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

It's earnings season again on Wall Street – for many stocks. But for defense sector stocks in particular, the earnings season ended with a blockbuster report from Huntington Ingalls. Now that the noise has died down, it's time to start looking for the industry's winners and losers.

And with its shares up 7.3% since reporting results last month, it's clear that General dynamics (G.D. 0.42%) is one of the biggest winners.

General dynamics in 2023

The actions of the defense major, known primarily as a builder of warships for the Navy and armored vehicles for the Army and Marine Corps (with a nice parallel activity in the construction of Gulfstreams for civilian jet-setters) were supported by strong sales growth in the fourth quarter, up. 7.5% to $11.7 billion. They were also not seriously affected by profits, although they increased less than 2% at just $3.64 per share.

This could be an indication of investor satisfaction with any growth in GD's Q4 earnings. For the full year, the company reported sales growth similar to that seen in the fourth quarter (7.3%, to $42.3 billion) – but its profit actually fell by 1.4 %, at $12.02 per share. The fact that General Dynamics was able to boast that the fourth quarter produced its best earnings per share, as well as its best quarterly revenue, may also have contributed to investor satisfaction with the results.

The question for investors now is whether General Dynamics will be able to maintain sales growth in the new year. And more importantly, will it be able to turn around after last year's lackluster results and start growing profits again?

General dynamics in 2024

Unfortunately for investors, this isn't a rhetorical question at all. Because in many respects, the trends do not seem particularly friendly to General Dynamics. Consider:

Growth performance across the defense giant's various divisions has been decidedly mixed. While the company's most prominent marine systems (warships) and combat systems (tanks and APCs) divisions experienced strong double-digit sales growth, the operating profit margin of both divisions decreased in 2023 compared to 2022.

In fact, the only division that increased its profit margin in 2023 is General Dynamics' historically high-profit civil aerospace business, which builds Gulfstream jets. However, sales growth there was completely lackluster, at less than 1%. A similarly weak performer was General Dynamics' Computer Technologies division, whose sales grew just 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 70 basis points to 10%, its lowest profit margin since 2012.

So, is General Dynamics stock a sell?

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

On the one hand, yes, the low profit margin undermined much of GD's profit growth potential last year. On the other hand, when it comes to cyclical defense contractors, I am more wary of high profit margin rather than a low one, because when these types of businesses become too profitable, it is often a sign that they have nowhere to go but down. On the other hand, because General Dynamics now has a significantly lower profit margin than the 13.5% rates it achieved in, say, 2015 and 2017, I suspect the company might be able to improve its margin if it tried .

This is especially true considering that in the armored vehicle market, the company doesn't really face much competition. Outside America Textron and Great Britain BAE Systems, General Dynamics is about the only game in town where the US Pentagon absolutely and 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 this space, and as we saw last week, profit margins have been on the rise for Huntington Ingalls lately.

I would expect that we will see a similar dynamic at General Dynamics before long.

Long story short, with a P/E ratio of 22.3 and a price-to-sales ratio of 1.8, General Dynamics is currently not my favorite defense stock to own. I TO DO I think the stock is still overpriced, and I wouldn't be surprised to see it fall further if the profit margin continues to narrow. Longer term, however, I see the potential for profit margins to recover and this stock to become a “buy” again.

I'm just waiting for the right price to make it happen.

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