EUR 850.00 For Business Accounts Only

Morningstar | We Assign General Dynamics a Wide Economic Moat and a $207 Fair Value Estimate

We assign General Dynamics a wide economic moat and a $207 fair value estimate. General Dynamics operates five segments: aerospace (23% of total 2018 sales), combat systems (17%), marine systems (23%), information technology (23%), and mission systems (13%). The CSRA deal roughly doubles the size of its existing IT business currently housed in IS&T. As a result, General Dynamics is now one of the largest IT contractors for the U.S. government.

The aerospace segment, which operates Gulfstream business jets, has enjoyed a commanding position in the high end of the business jet market thanks to the G650, but it is facing increasing competition from a resurgent Bombardier, which recently began delivering the Global 7500. We think Gulfstream business jet deliveries have found a bottom, and the segment will continue the growth it registered in 2018. Gulfstream's 2,000-plus fleet of installed aircraft will also provide recurring services revenue, and the 2018 acquisition of Hawker Pacific by the company's Jet Aviation subsidiary is evidence that the company is further building out its services capabilities. Although business jet margins will contract in 2019, we think the firm will maintain industry-leading margins even as it transitions to the G500 and G600 jets.

General Dynamics' ground vehicle business, combat systems, is poised for significant growth thanks to international work. In addition, the U.S. defense budget is returning to growth, and we believe that the U.S. Army will begin a long delayed vehicle modernization program. Marine systems operates in a duopoly for large U.S. Navy ships and submarines, and the Columbia program should drive growth and provide near-term cash flows thanks to advances.

We expect the firm to grow at an average annual rate of 4.3% from 2018-23, including CSRA. Operating margins will come under pressure due to the incorporation of CSRA, which will create amortization expenses; CSRA also has operating margins about 100 basis points below General Dynamics' consolidated margins, but this services business generally features lower invested capital than General Dynamics' hardware units. The transition to new products in business jets will weigh on margins, starting with the G500 ramp-up in late 2018. As a result, we're calling for consolidated General Dynamics operating margins (including CSRA) to average about 12.5% over our Stage I forecast. We project midcycle margins, which begin in 2023, at 12.6%.