a dividend yield of 2.7%, which could push total returns to a mid-double-digit percentage from current levels. General Dynamics' dividend is also very safe, with an expected payout ratio of 40% for 2021, making it highly likely that the company's consecutive growth streak of 28 years continues on into the future.
General Dynamics was impacted by Covid-19 during the quarter and full year, but saw strength in several key areas. The company's backlog is massive, which should provide several years of work. General Dynamics continues to be on the receiving end of high-value awards as well.
Expectations for 2021 are muted based on the company's guidance, but the market appears to be bullish on General Dynamics given the solid returns seen in the month since earnings results were posted.
Still, the stock trades below both its five-year average multiple and its GF Value. This could set up shareholders to see double-digit returns. Therefore, I continue to rate General Dynamics as a buy.
Author disclosure: the author maintains a long position in General Dynamics.
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