Streetwise

Lauren Rudd

Sunday, June 13, 2010

A Behemoth in the World of Defense Contracting

Although indispensable, defense spending does not warm the cockles of my heart, potential investment opportunities aside. The sad truth is that political instability, combined with a modicum of senseless idiocy, is unbridled evidence that the world is not ready to beat swords into plowshares. Therefore we will of necessity have to continue to maintain an outsized defense budget.

To elucidate the magnitude of the expenditures involved, consider that President Obama’s FY 2010 defense budget began at $533.8 billion. The addition of "overseas contingency operations" brought the total to $663.8 billion. When signed into law on October 28, 2009, the final number was $680 billion. The supplemental spending to support the wars in Iraq and Afghanistan will add an additional $40–50 billion.

Defense-related expenditures outside of the Department of Defense constitute between $216 billion and $361 billion, bringing the total to between $880 billion and $1.03 trillion in fiscal year 2010. The government’s 2010 fiscal year runs thru September of this year.

Even if it were possible to reduce defense spending to a more manageable level, ever watch what happens when a member of Congress sees his or her favored military procurement threatened? They become apoplectic.

Empire building within and between the various segments of the armed forces also encourages excessive feeding at the federal trough, often at the behest of military contractors. Private industry and the military make for poor bedfellows.

The continual push for more deadly armaments is never ending, as is the ongoing requirement for technology that increases both the efficiency of military intelligence and our ability to fight insurgency in hostile locations. Answering the call to arms is General Dynamics (GD), a behemoth within the defense contracting world that is capable of both devouring its smaller brethren and meeting the needs and wishes of the Defense Department.

When I last discussed the company a year ago, my earnings estimate for 2009 was $6.18 per share and $6.71 per share for 2010. My 12-month price target back then was $65 per share. So how did the company and its share price perform in 2009? Apparently I was a bit light in my estimate as earnings came in at $6.20 per share, while the shares recently traded at $63.85. In my defense (no pun intended), on June 3, the shares closed at $68.

Looking at the company’s first-quarter performance, earnings from continuing operations came in at $599 million, as compared to $593 million a year ago. Revenues for the quarter were $7.75 billion, while net earnings for the first quarter were $597 million, as compared to $590 million for the same period a year ago.

First quarter operating margins was 11.8 percent, as compared to 11 percent a year-ago. Funded backlog at the end of first-quarter was $47.4 billion, a 3 percent increase over the end of the fourth quarter 2009.

The company’s total backlog at the end of the first quarter was $63.9 billion and the estimated potential contract value was an additional $17 billion, which represents management’s estimate of the value of under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts and unexercised options.

Net cash provided by operations totaled $210 million. Free cash flow from operations, defined as net cash provided by operating activities less capital expenditures, was $150 million for the period.