4 Things General Dynamics Management Wants You to Know

General Dynamics (NYSE: GD) beat earnings in its fourth quarter of 2018 -- not that you could tell from the performance of its stock, which remains 2% below where it traded before earnings, nearly a month after the fact.

Why were investors so upset with General Dynamics, despite the earnings beat? Part of the answer was the company's guidance for 2019, which fell short of expectations. The $11.60 to $11.70 per share that General Dynamics said it will earn this year works out to only 4% earnings growth over 2018 -- quite a letdown after GD's 17% earnings-growth performance in 2018.

And yet, with a price-to-earnings ratio of just 15, and a price-to-sales ratio of 1.4, General Dynamics is currently, arguably, the closest thing to a "bargain" among defense stocks. So what are the chances GD will find the gas pedal again, and resume growing at a faster pace?

Last month's end-of-year earnings conference call may hold a few clues. Let's listen in.

Will Gulfstream find its wings?

While that full-year figure won't win many cheers, Novakovic went on to predict, later in the call, that aerospace revenue will be "about $9.7 billion" in 2019, a 14% increase over 2018 levels, driven by "deliveries of approximately 145 business jets."

Historically General Dynamics' most profitable division, and best known for its Gulfstream business jets, aerospace -- with its increased sales -- is probably the fastest way for General Dynamics to accelerate its rate of profit growth.

Back to basics

While General Dynamics is generally thought of as a defense contractor, the civilian Gulfstream business is its secret weapon in battling for profits. But the product the company is probably best known for -- the M1 Abrams main battle tank -- is no slouch in the profit department, either.

General Dynamics' combat systems division, which builds the Abrams, has reliably churned out operating profit margins of 15% or better for the past five straight years. The company's overall profit margin last year was only 12.3%, according to data from S&P Global Market Intelligence.

Accelerating order activity as 2018 progressed, therefore, bodes well for the company's ability to grow total profit faster -- and this potential Piranha deal (Piranha is an eight-wheeled armored personnel carrier, similar to the U.S. Army's Stryker) -- could add as much as four months' worth of revenue to this profitable business.

Canada? O Canada!

Speaking of tanks, though, you may recall that back in 2014, General Dynamics Land Systems Canada inked a deal to sell the Kingdom of Saudi Arabia a fleet of some 3,000 LAV 6.0 light armored vehicles worth $13 billion -- a deal facilitated by the Canadian government. Last year, that deal's future was called into question when Canada and Saudi Arabia got into a war of words, with the Canadian government criticizing Saudi Arabia's role in the killing of journalist Jamal Khashoggi, and the Saudis responding that Canada should mind its own business.

This is the "armored-vehicle supply contract" to which Aiken referred -- and at $13 billion in size, it's vital to the continued growth of General Dynamics' important combat systems division. While this has turned into more of a political question than a business question, and nothing in politics is certain, investors can take at least some comfort in Aiken's opinion that this contract remains on track for both fulfillment and payment.

Ahoy, marine systems

With an operating profit margin of only 9% last year, marine systems isn't General Dynamics' most profitable business, but most years it is the company's biggest or second-biggest producer of revenue -- and there's both good and bad news on that front.

Good news: While President Trump's plan to build a 355-ship Navy may now be on the rocks, at least plans to expand the submarine fleet are still going apace. As the Navy orders new Virginia-class subs, and soon, the even newer Columbia-class ballistic-missile submarine, this should keep General Dynamics' shipbuilding division awash in revenue.

Bad news: The Block V Virginia (let alone the monster-sized Columbia) "is a significant upgrade in size and performance" over the Block IV submarine before it, says Novakovic, "requiring additional manufacturing capacity" to produce. In 2019, says Novakovic, "the marine segment [will] command a larger share of our capital budget." While investors can expect this division to "drive additional revenue" for General Dynamics, it will involve more capital spending (draining free cash flow) as well, especially as "Columbia ... will begin early construction in [the] next year."

With General Dynamics' free cash flow ($2.4 billion) once again badly lagging GAAP earnings ($3.3 billion) in 2018, investors who hope the company's targeted rate of FCF will return to equaling or exceeding earnings may have to wait a bit longer.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.