Will General dynamics shares fall as federal budget cuts eat into defense spending? A bull and a bear face off.
The bull: Peter Arment, analyst, Sterne Agee
General Dynamics (GD) is going to feel the pressure from the drawdown of forces abroad, as most defense companies will. But it’s the only large one with a sizable consumer operation. Gulfstream, the private jet company, accounts for 30% of the company’s profits. The newest plane, the G650, an ultra-high-end business jet, is going to be the most profitable in GD’s history once it’s ramped up. It has a sold-out backlog through 2017. This will keep cash flow high. Historically, when the Gulfstream business does well, the stock commands a premium price/earnings multiple compared with its peers. Right now it’s in line with the sector, at a forward P/E of 9.5. We think that should be closer to 12.5. Shares are trading at $70, but we see them jumping to $82.
The bear: Brian Ruttenbur, analyst, CRT Capital Group
The company ‘s exposure to the Army — 40% of its revenue — is my biggest concern. As the Department of Defense goes, so does General Dynamics. With $55 billion of sequestration cuts coming from the DoD, the company’s projected 2013 sales are falling 12.6% from last year, and 2014’s budget could force even more cutbacks. Right now GD is trading higher than its 2009 levels, when the U.S. Army still had near-full troop levels in Afghanistan and Iraq. It should be trading closer to those 2009 levels, at 7.5 times earnings. We think the share price is inflated because of buybacks and dividends. Its Gulfstream business is strong, but at only 20% of overall sales, it’s not enough to bolster against the Army cutbacks. We see a price closer to $54.
This story is from the April 29, 2013 issue of Fortune.