General Dynamics (NYSE: GD) is one of the top defense contractors in the U.S. GD offers products and services to domestic and international governments and militaries. It is also the leading manufacturer of corporate jets, with its Gulfstream fleet accounting for one fourth of all business jet sales. The needs of the U.S. military have shifted greatly since the Cold War era, with an increased focus on a more responsive and versatile military. GD aims to fulfill those needs with its offerings such as Stryker combat vehicles, Virginia class submarines, DDG-1000 destroyers, and its information systems and technology solutions. The company earned $32 billion in revenue and $2.4 billion in net income in 2009.
With three-quarters of GD's sales coming from the US government, GD relies heavily on the U.S. Department of Defense (DoD) budget spending. The DoD budget is rather cyclical, but the war in the Middle East and the military's need to replace Cold War equipment has helped increase defense spending over the past few years. At the same time, the increased use of fixed price contracts has made General Dynamics and other defense contractors more vulnerable to unexpected delays or costs involved in their production. About 10% of GD's sales come from international defense customers; international sales can carry greater risks, however. Political instability and fluctuations in exchange rates can impact GD's revenues and profitability.
GD's Gulfstream business jets are among the most advanced business jets in the world. Gulfstream commands a 25% market share for business jets. Net Jets is the largest customer for GD’s Gulfstream jets. Demand for business jets can be affected by economic conditions as well as demand from businesses, governments, and wealthy individuals. Gulfstream jets offer extremely fast Internet access, Voip, as well as other advanced technologies and luxuries. Aerospace is GD's fastest growing segment, mainly due to the increasing demand from customers in Europe and Asia.
Aerospace includes the Gulfstream advanced business jets that range from the mid-sized, high-speed G150 to the large capacity, ultra-long-range G550. This has been GD's fastest growing segment as demand for business jets has been booming since the economic downturn in 2003. Gulfstream commands the leading market share in the business jet industry with 25%. Gulfstream planes include ultra-fast Internet access and Voip. The majority of domestic and international commercial sales come from this segment.
GD's Combat Systems segment offers the widest range of defense-related products of all the U.S. Army's contractors. In addition to the U.S. armed forces, this segment services over 30 countries. Some of the products and services offered by this division include:
GD and Northrop Grumman are essentially the only two companies that supply ships and submarines to the U.S. Navy. New orders for the DDG-1000 and LCS ships could fall over the next few years since they cost 2-4 times more than the ships they are replacing. Notable marine products and related services are:
Information Systems and Technology
This segment provides technology that allows on the move command and communication. IS&T is the largest of GD's segment thanks, in part, to the increased demand for information technology (IT). Some significant IT offerings in the GD portfolio include:
Of the major defense contractors, GD has arguably made the most effective transition from a bloated Cold War defense contractor to an efficient, innovative defense company. The Stryker combat vehicle, ballistic missile submarine conversions, Virginia class submarine, DDG-1000, LCS, and IS&T segment are all effective and efficient tools on today's battlefield. As a result, GD has achieved double-digit sales growth over the last several years and has averaged about a 15% return on invested capital over the last decade. An important aspect for a defense contractor is completing projects on schedule. The Hawaii is the most advanced submarine in the U.S. fleet; GD completed the Hawaii six months after christening, eliminating 2 million labor hours in the construction cycle compared to the first Virginia Class submarine. At the same time, however, the company's NASSCO shipyard has been having problems with operating expenses and may not be able to produce the Jones Act Oil Tankers within budget. GD has employed Daewoo to help manufacture the ships more efficiently, but GD's continued difficulties could result in a loss of money and business.
The U.S. government account for about three-quarters of General Dynamic's sales, making the U.S. government and Department of Defense very influential customers. Budget deficits and political pressures to lower defense spending can have a major impact on the appropriations available to fund GD contracts. The DoD budget has been increasing ever since 9/11 and the start of the war in Iraq, reflecting the impact that national security concerns can have on defense spending. An increased threat from China could also greatly augment the DoD budget, given the vast resources and capabilities of China. Both the DDG-1000 Destroyer and Virginia Class submarine were largely developed to address the potential threat of Chinese military aggression. GD is affected primarily by core budget spending and less so by supplemental spending. Core spending, which covers funding for basic expenses such as maintenance, is less likely to change drastically than supplemental spending, but it is by no means immune. GD has a large of amount of military-oriented products in its portfolio, which means that an increase in army activity or troop deployment would likely boost its sales.
The DoD budget has been rather cyclical in the past, meaning that a downturn could have a very negative impact on GD's revenues. In times of war or specific threat, defense spending usually grows in response. When the threat passes or the war ends, political pressure drives defense spending down to counteract the excess spending that took place. In recent years, Conflicts in the Middle East and the need to replace a Cold War oriented military have helped boost defense spending. Barring a sudden withdrawal of troops from Iraq, defense spending is likely to remain somewhat elevated for the immediate future.
Fixed price contracts have become increasingly popular with the Department of Defense; about half of GD's current contracts are fixed price. The problem with fixed price contracts is that GD will suffer more from delays or production missteps because, unlike with cost reimbursement contracts, there is a set budget. If GD exceeds the original budget, there are no additional funds available, forcing the company to write off the extra expenses. Additionally, all of GD's contracts are subject to change. Government appropriations are usually set fiscally, while contracts may stretch over multiple years. The availability of appropriations could change enough to reduce funding for, or even terminate, contracts. Historically, the government has had a good deal of leeway in terms of its defense contracts; it can terminate contracts essentially at will, whereas GD has much less flexibility.
General Dymanic's Gulfstream business jets are the industry standard for corporate aircraft. Gulfstream commands a 25% market share for business jets and has been GD's fastest growing segment. New Gulfstream sales have increased about 20% for each of the last two years, largely the result of rising demand in Europe and Asia. The demand for business jets is largely affected by economic conditions and demand from businesses, governments, and wealthy individuals. Fortune 500 companies and Berkshire Hathaway's Net Jets are two of the largest customers for Gulfstream jets. As companies become increasingly global in nature, the demand for domestic and international business travel is increasing; this has helped drive demand for business jets.
While Gulfstream dominates the market for upper-range business jets, it has historically shied away from the low- and mid-range jet markets. The introduction of the mid-sized G150 changed this, however, allowing GD to enter and compete in the more competitive mid-size arena. Gulfstream jets are highly advanced, offering such features as ultra-high-speed Internet access, Voip, and the latest in aeronautical equipment and technology. North America accounts for the majority of GD's Gulfstream sales and has continued to grow over the years. The largest sources of growth, however, have been Europe and Asia; rising incomes in both developed and emerging markets has spurred the demand for airline travel and, therefore, business jets. The expected growth of this segment has led GD to invest $300 million over 7 years to expand its manufacturing facilities, a move that will increase employment in the Aerospace segment by 25% and add 453,000 square feet of production capacity.
The U.S. Court of Federal Claims recently ruled that the U.S. Navy rightfully canceled the contract for the carrier-based stealth A-12 aircraft with contractors GD and McDonnell Douglas (a unit of Boeing) in 1991. GD plans to appeal the decision; if the appeal is unsuccessful, GD and Boeing are liable for about $2.6 billion, after interest.
The A-12 stealth aircraft was commissioned to GD and McDonnell Douglas. Due to their inability or unwillingness to build the aircraft, the A-12 contract was canceled by the U.S. Navy in 1991. The two contractors then filed a legal complaint, claiming that the project was wrongfully canceled. The courts originally decided that the contract was, indeed, wrongfully canceled, but the Navy then appealed, believing that the decision was setting an undesirable precedent for failing projects. After two appeals, a federal judge ruled in the Navy's favor.
General Dynamics competes against the four other major defense contractors: Boeing Company (BA), Lockheed Martin (LMT), Raytheon Company (RTN), and Northrop Grumman (NOC). These defense contractors are susceptible to many of the same risks, as they are all substantially influenced by the U.S. DoD budget and geopolitical factors. Boeing and GD have the lowest vulnerability to the DoD budget because they each have separate commercial aerospace segments. GD competes most closely with Raytheon, which acquires numerous contracts for smaller projects (and also parts of larger projects) that are generally given to Boeing, Lockheed, or Northrop. GD is often employed as a subcontractor to work on projects with the other defense companies, such as on the Virginia Class submarine and DDG-1000 destroyer with Northrop. Northrop and GD are essentially the only two defense contractors with the capability to supply the U.S. Navy with the next generation of ships and submarines.
GD's aerospace segment competes primarily in the upper end of the business jet industry, though the G150 has been well-received in the mid-range jet market. The company's main competitors are Textron's Cessna jets and Boeing's business jets. Cessna is most competitive against the G150 and smaller business jets, whereas Boeing also focuses on the large, high-end jet segment. Overall, GD is the dominant player in the business jet industry, with a 25% market share worldwide.