General Dynamics Had a Ho-Hum 2023. Will 2024 Be Better?

It’s still earnings season on Wall Street — for many stocks. But for defense stocks in particular, earnings season wrapped up with a blockbuster report from Huntington Ingalls. Now that the noise has died down, it’s time to start looking for winners and losers within the sector.

And with its shares up 7.3% since earnings were released last month, it’s clear that General Dynamics (GD 0.42%) is one of the biggest winners.

General Dynamics in 2023

Shares of the defense major, known mainly as a builder of naval warships for the Navy, and armored vehicles for the Army and Marine Corps (with a nice side business building Gulfstreams for civilian jet-setters) were buoyed by strong Q4 sales growth, up 7.5% to $11.7 billion. They weren’t hurt badly by earnings, either — although those rose less than 2% to just $3.64 per share.

That may have been an indication of investors’ happiness with any growth at all in GD’s Q4 earnings. For the full year, the company produced sales growth similar to what we saw in Q4 (7.3%, to $42.3 billion) — but its earnings actually declined by 1.4%, to $12.02 per share. The fact that General Dynamics was able to boast of Q4 as producing its best-ever earnings per share, and its best-ever quarterly revenue as well, also may have contributed to investors’ satisfaction with the results.

The question for investors now is whether General Dynamics will be able to keep the sales growth going in the New Year. And even more importantly, will be it able to turn around last year’s lackluster earnings, and resume growing its profit as well?

General Dynamics in 2024

Unfortunately for investors, that’s not at all a rhetorical question. Because in several respects, the trends do not appear to be particularly good friends to General Dynamics. Consider:

Growth performance across this defense giant’s several divisions was decidedly mixed. While the company’s highest-profile marine systems (warships) and combat systems (tanks and APCs) divisions enjoyed strong double-digit sales growth, the operating profit margin at both divisions in 2023 declined versus 2022.

As a matter of fact, the only division that grew its profit margin at all in 2023 was General Dynamics’ historically high-profit-margin civilian aerospace business, which builds Gulfstream jets. Sales growth there, however, was entirely lackluster, at less than 1%. Showing similarly weak performance was General Dynamics’ IT-focused Technologies division, which grew its sales barely 3% year over year, and suffered a 50-basis-point decline in profit margins.

Overall, General Dynamics’ operating profit margin across its four divisions declined by 70 basis points to 10%, its weakest profit margin since 2012.

So is General Dynamics stock a sell?

Yet for investors considering a new position in General Dynamics stock, I’m not sure that’s necessarily a bad thing.

On one hand, yes, weak profit margin sapped much of the potential for GD to grow its earnings last year. On the other hand, when it comes to cyclical defense contractors, I’m actually more leery of a high profit margin than of a low one, because when these kinds of companies get too profitable, it’s often a signal that they’ve got nowhere to go but down. In contrast, with General Dynamics now earning a profit margin significantly lower than the 13.5% rates it was achieving in 2015 and 2017, for example, I suspect the company might be able to eke out some improvements in margin if it tries.

This is especially true when you consider that when it comes to the armored-vehicles market, the company really doesn’t face a whole lot competition. Aside from America’s Textron and Britain’s BAE Systems, General Dynamics is pretty much the only game in town when the U.S. Pentagon, absolutely, positively feels it needs to buy a few more main battle tanks or armored personnel carriers. And it’s even more true when it comes to building military warships. Huntington Ingalls is GD’s biggest rival in that field, and as we saw last week, profit margins are moving on up for Huntington Ingalls lately.

I’d expect we’ll see a similar dynamic at General Dynamics before long.

Long story short, at a P/E ratio of 22.3 and a price-to-sales ratio of 1.8, General Dynamics is not currently my favorite defense stock to own. I do believe the stock is still too expensive, and I wouldn’t be surprised to see it fall further if the profit margin continues to get squeezed. Longer term, however, I see the potential for profit margins to turn around, and for this stock to become a “buy” once again.

I’m just waiting for the right price to make that happen.

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