This Could Be A Dynamic Investment

By Chad Henage - August 6, 2012 | Tickers: GD, LMT, TXT, BA | 0 Comments

• Email
• Print

Many investors might be surprised that a new dividend aristocrat could come from the aerospace and defense industry. With a lot of talk about potential budget cuts in defense over the next few years, there is somewhat of a cloud hanging over any company related to this type of spending. However, becoming a dividend aristocrat means raising your dividend for at least 25 straight years, and General Dynamics (NYSE: GD) has been able to accomplish just that. During this 25 year period, the company has seen multiple ups and downs in defense spending and through it all the dividend has continued to increase.

Unfortunately as investors have found out in the last few years, just because a company makes this aristocrat status doesn't mean it will stay that way. For this reason, I always like to see if investors can trust in the company's dividend growth, or if this could be the next potential blow up. The first step, is to know how a company fits in its general industry. Since General Dynamics competes in the aerospace and defense industry, they face competition from large well-funded institutions such as Lockheed Martin (NYSE: LMT), Textron (NYSE: TXT), and Boeing (NYSE: BA). Specifically, General Dynamics has to compete with Lockheed for defense contracts, and faces both Textron and Boeing in its aerospace division. This secondary division of building and maintaining large and mid-size business jets give some diversification to General Dynamics shareholders. Let's take a look at how these companies compare to each other and see if General Dynamics is fairly valued:

While all four companies overlap somewhat in their products and services, when it comes to gross margin and free cash flow there are large differences. General Dynamics seems to stack up well considering the fact that its growth rate is not the lowest, it has the second-highest yield, the second-highest gross margin, and the highest free cash flow numbers. With the stock selling at a forward P/E ratio of about 9, it also seems fairly valued based on its growth and yield combination. If investors are looking for income, Lockheed Martin could be an attractive choice as it pays the highest current yield and has one of the best dividend growth track records. Growth investors would likely favor Textron as the company is expected to see faster growth going forward as the economy improves and business jets once again become more popular, and older models are replaced. Where Boeing is concerned, the company has a huge backlog of commercial jet orders. However, with the lowest free cash flow, and the second lowest yield, Boeing seems to be left behind as a secondary option. Given that General Dynamics looks appropriately valued, let's take a look at the company's payout ratio to see what portion of their cash flow is being returned to shareholders in the form of dividends.

The company's payout ratio in the last few years has barely changed. In 2009 it was just over 23% and today it stands at just over 24%. Part of this has to do with the fact that the company grew its free cash flow by over 12% in the last three years. Another factor is that in the last few years the company has slowed down its dividend growth.

In similar fashion to something I've seen happen at many other companies prior to the great recession, General Dynamics was increasing its dividend at a huge rate. While the company has issued respectable increases recently, it seems management is preparing for the inevitable spending cuts in the defense industry. You can see what I mean looking at the chart of dividend growth over the last six years:

In the first three years of the chart, the company increased its total dividend by about 55%. In the most recent three years, this dividend growth has been cut nearly in half. Given analyst expectations for roughly 7% growth in earnings going forward, it's likely that the slower growth of the last few years is a good blueprint for what investors should expect in the future.

Though the company's payout ratio is very low, this has been the case in the last few years, while the company's average increase has been about 10% per year. With the potential for defense spending cuts, it seems likely that management will continue this more conservative approach to dividend increases. I would suggest that investors can expect between 7% and 10% dividend increases over the next few years. Since the company pays out just over 24% of its free cash flow, even a significant decrease in their business shouldn't present a challenge to the dividend or this type of growth. For investors looking for exposure to the defense and aerospace industries, the company looks like it could be a dynamic choice.

• Email
• Print
• Feedback