Increasing General Dynamics’ FVE to $237

After reviewing General Dynamics’ recent results and our assumptions, we have increased our fair value estimate to $237 from $226, as we forecast the company’s sizable investments in new aircraft, submarine programs, and even its IT services business bearing fruit in the form of new revenue and higher long-term profitability.

As a result of those prudent investments in its economically profitable business, along with its sound balance sheet and appropriate track record of returning capital to shareholders, we are updating the firm’s capital allocation rating to Exemplary from Standard.

We also reaffirm General Dynamics’ wide economic moat rating and stable moat trend rating, predicated on the intangible assets it has amassed in the technical complexity of its products and production know-how. In the military parts of its business, the moat is buttressed by meaningful switching costs as the government, once it has committed to a program, faces significant barriers to wholesale switching of supply. Compared with other large defense contractors, General Dynamics’ portfolio offers a somewhat differentiated and potent mix of roughly equal parts (in terms of operating profits) submarines and Navy ships, tanks and armored vehicles, business jets, and specialized computing services and equipment.

In light of press coverage of the conflict in Ukraine, including promised orders and deliveries of armored vehicles and munitions destined for Ukraine and its Eastern European neighbors such as Poland, we caution investors not to overestimate the relationship with such upticks in demand and the near-term bottom line at a firm like General Dynamics. During the firm’s third-quarter 2022 earnings call last October, CEO Phebe Novakovic explained that it can take months to finalize contracting, ramp up production, and deliver (and thus book revenue) on such orders, and that they do not necessarily add to operating margin given the extra effort and cost required to fulfill them.