The U.S. defense contractors have seen mixed results recently. The exit from fighting in Afghanistan and a bump in defense spending that was only slightly higher than expected for fiscal year 2022 has been a headwind for most of the defense names that have already reported earnings.
General Dynamics Corp. (GD, Financial) wasn’t immune to this decline as its defense-related businesses were down almost 4% in the fourth quarter. On the other hand, the company’s aerospace segment, specifically its line of private jets, showed immense growth and a robust backlog, which should help alleviate some of the pain from the defense businesses. This diversified business model should allow the company to better navigate the market headwinds for aerospace and defense players.
Earnings highlights
General Dynamics reported its fourth quarter and full-year fiscal 2021 earnings results on Jan. 26.
For the quarter, revenue fell 1.8% year-over-year to $10.3 billion, which was $400 million less than what Wall Street analysts were expecting. Net earnings of $952 million, or $3.39 per share, compared unfavorably to net earnings of $1 billion, or $3.49 per share, in the prior-year quarter. Earnings per share did top estimates by 2 cents.
For full-year 2021, revenue grew 1.4% to $38.5 billion. Net earnings of $3.3 billion, or $11.55 per share, was an improvement from net earnings of $3.2 billion, or $11.00 per share, in 2020.
All businesses saw full-year revenue that was above what was generated in 2020. Most businesses also saved their best quarter for last in 2021.
Marine systems grew 0.5% year-over-year in the fourth quarter to $2.87 billion, extending this segment’s year-over-year revenue growth streak to 17 consecutive quarters. This segment also hit a record full-year revenue total of $10.5 billion.
Revenue for combat systems fell 3.7% to $1.89 billion. All businesses within the segment grew compared to 2020.
Technologies was the weakest performer as quarterly revenue declined almost 8% to $2.98 billion. The mission systems segment has suffered for much of the year due to the global shortage of semiconductor chips.
The real standout performer was aerospace, which improved more than 5% to $2.56 billion. This segment saw a very significant improvement in its Gulfstream private jet business. The book-to-bill ratio was a strong 1.6 for the entire segment, but was paced by Gulfstream’s book-to-bill ratio of 1.7. The total backlog for aerospace was higher by 40% compared to the same period of 2020. Aftermarket services was a tailwind as well, with service revenue growing 16%.
General Dynamics offered guidance for 2022. The company expects revenue for the year to grow 2.1% to $39.3 billion. Earnings per share is projected in a range of $12.00 to $12.15, representing a 4.6% improvement at the midpoint.
Takeaways
General Dynamics’ Gulfstream business faced a tough 2020 period as orders were delayed during the beginning of the Covid-19 pandemic. As a result, the book-to-bill ratio for the aerospace segment dropped to 0.88 for that year.
The strength in the book-to-bill ratio is coming off an easy comparable period, but that doesn’t explain the whole story. Gulfstream, which saw the addition of two new aircraft to the product line during the quarter, has seen orders ramp up in 2021. Compared to the prior year, General Dynamics delivered one less aircraft in the quarter and eight fewer aircraft for the year. Still, demand for private aircraft has led to orders nearly doubling in the fourth quarter.
With a book-to-bill ratio of 1.64 for the year for aerospace, demand for aircraft was more than 60% higher than total sales, speaking to the company’s strength in this area. For the quarter, demand accelerated as orders were 69% higher than revenue.
The defense portion of the business was weaker in the fourth quarter, but marine systems and combat systems grew 8.8% and 8.1%, respectively, on a sequential basis. This provides some evidence that General Dynamics’ defense businesses are improving at least on a quarter-over-quarter basis.
Technologies, which produced lower revenue results each successive quarter, fell 4.6% compared to the third quarter of the year. This segment is likely to continue to struggle with the chip shortage for much of 2022 at the very least. Even so, this business had a book-to-bill ratio of 1 last quarter, meaning that customers are still placing orders, a positive sign for when the chip shortage is eventually mitigated.
General Dynamics ended the quarter and year with a book-to-bill ratio of 1. The total backlog stood at $87.6 billion at year’s end, which was a 2.2% decline from the prior year, but was relatively stable sequentially.
Much of the decrease can be attributed to a decline in the backlog of the marine systems segment, with aerospace and technologies higher from the prior year.
Including the options that can be exercised by customers, General Dynamics has a total estimated contract value of $127.5 billion, which would give the company more than three years of work using 2021 revenue totals.
Valuation analysis
Shares of General Dynamics closed the most recent trading session at $212.10, giving the stock a forward price-earnings ratio of 17.6 times using the midpoint of expected earnings per share for 2022. This is a premium to the five- and 10-year average price-earnings ratios of 16.3 and 14.4, respectively.
General Dynamics is also trading above its intrinsic value according to the GuruFocus Value chart.
With a GF Value of $188.36, General Dynamics has a price-to-GF-Value ratio of 1.13. Shares would need to decline 11.2% to reach the GF Value. GuruFocus rates General Dynamics as modestly overvalued.
Final thoughts
The defense industry isn’t the hot area it was just a few years ago. Most of the major contractors that have reported have shown this business to be lower than usual. General Dynamics is no different as year-over-year results were mixed in its defense businesses.
The good news is that the company’s aerospace segment, led by robust orders for the Gulfstream line, is performing very well. The defense businesses also saw improvements from the third quarter of 2021, which could mean that these areas are seeing some stabilization.
Beyond this, General Dynamics is a Dividend Aristocrat with three decades of dividend growth, giving the stock one of the longest dividend growth streaks in the aerospace and defense sector. Shares yield 2.2% at the moment, nearly a full percentage point better than the average yield for the S&P 500 Index.
Personally, I find the performance in aerospace reassuring, as well as the sequential improvement in most defense areas. The technology segment will be somewhat of an anchor around the company until semiconductors are more readily available.
Shares of the company are not cheap, but General Dynamics’ aerospace business appears to be accelerating and the backlog remains very high. For investors looking for a more diversified aerospace and defense company, General Dynamics could be a solid option.
