general dynamics consolidated report
TRANSCRIPT
TABLE OF CONTENTS
GENERAL DYNAMICS 11
COMPANY HISTORY 15
PRODUCTS AND COMPETITION 17
MAJOR PRODUCTS 17
COMBAT SYSTEMS 18
MARINE SYSTEMS 19
INFORMATION SYSTEMS AND TECHNOLOGY 20
AEROSPACE 21
MAJOR COST COMPONENTS 22
CUSTOMERS 22
COMPETITORS 22
MARKET SHARE DATA 23
DOMINATE COMPANY IN THE INDUSTRY 23
CORPORATE CONTROL 24
MANAGEMENT TEAM 24
SHARE ONWERSHIP AND COMPENSATION 26
EXECUTIVE COMPENSATION PLANS 26
BOARD MEMBERS 29
STOCK INSIDER ANALYSIS 31
THE FUTURE 33
ANALYST REPORT 33
ANALYST EARNINGS AND SALES ESTIMATES 33
ANALYST RECOMMENDATIONS 34
EXPERT FORECAST 35
PERSONAL FORECAST (GROUPS FORECAST) 36
STOCK PRICE PERFORMANCE 41
PRICE PERFORMANCE 41
COMPETITORS 41
AEROSPACE AND DEFENSE INDEX/ MARKET 42
ABSOLUTE PERFORMANCE 43
PERFORMANCE CONCLUSION 45
FINANCIAL PERFORMANCE 46
GROWTH PERFORMANCE 46
REVENUE 46
GROSS MARGIN 47
EBITDA 48
DIVIDEND GROWTH 48
SUSTAINABLE GROWTH 49
FINANCIAL PERFORMANCE 50
FINANCIAL CONDITION RATIOS 50
PROFITABILITY RATIOS 51
MANAGEMENT EFFECTIVENESS RATIOS 52
ASSEST MANAGEMENT RATIOS 52
DUPONT ANALYSIS 53
GENERAL DYNAMICS 53
COMPETITORS 54
INDUSTRY 55
ALTMAN’S Z-SCORE ANALYSIS 56
GENERAL DYNAMICS 56
COMPETITORS 57
INDUSTRY 58
COST OF CAPTIAL, CAP ITAL STRUCTURE ANALY SIS AND DISTRIBUTION 62
DEBT 62
RELEVANT COST OF DEBT 62
DEBT RATIOS 63
EXTERNAL EQUITY 68
RELEVANT COST OF EXTERNAL EQUITY 68
UNLEVERED AND RELEVE RED BETA 70
INTERNAL COST OF EQUITY 72
RELEVANT COST OF INTERNAL EQUITY 72
CAPTIAL STRUCTURE 75
GENERAL DYNAMICS CAP ITAL & STRUCURE 75
COST OF CAPITAL 77
WACC 77
SECTION 1: FORECAST PARAMETERS 81
ASSUMPTIONS 81
ECONOMIC OUTLOOK 81
DEFENSE OUTLOOK 81
AEROSPACE OUTLOOK 82
SECTION 2: PRO FORMA FINANCIAL STATEMENTS 83
RATIOS TO CALCULATE OPERATING PROFIT 83
SALES GROWTH RATE 83
COGS/SALES 84
SGA/SALES 85
DEPRECIATION/NET PPE 85
RATIOS TO CALCULATE OPERATING CAPITAL 86
CASH/SALES 86
INVENTORY/SALES 86
ACCTS REC/SALES 87
OTHER SHORT TERM OPE RATING ASSETS/SALES 87
NET PPE/SALES 88
OTHER LONG TERM OPERATING ASSETTS/SALES 88
ACCOUNTS PAYABLE/SALES 89
ACCRUALS/SALES 89
OTHER CURRENT LIABILITIES/SALES 90
RATIOS TO CALCULATE OPERATING TAXES 90
DEFERRED TAXES/NET PPE 90
AVERAGE/MARGINAL TAX RATE 91
DIVIDEND AND DEBT RATIOS 91
DIVIDEND POLICY: GROWTH RATE 91
LONG TERM DEBT/MARKE T VALUE OF THE FIRM 92
RATIOS TO CALCULATE REST OF INCOME STATEMENT AND BALANCE SHEET 92
FORECASTED FINANCIAL STATEMENTS 92
FORECASTED INCOME STATEMENTS 92
FORECASTED BALANCE SHEETS 94
SECTIOIN 3: PRO FORMA RATIO ANALYSIS, DUPONT AND ALTMAN Z-SCORE 95
PROFITABILITY RATIOS 95
OPERATING MARGIN 96
PROFIT MARGIN 96
ROIC 96
LIQUIDITY RATIOS 97
CASH RATIO 97
QUICK RATIO 97
CURRENT RATIO 98
LEVERAGE RATIOS 98
DEBT/EQUITY: 98
INTEREST COVERAGE RATIO 98
EFFICIENCY RATIOS 99
INVENTORY TURNOVER 99
ACCOUNTS RECEIVABLES TURNOVER 99
ASSET TURNOVER 100
MARKET VALUE RATIOS 100
PRICE TO EARNINGS 100
MARKET TO BOOK 101
EARNINGS PER SHARE 101
DUPONT ANALYSIS 101
ALTMAN’S Z-SCORE FORECAST 103
FORMULA, COMPONENTS & INDICATORS 103
FORECASTED Z SCORE 104
VALUATION METHODS 111
ENTITY VALUATION 111
KEY DRIVERS OF ENTITY VALUATION 112
ADJUSTED PRESENT VALUE 112
KEY DRIVERS 112
MODIFIED FCFE 113
KEY DRIVERS 113
COMPARISON WITH MARKET VALUE 113
COMPARABLES 118
BOEING CO. (BA) 119
UNITED TECHNOLOGIES CORP. (UTX) 119
LOCKHEED MARTIN CORP. (LMT) 120
RAYTHEON COMPANY (RTN) 120
NORTHROP GRUMMAN CORP. (NOC) 121
PRECISION CASTPARTS CORP. (PCP) 121
TRANSDIGM GROUP INC. (TDG) 122
ROCKWELL COLLINS INC. (COL) 122
TEXTRON INC. (TXT) 123
HARRIS CORP. (HRS) 123
MULTIPLES BREAKDOWN & ANALYSIS 123
MUTLIPLES USED 124
P/E MULITPLE 124
PRICE TO SALE 125
PRICE TO BOOK 125
PRICE TO CASH FLOW 126
PRICE TO FREE CASH FLOW 127
PRICE TO EBITDA 127
BETA 128
RELATIVE VALUATION 129
ANALYSIS AGAINST COMPARABLE COMPANIES 129
ANALYSIS AGAINST INUDSTRY, SECTOR AND THE S&P 500 130
GENERAL DYNAMICS
TICKER: GD INDUSTRY: AERO SPACE&DEFEN S E
GENERAL INFORMATION
GD provide products and services for the U.S. government,
Department of Homeland Security, Department of Defense, the
Health and Human Services agency and commercial airlines. The
company generates annual revenues of over 30 billion dollars
consistently for over five years, Free Cash Flows of over three billion
dollars, and the company currently operates with over 90 billion
dollars in funded, backlogged orders.
Organizational Goals:
Maintain a low debt structure of <10% debt financing
Provide shareholder wealth through a residual dividend
structure and long term capital gains
Procure new Government contracts
Diminish agency cost through shareholder approved
compensation plans
BUSINESS UNITS
Combat Systems: 21.77% of Operating Earnings
Marine Systems: 17.74% of Operating Earnings
Information Technologies: 19.82% of Operating
Earnings
Aerospace: 40.67% of Operating Earnings
General Dynamics’ is the leading provider for nuclear
submarines and destroyer warships for the U.S. Navy. GD operates
the only full-fledged shipyard on the west coast and designs and
constructs oil tankers and other surface carriers for Jones Act Ships.
General Dynamic’s aerospace division designs and builds business-
jets for private and public companies and operates a maintenance
and repair service with 25 service center locations worldwide. Since
2009 they invested over three billion dollars in acquisition and
divestitures. These acquis itions generated significant increases in
GD’s market share, mainly due to the technological advances of the
purchased companies and vertical integration of the overall supply
chain.
COMPENSATION PLANS
The compensation philosophy of General Dynamics is to align
executive compensation with company, business group and individual
performance, to provide the incentives necessary to attract, motivate
and retain high profile talent that help drive the company’s success.
The compensation committee approved a number of program
changes in recent years, including:
Implemented a three-year return on Invested capital metric,
instead of a one-year metric, for performance restricted
stock units
Lengthened the term and vesting period of stock options to
further align options with long-term company stock
performance
FINANCIAL DATA
ANALYST OPINION
General Dynamics’ is coined as a must buy by several
analysts, and continues to show its ability to provide improved returns
to shareholders. Its large backlogged orders for the U.S. government,
as well as many international commercial businesses, provide it with
a strong position in the defense systems market. With many five year
projections showing positive and fast growth, General Dynamics’s is
in a great position to capture more of the market share from its larger
competitors. The information following depicts a brief company
history, products and services they offer, corporate governance and
control, and future financial analytics.
UNIT 1 GENERAL DYNAMICS
Incorporated in Delaware in
1952, General Dynamics is an aerospace and defense company that offers a wide range of products and business services, ranging from corporate aviation, military combat vehicles and weapon systems, shipbuilding, and information technology. Up until the 1990s General Dynamics grew periodically through acquisitions and product development, it then decided to sell most of its business divisions except its Electric Boat and Land Systems. During the mid-1990s they began to undertake new business ventures including the acquisition of combat vehicle-related businesses, new and improved shipyards, information technology companies, and eventually the acquisition of Gulfstream Aerospace Corporation in 1995.
Since their purchase of
Gulfstream the General Dynamics Company acquired and integrated more than 65 businesses to gain market strength and diversify their business portfolio. General Dynamics employs over 90,000 people worldwide and operates with four major business divisions; Aerospace, Combat Systems, Marine Systems, and Information Technology. These four divisions are discussed in further detail throughout the analysis.
The main revenue generator for
General Dynamics is their Information Systems and Technology division. For years ending 2010-2013 this division’s revenue accounted for 34 percent of the
company’s business. This division provides both the Government and commercial entities with the crucial technologies necessary to share secure and private information. They divide this Information Technology sector into three sub-sectors; secure mobile communication systems, information technology solutions with mission support services, and surveillance reconnaissance systems.
Their Secure Mobile Communication System provides a high tech secured communication system, along with its operational hardware, to customers such as the U.S. Department of Defense, several federal and civilian public safety groups, and a wide range of international businesses. The goal of this division is to provide their customers with a secure and safe way to communicate vital information, using fast and private bandwidth networks. Two major sections and programs are the U.S. Army’s Warfighter Information Network-Tactical (WIN-T), and the Handheld Maniac Small Form Fit (HMS) radios. General Dynamics is the prime contractor for both of these systems, providing the design, engineering, integration, production, support, and program management for the entire network. The U.S. Army already purchased over 25,000 of the radios from the HMS program and plans to purchase more than 240,000 in the future as the technology advances. As well as being the lead contractor for these systems for the Government,
General Dynamics also provided the FAA with over 13,000 radios for civilian air traffic control use. The popularity of this system General Dynamics provides helped them win a new contract with the FAA for future disbursement of updated radios that are using the latest communication technology. To further diversify this department, General Dynamics also provides tactical communication systems to the Canadian Department of National Defense, the U.K. Ministry of Defense, and several other public agencies across Europe and the Middle East. Most notably they designed and integrated one of the most advanced control systems for the port in United Arab Emirates, making it one of the most advanced ports in the world.
Their second division is the
Information Technology solutions and mission support services. This division provides IT support and operational systems to several large organizations including the Department of Homeland Security, Health and Human Services agency, and other commercial domestic and international customers. Their product base is focused on large-scale data centers, secure wireless and wired networks, and operational training systems. General Dynamics is the full supporter of our Department of Homeland Securities headquarters, which includes one of the most advanced IT infrastructures in the world. Along
with providing the Homeland Security with safe and fast infrastructure for its data, General Dynamics is also the leading company offering modern technology and management for the Government Health Care system. They focus on fraud prevention and detection, analytics, and program management.
The third and final division is the
Intelligence, surveillance and reconnaissance system. General Dynamic’s main focus is on developing and integrating operational support systems for the U.S. defense sectors, intelligence agencies, and homeland security. A large service provided is its in depth and state of the art cyber security systems. These systems are in place to help both government and commercial customers protect their secret and private data by using real time network support. Over the last 40 years General Dynamics provided the U.S. Navy with submarine systems that support integrated tactical controls for many of their submarine classes. All three divisions of the Information Systems and Technology sector are providing the ongoing needs of both domestic and international governments. With the increasing demand for such services, General Dynamics is solidifying their position in the market and are diversifying their business portfolio enough to maintain that position for the foreseeable future.
Figure: 1-1 Description of the Information Systems and Technology’s Business Unit main products
The second largest division of General Dynamics is the Combat Systems group. This division is a world leader in the development and production of tracked and wheeled vehicles for several military groups, and weapon systems munitions for the U.S. and its allies. This sector of General Dynamics provides around 27 percent of revenue for the company. The Combat Systems division is a strong sector because of its long-term production contracts with the U.S. military, which provides long-term revenue for General Dynamics and
maintains their cash flows for future investments. The two main production models for this division are the Stryker combat vehicle and the Abram battle tank. General Dynamics is committed to the service and enhancements of these vehicles, which enables them to be the leader in maintenance and repair for each model. This business model allows them to maintain cash flow from the government because they are the only company that can provide complete services for these two vehicle platforms.
Figu re: 1 -2 Description of the Combat Systems Business Unit main products
The third largest division is the Aerospace sector. This sector provides about 22 percent of revenues for the company. As mentioned before their aerospace division was started in 1995 when they purchased and integrated the Gulfstream business aircraft. Unlike the other divisions in the company the Aerospace division is mainly focused on providing the corporate business culture with products, not domestic and international governments. General Dynamic’s niche in the market comes from their superior aircraft quality and design. They offer better performance, safety, and technologically advanced planes than their competitors. Something else that sets this company apart is its diverse line of aircraft, ranging from large cabin business jets, to smaller price mid-sized cabined planes. All of their aircraft are engineered and put together in its U.S. facility in Savanna Georgia.
With the increased demand for such aircrafts, General Dynamic’s aerospace division remains a strong competitor in the world market. The North American demand remains constant but the most important demand is driven by international demand, specifically the Asia-Pacific region. This region comprises about 60 percent of the companies’ backlogged orders. Due to this increased international demand, General Dynamics built service centers around the world, in places such as China and Brazil. These service centers provide customers with urgent deployable technicians, which is another distinguishing factor driving the companies increased demand for their aircraft. The Aerospace division is dedicated to its customer base and is considered a market leader in the business jet industry. The demand for their business jet aircrafts provides investors with a promising outlook for future performance.
Figure: 1-3 Description of the Aerospace Business Unit main products
The fourth and final division is the
Marine division. It makes up about 21 percent of total revenues. This division designs, and builds submarines and surface warships for the U.S. Navy. They
focus on nuclear powered submarines, surface warfare ships, commercial ships, and the engineering support that goes into each model. The primary work for the U.S. Navy includes the construction of new vessels and the ongoing
development and maintenance of the current naval fleet. A distinguishing factor that keeps General Dynamics in the lead for this market is their ability to provide these ongoing services to the U.S. Navy. Not only do they build the ships,
they provide all the maintenance and repair, which keeps the governments costs down and keeps General Dynamics awarded contracts solidified for the future.
Figu re: 1 -4 Description of the Marine Systems Business Unit main products
CO MPANY HISTO RY
General Dynamics was awarded
over 1.7 Billion dollars in contracts in the
year 2015 alone. The majority of these
contracts come from the U.S. government.
These ongoing contracts are what give
this company its edge in the market.
General Dynamic’s long standing history
with being awarded large government
contracts solidifies investors’ confidence
in the company for the foreseeable future.
It is a major determining factor that
drives the stock’s value. In February the
company was awarded a 415 million
dollar contract which allowed them an
ongoing management service to the U.S.
Army. This announcement caused an
increase in stock price the next day by 10
percent and increased the trading
volume by 300,000 shares. In March the
board of directors decided to increase
the dividend payment from .62 cents
to .69 cents, which resulted in another
increase in the stock price. When that
dividend was declared General Dynamics’
stock price went to a 16 month high of
over 150.00 dollars per share, in
comparison to its average of around
140.00 dollars per share.
A major recent event for General
Dynamics’s was the announcement and
contract award for the U.S. Navy’s new
Virginia Class Submarine valued at over
18 billion dollars. This announcement
alone raised the stock price after a
several month low in early 2014. General
Dynamic’s share volume also increased
by nearly 3 million in a single days
trading period. During this period their
earnings per share increased from 6.72
to 7.83, along with an increase in their
price earnings ratio.
In July of 2015 General Dynamics
raised its profit forecast due to their
second quarter revenue boost from their
aerospace and information technology
sectors. The marginal increase in
quarterly revenue, which was roughly 16
percent, also provided the company with
the ability to repurchase 7.5 million
shares from the open market. Another
reason for this profit forecast is the
company’s strong order backlogs. These
backlogs amount to around 70 billion
dollars. The backlogs are considered
funded backlogs which means they are
able to give investors’ confidence of the
cash flows they produce. The aerospace
division alone accounted for a 7 percent
increase in the quarter from the year
previous. The current estimated
contract value of both the aerospace and
information technology divisions are
around 25 billion dollars. If you add that
number to the already funded 70 billion
dollar backlog, the total potential
increase in value to the company is
around 95 billion dollars.
On the other spectrum, recent
news announcements hurt the
company’s stock price. Most recently on
September 14, 2015 their stock price
dropped by .13% due to investor
speculation that the U.S. Navy is going to
cancel an order that is already in
production. According to sources the
ship that General Dynamics is producing
is already over 40 percent complete and
a halt in production results in
devastating consequences to the
operations and cash flow for the
company. This ship is part of a 22 billion
dollar program awarded to General
Dynamics to build the Navy’s new
Zumwalt-Class destroyer. The reason for
the stock price decrease is that the
Department of Defense announced a
consideration to cancel the order due a
new fiscal budget forecast for 2017.
General Dynamics’ also is a major
player when it comes to Acquisitions and
Divestitures. In 2013 and 2014 the
company did not do any such
transactions, but from 2009 up until
2013 General Dynamics’ invested over 3
billion dollars in cash to acquire multiple
companies. These acquisitions give the
company a leading edge in the market.
General Dynamics’ is meticulous in the
valuation of which companies they
acquire. Each and every company
acquired in the years 2009 to 2012 added
significant value to the company’s
operations. In 2009 the acquisition of
Axsys Technologies, Inc. was completed.
General Dynamics’ acquired this
company to capitalize on Axsys position
as being a global leader in the
manufacturing and design of high tech
infrared, and optical sensors that go into
cameras. Another major acquisition to
boost their health care portfolio was the
2011 purchase of Vangent Holding Corp.
Vangent was the leading provider of
healthcare information technology,
which was used by several business
systems and the federal government.
To close out the fiscal 2011 year
General Dynamics’ acquired the
company Force Protection, Inc., one of
the armed forces suppliers of wheeled
vehicles, survivability solutions, and
certain sustainment services. General
Dynamics’ is a major producer for the U.S.
Army or wheeled vehicles and tanks, so
the acquisition of Force Protection gave
the company more of a leading edge in
their market sector.
Figu re: 1 -5 Recent company acquisitions and divestures by year
PRODUCTS AND COMP ETITION
MAJO R PRO DUCTS
CO MBAT SYSTEMS
The Combat Systems group provides systems engineering, spanning design, development, manufacture and support military vehicles, weapons systems, munitions and military vehicles for the United States and NATO allies. The group produces and delivers battle tanks and tracked combat vehicles, wheeled combat and tactical vehicles, weapons systems and munitions and provides sustainment, maintenance and logistics support services. The production of the portfolio of military vehicles are produced at operation facilities in North America and Europe.
The group is comprised of three divisions: the European Land Systems, Land Systems and Ordnance and Tactical
Systems.
European Land Systems division operates in Austria, Germany, Spain and Switzerland. The European Land Systems constructs and provides tracked, amphibious and wheeled vehicles, other combat weapon systems, armaments and
munitions to global customers.
Land Systems: Land systems offer a spectrum of design, development, production and lifecycle support. Land System’s produce and support heavy, medium and light wheeled vehicles and
heavy and medium tracked vehicles such as the Abrams main battle tank and Stryker, LAV and MRAP wheeled combat vehicles. Land Systems utilize first-class expertise to manufacture and provide systems integration processes in order to develop vehicles designed to meet the ground combat requirements of the future.
General Dynamics Ordnance and Tactical Systems manufactures large-, medium- and small-caliber direct and indirect-fire munitions, and leads the development and production of weapons and armament systems and lightweight tactical vehicles. GD designs and produces shaped charge and penetrator warheads and manufactures precision metal components for rockets, missiles and composite structures for the commercial, aerospace and defense purposes. The group produces non-lethal and force-protection products as well as propellants. Specifically the group manufactures and supplies the US government and its allies with medium-caliber ammunition, large-caliber tank ammunition, mortar and artillery projectiles, Hydra-70 rockets, tactical missile aero structures and high-performance warheads, conventional
bombs and bomb cases.
Figu re: 1 -6 Revenues attributed by the Combat Systems unit
The Combat Systems Department generated 18.6%, 19.6% and 25.4% of General Dynamics Total Revenues during 2014, 2013 and 2012 and generated $862,000,000, $904,000,000 and
$663,000,000 in operating profit during those same years.
MARINE SYSTEMS
General Dynamics' Marine Systems group designs, builds and supports Jones Act ships for commercial customers as well as submarines and surface ships for the U.S. Navy:
The group provides overhauls, repairs, lifecycle, design and engineering support services, manufactures surface combatants, auxiliary and combat-logistics ships, nuclear submarines and commercial containerships and product carriers.
The Marine Systems group is made up of three divisions: Bath Iron Works, Electric Boat and NASSCO.
Bath Iron Works designs, builds and supports a fleet of US Navy surface vessels and missile destroyers. Bath Iron Works developed a variety of ship construction programs, such as the
Mobile Landing Platforms, which serve as floating, mobile transfer stations to support the US military’s amphibious operations.
Electric Boat is the frontrunner in submarine technology. Electric Boat designs, builds and delivers lifecycle support for the U.S. Navy's attack and ballistic missile submarines. Electric Boat is the lead contractor of the Virginia-class submarine program and was tasked with the development of the ballistic-missile replacement for the Ohio-class Submarine. NASSCO design and build auxiliary and support ships for the U.S. Navy, oil tankers and dry cargo carriers for commercial purposes. It owns only functioning full service shipyard on the Pacific West Coast. NASSCO also provides naval repair services in San Diego, CA., Norfolk, Va., and Jacksonville, FL.
Figu re: 1 -7 Revenues attributed by the Marine Systems unit
The Marine Systems group
generated 23.7%, 21.5% and 20.9% of
General Dynamics Total Revenues for
2014, 2013 and 2012 and generated
$703,000,000, $666,000,000 and
$750,000,000 in operating profit during
those same years.
INFO RMATIO N SYSTEMS AND TECHNO LO GY
The Information Systems and
Technology department produces
products, technologies and services that
address a wide range of military,
governmental and commercial
information-systems requirements. The
group enjoys great success in the market
because of the decades of experience,
expertise and continuous innovation to
provide feasible solutions to customers.
The department contains two divisions:
Information Technology and Mission
Systems. The IT division provides
customers with defense, homeland
security and intelligence IT solutions. It
builds, designs and constructs secure IT
systems and networks for US
government agencies
The It group partners with the U.S.
defense, intelligence, cyber and
homeland security agencies, and GD
Mission Systems division delivers
sophisticated technology, from open
architecture for submarines, aircrafts
and U.S. Navy surface ships to ground-
based tactical networking. The group’s
experience and expert support staff
deliver platform integration, ruggedized
displays and tactical networks.
The group is also a leading
provider in the U.S. healthcare IT market
and provides health care reform and
medical benefits programs service
support for government, civilian and
military health systems,. The group
offers data management, process
automation and program management,
fraud prevention and detection software
service solutions for commercial and
public health care systems.
The group designs, builds, deploys
and supports mobile communication
systems and ISR solutions for the U.S.
Department of Defense, homeland
security agencies, and U.S. and NATO
allies. The group integrates and
manufactures secure communications
systems, command and control solutions,
signals and information collection,
processing and distribution systems;
imagery sensors; and cyber security,
information assurance, and encryption
products, systems and services
Figu re: 1 -8 Revenues attributed by the Information Systems and Technology unit
The Information Technology and
Mission Systems group T generated
29.7%, 32.9% and 31.8% of General
Dynamics Total Revenues during 2014,
2013 and 2012 and generated
$785,000,000, $795,000,000 and
($1,369,000,000) in operating profit
during those same years.
AERO SPACE
The Aerospace department of GD manufactures, produces and services small-, mid- and large-cabin business-jets to American and global Customers. The Aerospace department is divided into two divisions: GulfStream Aerospace and Jet Aviation. Gulfstream produces, provides and services private jets for commercial and business use. In addition to the design and production of new aircraft models, the group works diligently to enhancement the current product line as well as develop new technologies that improve systems and technologies in advanced avionics, renewable fuels, composites, flight-control systems, vision systems and cabin technologies.
The large-cabin business-jets are
produced in Savannah Georgia, while the mid-cabin business jet production and manufacturing is are contracted out to Israel Aerospace Industries.
Jet Aviation is a full-fledged aviation maintenance and repair service company with more than 25 service center locations worldwide. Jet Aviation provides world-class maintenance, repair, aircraft management and Fixed-base Operator services to a global customer base through their facilities network that spans across four continents.
Figu re: 1 -9 Revenues attributed by the Aerospace unit
The Aerospace group generated
28.0%, 26.0% and 21.9% of General
Dynamics Total Revenues during 2014,
2013 and 2012 and generated
$1,611,000,000, $1,416,000,000 and
$858,000,000 in operating profit during
those same years.
MAJO R CO ST CO MPO NENT S
General Dynamics’ groups’
expenses consist largely of costs of goods
sold and SG&A, however, the Aerospace
group experienced large fixed costs in
the last three years as Gulfstream’s
Savannah campus is currently
undergoing a $500 million seven-year
facilities amplification project to expand
the company’s R&D center, overhaul the
current infrastructure and construct new
facilities. General Dynamics Statement of
Cash Flows shows that GD experienced
annual cash outflows for investments in
property, plant and equipment and
shows regular cash outflows for
inventories. Upon further analysis, the
common-size shows that costs of goods
sold or cost of revenue in 2014 was
80.96%, and SG&A accounted for 6.43%
of revenue. This shows that the company
largely incurs operating and
manufacturing expenses, and to a
smaller degree incurs SG&A and capital
expenditure.
CUSTO MERS
General Dynamics’ primary
customer is the US government's
Department of Defense, however, the
company also caters to US and non-US
commercial customers as well as non-US
defense customers. 60 percent of the
group's customer base are non-US
customers. 58 percent of General
Dynamics’ 2014 sale revenues came from
the US government, 17 and 14 percent
from US and non-US commercial
customers and the remaining 11 percent
derive from non-US defense customers.
CO MPETITO RS
Within the US General Dynamic
faces its main competition from the other
leading Aerospace and Defense
companies: Boeing Co., United
Technologies Corp., Lockheed Martin
Corp. and the Airbus Group. GD also
competes with many small market firms
that provide and other specialized niche
market firms. Outside of the US, GD
competes with global defense
contractors as well as state-owned
defense companies. General Dynamics IT
department faces competition from a
large array of competitors both big and
small. General Dynamics competes with
the competitors in basis of price, quality
and timeliness, but GD is also often
required to partner with its competitors
in order to better fulfill a customer’s
needs. General Dynamics Aerospace
group must be competitive in areas of
comfort and in-flight productivity; new-
product and technological innovation;
aircraft reliability, safety and
performance as well as service quality.
MARKET SHARE DATA
Figu re: 1 -1 0 Market Share Data from Morningstar
According to data captured from MorningStar, Boeing leads the Aerospace and Defense industry with $91,507,000,000 followed by United Technologies Corp. with
$82,228,000,000, Lockheed Martin Corp. with $64,221,000,000, Airbus Group SE with $49,771,000,000 and then General Dynamic with $45,788,000,000.
DO MINANT CO MPANY IN THE INDUSTRY
Boeing is the dominant company
in the Industry with a market share of
$91,507,000,000. With facilities in over
140 countries Boeing is the dominant
company in the industry because of its
robust global presence, its strong, well-
positioned global distribution network
and because Boeing enjoys solid
relationships with many companies and
successfully set up joint ventures with
other well positioned Aerospace and
Defense companies such as Lockheed
Martin, who captures the second largest
market share of the Defense and
Aerospace Industry. Boeing built and
continues to service over 12,000
commercial jetliners, which is about 75%
of the world's commercial airliner fleet.
They are committed to deliver in-depth
support for out-of-production airplanes
and continue provide parts for these
jetliners. Lastly, Boeing became the
dominant company in this industry
because they worked close with
international suppliers to develop
unique concepts and technologies, which
created a very loyal following from
suppliers making them more likely to
enter into new contracts with Boeing
rather than its competitors.
CORPORATE CONTROL
MANAGEMENT TEAM
Phebe N. Novakovic Chairman and Chief Executive Officer of General
Dynamics Corporation since January 1, 2013. President and Chief Operating Officer at General
Dynamics Corporation from May 2, 2012 to December 2012.
Executive Vice President of General Dynamics Marine Systems, Inc. from May 01, 2010 to May 2012
Senior Vice President of Planning & Development at General Dynamics Corporation and General Dynamics Land Systems Inc. from July 2005 to May 1, 2010.
Vice President of Strategic Planning at General Dynamics Corporation from October 2002 to June 30, 2005.
Staff Vice President of General Dynamics Corporation from May 2002 to October 2002.
Director of Strategic Planning and Development March 2001 to May 2002.
She serves as a Director of Abbott Diabetes Care, Inc. She was an Independent Director at Abbott Laboratories since 2010.
Total Calculated Compensation $19,388,084
John P. Casey Executive Vice President, Marine Systems, since
May 2012; Vice President of the company and President of
Electric Boat Corporation, October 2003 – May 2012.
Vice President of Electric Boat Corporation, October 1996 – October 2003
Total Calculated Compensation $4,868,733
S. Daniel Johnson Executive Vice President, Information Systems
and Technology, and President of General Dynamics Information Technology since January 2015.
Vice President of the company and President of General Dynamics Information Technology, April 2008 – December 2014.
Executive Vice President of General Dynamics Information Technology, July 2006 – March 2008
Jason W. Aiken Senior Vice President and Chief Financial Officer
since January 2014 Vice President of the company and Chief
Financial Officer of Gulfstream Aerospace Corporation, September 2011 – December 2013
Vice President and Controller of the company, April 2010 – August 2011
Staff Vice President, Accounting of the company, July 2006 – March 2011
Total Calculated Compensation $5,112,642
Joseph T. Lombardo
● Executive Vice President, Aerospace, since April 2007 ● President of Gulfstream Aerospace Corporation, April 2007 – September 2011 ● Vice President of the company and Chief Operating Officer of Gulfstream Aerospace
Corporation, May 2002– April 2007
SHARE O NWERSHIP AND CO MPENSATIO N
EXECUTIVE CO MPENSATIO N PLANS
General Dynamics’ executive compensation is linked strongly to the financial and operational performance of the business. Over 90% of the CEO’s total compensation is at risk in any given year if the company performs poorly. Similarly over 85% of the named executive officer’s compensation is also at risk. A significant amount of the compensation at risk is delivered through equity, specifically performance restricted stock units, restricted stock and stock option. In order to emphasize a culture of ownership and to align management’s goals with long-term shareholder interest, General Dynamics requires one of the strictest set of ownership guidelines in the aerospace and defense industry. For example, the CEO is required to whole 15 times base salary in General Dynamics stock, other executive officers must to hold 10 times their base salary in GD stock. Executive officer compensation is based on clear, measureable goals related to company and business group performance. Ms. Novakovic implemented, approved by committee, a score card system for evaluating whether the company’s executive officers are meeting their goals. Compensation committee sets, and the Board approves, performance objectives for the coming year that are designed to be
challenging yet achievable. The program’s effectiveness was best demonstrated in 2012, when due to lacking performance all the restricted stock options were forfeited by executives. However, the program is not an all or nothing deal, many executives received smaller target payouts over the past two years for meeting some but not all of the compensation committee goals. To ensure market competitiveness, General Dynamics links executive compensation to the market. Each component of the executive officers compensation is targeted to the 50th percentile of a core group of aerospace, defense and industrial companies with whom GD competes for business and executive talent. The goal of the committee is to set compensation levels to be in excess of the median compensation levels of General Dynamics’s competitors. This is not to say that compensation levels are benchmarked at the median. If the company and business groups exceed their performance goals then compensation exceeds the median, likewise if performance goals aren’t met compensation is reduced. Below is a chart of the most recent year’s compensation packages for executive officers with in General Dynamics.
Figu re: 1 -1 1 Breakdown of executive compensation over the past three years
Along with implementation of the score
card system, General Dynamics’s
compensation committee implemented
other program changes in 2014 to
continuously improve the executive
compensation program and to further
align management goals with
shareholders.
Figu re: 1 -1 2 Recent program changes involving executive compensation
CO MPARISO N WITH CO MPANIES WITHIN THE IND USTRY
LO CKHEED MARTIN CO RP. & BO EING INC.
Much like General Dynamics,
Lockheed Martin Corp. and Boeing Inc.,
GD’s biggest competitors, promote a
compensation plan that is market
competitive and performance based. Like
GD, both competitors look at the 50th
percentile of companies that the actively
compete with for market share and top
tier talent. After analyzing this percentile
both competitors establish base salary and
compensation levels for their named
executive officers. Additional
compensation is then based specifically on
performance and business unit metric
established by the compensation
committees and approved by each
company’s respective board members. GD
and its competitors all implemented Say
on Pay programs where shareholders are
allowed to vote on the proposed
compensation plans. These practices were
quite effective over the past years as
shareholder voting dramatically increased
since the first year of these programs
being enacted. Since the implementation
of these programs not one compensation
plan was vetoed by GD or its competitors.
While the compensation plans were not
vetoed, it is encouraging to see the
increase in shareholder involvement in
compensation plans across the industry.
Further shareholder voice, hopefully
increases the competiveness of
compensation plans with in the industry,
leading to more compensation being tied
to firm specific performance. Below you
can view charts of the total compensation
received by the executive officers of both
Lockheed Martin Corp. and Boeing Inc.
Lockheed Martin Corp.
Figu re: 1 -1 3 Lockheed Martin Corp. salaries and compensation for the year 2014
Figu re: 1 -1 4 Qualitative performance characteristics of Lockheed Martin Executives
Boeing Inc.
Figu re: 1 -1 5 Boeing Inc. salaries and compensation for the year 2014
BO ARD MEMBERS
General Dynamics Board of Directors:
Figu re: 1 -1 6 List of General Dynamics Board of Directors with classification
In keeping with General Dynamics’s goal of
strong corporate governance, the board of
directors is responsible for ensuring the
culture of ethics with in GD remains
untarnished. GD adopted ethics codes
specifically applicable to the board of
directors and financial professionals to
ensure the company meets its defined core
values of: Honest, Trust, Humanity,
Alignment and Value Creation. To assist in
executing its duties the Board of Directors
established four standing committees:
Audit, Compensation, Finance and Benefit
plans, and Nominating and Corporate
Governance. Committees are composed of
the non-management and independent
board members. The guidelines for what
constitutes an independent board
members are stated below.
Independent Board Director Criteria:
Figu re: 1 -1 7 Criteria for independent board members
Board of Directors Compensation
Figu re: 1 -1 8 Compensation for the Board of Directors
* Ms. Novakovic’s compensation as a member of the Board is included in Figure 1-11
STO CK INSIDER ANALYSIS
Over the past 12 months the number of
insider purchases largely dwarfed the
number of insider sales, as reported to the
SEC. It is important to note that even
though there were more purchases
executed by insiders over the past 12
months, the volume of shares sold and
purchased by insiders is close to equal.
Over this time frame 585,811 were
purchased and 528,037 were sold by
insiders. This is most likely due to adverse
opinion of a few insiders who sold large
portions of their shares over the past 12
months. Overall, the actions of the insiders
indicates they are confident in the
company’s financial standing and believe
GD to be a strong investment for the years
to come.
Transaction Summary over past 12 months:
Figu re: 1 -1 9 Insider transaction summary
Transactions since May 2015:
Figu re: 1 -2 0 Insider transaction since May 2015
CO MPARISO N WITH CO MPANIES WITHIN THE IND USTRY
Lockheed Martin Corp.
Over the past 12 months Lockheed
insiders purchased less shares and sold
more shares of ownership. Sales by
Lockheed insiders over the past 12
months amounted to 41, while purchases
only totaled to 34. While sales by insiders
exceed purchases, the number of shares
purchased by insiders over the past 12
months exceeded the volume of shares
sold, 206,251 sold, 236,359 purchased.
These numbers indicate a split opinion by
Lockheed investors as to whether LMT is a
good investment for the future. In
comparison with GD, it appears that
Lockheed’s insiders are less certain about
the financial strength of LMT moving
forward.
LMT Transaction Summary over past 12 months:
Figu re: 1 -2 1 Lockheed Martin insider transaction summary over past 12 months
Boeing Inc.
Much like Lockheed Martin, Boeing
experienced greater sales of ownership by
insiders than purchases. Over the past 12
months, sales of ownership exceeded
purchases by 10. Unlike Lockheed Martin,
Boeing’s insiders sold a greater volume of
shares than they purchased, total volume
of sold shares equates to 740,535 while
total shares purchased remained at
685,571. This trend suggests that insiders
at Boeing are less confident in the
company’s financial future when
compared to similar investments.
BA Transaction Summary over past 12 months:
Figu re: 1 -2 2 Boeing Inc. insider transaction summary over past 12 months
THE FUTURE
ANALYST REPO RT
ANALYST EARNINGS AND SALES ESTIMATES
Bloomberg Analysts predict that
General Dynamics are set to earn $31.85
billion dollars of revenue in 2015, 32.68
billion in 2016, 33.47 billion in 2017 and
34.40 billion in 2018, averaging about
2.73% growth over the 4 year period. This
is consistently similar to Yahoo Finance
analysts’ sales and sales growth estimates.
During that same time period Bloomberg
analysts forecast earnings per share to
equal $8.83 in 2015, $9.44 in 2016, $10.20
in 2017 and $10.94 in 2018, averaging
about a 7.23% growth in EPS over the 4
year period.
EARNING SURPRISES
In both 2013 and 2014 General
Dynamics experienced positive earnings
surprises in Earnings per share, sales and
net income. It beat its estimated EPS
(GAAP) in 2014 by 3.36% and .05% in
2013. GD also witnessed a positive
surprise earnings in Sales of .88%
and .36%. It also outperformed its
estimated net income in 2014 by 1.44%
and .28% in 2013. Exhibit ## shows that
GD met all of their earnings estimated for
EPS over the last 8 years except in 2011
and 2012. This is due to large impairments
in intangible assets that were deferred till
2011. This seriously affected their
earnings and is the major reason for the
negative earnings surprises in those years,
and even though net income was only
affected in 2012 it missed its earnings
estimate by 6.73%. GD did outperform its
sales estimates for 2014 and 2013 despite
the decrease in the US defense budget, but
missed its sales estimates from 2007 to
2012 by an average of -.98%.
Figu re: 1 -2 3 Data from Bloomberg illustrating recent surprises in the past years earnings
ANALYST RECO MMENDATIO NS
General Dynamics’ stock
recommendations for 2015 are very
strong. The industries top analysts from
Credit Suisse, JP Morgan, Wells Fargo
Securities and UBS rate the stock with a
buy, outperform or overweight
recommendation, signaling that the stock
is performing very well compared to the
market. Similarly, exhibit ##
demonstrates that General Dynamics’
stock performed consistently with analyst
estimates over the past 5 years and it
validates said analysts’ recommendations.
Figu re: 1 -2 4 Analyst recommendations since 2010
EXPERT FO RECAST
According to Bloomberg analysts,
General Dynamics is set to experience
3.55% growth in revenue on average over
the next five year period, generating
$31,866,400,000 in 2015 and
$36,615,000,000 by 2019. During that
same time, it’s expected to generate an
increase in gross profit of 3.98% percent
on average, however, the analysts only
forecast this account for 2015 and 2016.
This is possibly due to the forecasted
marginal decrease in the US government
defense spending budget. Net income is
expected to increase by 3.43% over the
next 5 years on average reaching
2,902,100,000 in 2015 and
$3,210,000,000 by 2019, which is
consistent with forecasted revenues for
those same years. This indicates that the
analysts’ are confident that General
Dynamics’ productivity is set to remain
relatively constant over the same time
period, thus General Dynamics is
maintaining cost structure and costs are
forecasted to grow persistent with sales
growth. Analysts forecast that dividends
are set to increase as well over the 5 year
period by an average of 7.71%. Exhibit ##
also shows that analysts are confident
General Dynamics EPS is set to experience
increases of growth of about 8.13% over
the next 5 years, generating $8.83 per
share to $12.07 per share by 2019.
Deloitte’s annual Aerospace and Defense
industry outlook forecasts that the
industry is projected to grow around 3%
Figu re: 1 -2 5 Experts forecast for key financial indicators
PERSO NAL FO RECAST (GRO UPS FO RECAST)
According to the groups analysis,
the growth rates were chosen based on the
experts’ average growth rates over the
next five years because General Dynamics
performed quite well since its
management change due to positive
earnings surprises in both 2013 and 2014.
The expert analysis already takes into
account the forecasted decreases in
defense spending planned by the US
government over the next five years, thus
the growth rates are proportionate to
expected industry growth. It is also
expected that the commercial aerospace
sector is set to grow at 8%, which offsets
the slowed growth in the General
Dynamics defense revenues. Based on the
3.55% growth rate in revenues General
Dynamics is forecasted to earn
$31,946,180,000 in 2015 and
$36,724,980,000 by 2019. Net income and
dividends are both set to grow by 3.43 %
and 7.71% respectively. Net income is
forecasted to reach 2,619,760,000 in 2015
and $2,997,570,000 by 2019, while
dividends are expected to grow to $2.61 in
2015 and $3.51 by 2019. General
Dynamics’ is set to earn $8.17 dollars per
share in 2015 and this is expected to grow
at 8.13% and reach $11.18 dollars per
share by 2019.
Figu re: 1 -2 6 Expected forecast based upon Bloomberg historical data and recent trends
GENERAL DYNAMICS
STOCK PRICE PERFORMANCE
Over the past 10 years, General Dynamic’s stock
performance is correlated with its competitors. On average
General Dynamic’s stock return out performed its two large
competitors Lockheed Martin Corp., +2.06%, and Boeing Inc.,
+2.66%. It out-performed United Technologies Corp. and the
S&P500 by 2.96% and 5.51% respectively over the same period.
General Dynamics’ stock performed its best over the past two
years due to positive earnings surprises with returns of 44.03%
and 37.94% in 2014 and 2013 respectively. In 2014, GD
outperformed all competitors and the S&P 500 by and average
return of 34.73%.
Yearly Stock Returns: GD vs. Competitors & S&P500
ABSOLUTE PERFORMANCE
ARITHMETIC VS. GEOME TRIC MEAN OF RETURNS
General Dynamics S&P Industry Index
S&P 500
Over a ten year period General Dynamics on average
out-performed the S&P Industry Index, along with the S&P 500
market index.
Its Coefficient of Variation is lower than that of the S&P
500 which suggests a better risk return tradeoff, however, it is
more volatile than the Aerospace Defense Industry as a whole.
FINANCIAL PERFORMANCE
GRO WTH PERFO RMANCE
REVENUE
Due to government contracts on average revenues grew at a rate
of 5.08% over the last ten years. However, revenues decreased
marginally over the last three years due to decreases in the
defense budget.
DIVIDEND GROWTH
General Dynamics shows positive Dividend growth,
despite the defense budget decrease.
FINANCIAL PERFORMANCE & DUPONT ANALYSIS
A two year increase in Return on Equity is accompanied
by a decrease in Asset efficiency and an increase in Debt.
The budget cuts hurt its ability to use its assets
efficiently for sales.
Z-SCORE ANALYSIS
General Dynamics and the
Aerospace and Defense industry
is in no position to expect
financial distress.
2012 2013 2014
Dividend 2.04 2.24 2.48
Dividend Gr. 8.51% 9.80% 10.71%
2013 2014
ROE 19.39% 20.45%
Asset Turn. 0.9 0.87
Debt/Equity 0.27 0.33
Rev per emp. 310,070.00$ 325,188.00$
PM A/T EM
DuPont GD 8.21% 0.87 2.69
Industry 8.58% 0.53 1.7
Z Score
General Dynamics 2.85
Industry 2.49
UNIT 2 STOCK PRICE PERFORMANCE
PRICE PERFO RMANCE
In comparison with General Dynamics’
largest competitors, the S&P
Aerospace/Defense Index, and the S&P
500’s ten year stock prices and yearly
returns are strongly correlated. After
graphing the yearly returns of General
Dynamics’, its competitors, the market,
and the industry index it is clear from
Exhibit ## that these returns move
together in the market. Looking
specifically at General Dynamics’ stock
performance, our analysis shows that GD’s
stock experienced, while inconsistent,
positive growth over the time period we
observed, 12/31/03-12/31/14. During
two years over the specified time period
GD’s stock suffered a negative return of -
6.41% and -35.26%, in 2011 and 2008
respectively. The large loss in 2008 can be
attributed to the Great Recession and the
drastic toll it took on the entire U.S.
economy. However, the loss in 2011 is firm
specific, attributable to large impairments
of intangible assets and large amounts of
discontinued operations which hurt the
bottom line. Since 2011 GD’s stock
performed strong , earning a return of
44.03% and 37.94% in 2014 and 2013
respectively, and outperforming its
competitors, the S&P 500 and the S&P
Aerospace/Defense Industry Index by an
average of 34.74% ( Exhibit ##), in the
year 2014.
CO MPETITO RS
Lockheed Martin: As one of General
Dynamics’s largest competitor it is
important to compare the stock
performance of GD with Lockheed
Martin’s performance. Exhibit ## shows
that over the ten year period on average
LMT’s (Lockheed Martin) stock return is
14.94%, which outperformed GD’s return
of 12.90%. The geometric average of the
yearly returns, which is a better indicator
of the actual average return, was used to
show how LMT outperformed GD over the
same time period using a different, more
mathematically correct approach.
Boeing: In comparison with its
largest competitor Boeing (BA), GD stock
price underperformed over the ten+ year
time frame. Boeing’s average arithmetic
return over the time period was 15.56%,
where General Dynamics’ average was
only 12.90%. Diving deeper, its apparent
Boeing outperformed General Dynamics
by an average of +2.66% a year over our
analytical time frame. However, from
2012-2014, General Dynamics’ stock
return exceeded Boeing’s by an average of
+2.40% per year.
United Technologies: As is the case with
General Dynamics previous competitors
the stock return of United Technologies
(UTX) did consistently outperform GD’s
stock return over the ten year time frame.
However, due to GD’s recent dominating
stock performance over the past two years,
the average over the past 10 years was
skewed and GD’s stock return
outperformed UTX’s by 2.96%. Looking at
the time period of 2004-2011 it’s revealed
that UTX’s stock return out performed
GD’s by +.21% per year. Looking at the
most recent three years GD’s stock return
outperformed UTX’s by an average of
11.42% per year.
AERO SPACE AND DEFENSE INDEX/MARKET
Moving forward, it’s important to
analyze GD’s stock returns with the
returns of the market, S&P 500, and the
S&P Aerospace/Defense Industry Index.
Looking at Exhibit ## and see it’s clear that
the returns of GD are strongly correlated
with the market and index returns. Diving
deeper we can discern that GD’s returns
were consistently outperformed by the
market and index from 2009-2012. Like
many in its industry, GD experienced a
sharp increase in returns during 2013. The
greatest return during this period of
81.12%, was achieved by Boeing Co.
However, it is important to note that after
2013 most competitors of GD and the
market/index experienced a sharp decline
in their returns. From the graph we see
that GD’s return did not sharply decline
like that of its competitors. During the
year 2014 GD’s returns increased from
37.94% in 2013 to 44.03%. While our
analysis shows that GD was outperformed
by the market and its competitors over the
analytical time frame, we also see that over
the past three years GD’s stock returns
enjoyed an upward sloping trend, which
allowed it to surpass its competitors in
recent years.
Figure: 2-1 Difference in competitors, industry and market returns when compared to General Dynamics over the past 10 years
Figu re: 2 -2 Comparison of stock returns over the past 10 years
ABSO LUTE PERFO RMANCE
Moving forward in the analysis it is
imperative to look into the absolute
performance of GD’s stock prices and
returns in comparison with its
competitors, market and industry index.
Begin by calculating and observing GD’s
and competitor’s geometric mean. The
geometric mean is a preferred measure
when comparing two companies’ stock
returns. This is due to the fact that the
geometric mean recognizes that the
individual returns of a company are not
independent from year-to-year. If returns
were completely independent of each
other from year-to-year the arithmetic
mean is an acceptable method for
computing the average, like calculating the
class average on a test. However, returns
are dependent upon each other, consider
for example if one loses a lot of money one
year, then at the beginning of the following
year there is less capital to generate
returns. By calculating the geometric
mean one can better compare two
companies as apples-apples rather than
apples-oranges. Looking at the geometric
means of the last 10+ year’s returns it is
clear that GD underperformed in
comparison to Lockheed Martin and
Boeing. However, GD’s stock returns
performed better than that of United
Technologies, the S&P 500 and the
industry index when comparing the
geometric means. Moving on to the next
measure of absolute performance,
standard deviation, which is a metric that
calculates the relative volatility of the
yearly returns. Looking at the calculation
it is evident that GD yearly stock returns
over the past 10 + years were less volatile
than LMT and BA its two largest
competitors. This means GD experienced
more consistent returns over the
analytical period than did LMT and BA. On
the other hand, GD’s volatility is higher
than UTX’s, SPX 500’s and SPX Industry
Index’s. This indicates that GD
experienced a larger disbursement of
returns in comparison to United
Technologies, the market and the S&P
industry index.
Now it is good to know the volatility
of returns in comparison to comparable
corporations, however that doesn’t quite
tell the whole story. Moving on to the
coefficient of variance helps fill in the rest
of the picture. The coefficient of variance
allows us to assess risk as a function of
returns. The metric indicates how much
volatility or risk an investor is assuming in
comparison to the amount of return you
can expect form your investments. The
lower the coefficient of variance is the less
risk an investor assumes for to obtain the
expected returns. Comparing GD’s
coefficient of variance to that of it’s
competitors and the market indicates that
investors of GD assume less risk to obtain
their returns than investors who bought
into UTX, BA and the S&P 500. However,
GD’s coefficient of variance is greater than
that of LMT and the S&P industry index,
indicating that investors of GD assumed
more risk for their returns than did the
investors of LMT and the S&P industry
index. The final measure of absolute
performance that is good to observe is
simply asking, if an individual invests
$10,000 dollars at the beginning of the
analytical period what is the value of their
investment today? Observing Exhibit ##,
one can see that when an individual
invested $10,000 at the end of 2004, their
investment grew to a value of over
$30,000 by the end of the year 2014. One
can also see from Exhibit ##, that an
investment in GD at the end of 2004 is
worth more today than an equal monetary
investment at the same time in the S&P
500 and the Aerospace & Defense index. It
is understandable after going through the
previous analysis that an investment of
similar value in Lockheed Martin at the
end of 2004 yields a greater value today
than the same investment in GD.
Figu re: 2 -3 Graph depicting the key stock performance indicators of General Dynamics, competitors, the market and industry
Figu re: 2 -4 Graph illustrating a comparison of growth in a $10,000 investment over the past 10 years
PERFO RMANCE CO NCLUSIO N
After completing the stock performance
analysis it is the opinion of these analyst
that General Dynamics is an inferior
investment to Lockheed Martin, a superior
investment to United Technologies,
Boeing and the S&P 500 and a similar
investment to the S&P Aerospace/Defense
Industry Index. The conclusion that GD is
an inferior investment to LMT is derived
from the fact that LMT experienced a
higher average arithmetic mean, a higher
geometric mean, a marginally higher
standard deviation and a lower coefficient
of variance when compared to GD’s
returns over the same time period. LMT’s
greater geometric mean and lower
coefficient of variance indicates that
investors assume less risk for returns that
are on average higher than GD’s returns.
The same logic is applied when looking at
United Technologies, Boeing and the S&P
500. When observing the geometric mean
and coefficient of variance of these
investments it is clear to see from Exhibit
## that investing in UTX, BA and SPX 500
assumes more risk than investing in GD
but provides less returns, or returns that
are marginal greater in the case of BA.
Moving forward, it is easy to see from
Exhibit ## that GD is incredibly similar to
the S&P Aerospace/Defense index. The
absolute performance of GD and the index
over the analytical period are incredibly
identical, making them good similar
investments.
It is the opinion of these analyst
that General Dynamics’s strong stock
return performance over the last three
years continues on into the future. One
reason for this belief is that U.S. govt.
defense spending is estimated to remain at
current levels of over $800 billion dollars
per year all the way through 2020. With
General Dynamics’ strong performance
over the past three years the company is in
line for more than its fair share of
government contracts in the coming years.
Seeing as U.S. government contracts make
up more than 60% of GD’s revenue it is
reasonable to speculate that this large
portion of revenue won’t be adversely
affected in the future. Another reason for
the analyst optimism towards General
Dynamics are the recent defense contracts
that the company won this past year. On
Sept. 30th, 2015 GD was awarded a $358
million dollar contract for Abrams Tanks
only 13 days after it was awarded a $322
million dollar contract from the Navy for a
nuclear submarine project. Analyst believe
these contract trends are projected to
remain consistent over the coming years
indicating GD can experience healthy
growth and returns over that same time
period. The final reason for analyst
optimism lies within the new corporate
management, in particularly with the new
Chairman and Chief Executive Officer
Phebe Novakovic. Since Mrs. Novakovic’s
appointment to CEO on January 1st, 2013
the company experienced the best returns
and stock performance over the past 10+
years. With Mrs. Novakovic’s continued
leadership and direction General
Dynamics looks to be a great investment
for the immediate future.
FINANCIAL PERFORMANCE
GRO WTH PERFO RMANCE
General Dynamics’ consistently
shows positive growth in the Aerospace
and Defense industry. According to
Deloitte’s industry outlook, the Aerospace
and Defense sector is currently projected
to grow by 3 percent for the rest of 2015.
Accompanying this growth are also higher
profit margins even with increases in fuel
costs as a function of sales. This infers that
the industry as a whole becomes more
efficient in asset utilization and are
experiencing the economic principle of
economies of scale. There is sufficient
analytical evidence and research to
conclude that General Dynamics’ is also
projected to follow this industry growth
rate. Historical analysis shows that
General Dynamics’ not only increased
their dividend payment to investors, it also
increased its Return on Equity despite the
decrease in recent year’s revenues. The
analysis shows these historical growths
and breaks down the individual ratios and
drivers that influence the growth of the
company.
REVENUE
For the last ten years General
Dynamics’ revenues show an average
growth of 5.08%. From 2005 up until the
financial recession its growth was
significantly higher than their average, it
reached 14.70% in 2006 and tailed off to
13.50% in 2007 before the distress hit the
market. In 2008 General Dynamics’
witnessed a severe drop in sales due to the
contraction of government spending; their
sales growth fell 50 percent down to 7.00.
Their competitors also experienced such
financial distress due to the economic
recession. Lockheed Martin (LMT), a
similar government defense contractor’s
sales experienced a mere growth of 2.57
percent. Despite the recession General
Dynamics’ and its competitors maintained
a relatively positive sales growth.
Revenues for it and Lockheed Martin were
growing consistently until 2011 year end
when both companies witnessed their first
decrease in sales since the beginning of the
millennium
Figu re: 2 -5 Comparison of sales growth between General Dynamics and its competitors over the past 10 years
GRO SS MARGIN
For ten years General Dynamics
also maintained a consistent gross profit
margin, despite the economic downturn in
2008. From 2005 until 2014 it maintained
an average gross margin of 17.68%, which
was nearly double that of its competitor
Lockheed Martin. It is only inferior to
United Technologies which maintained an
average of 27.24% for the ten year period.
It was directly comparable to Boeing Co.
whose gross margin was 17.31% during
the same period. The industry as a whole
continued to show strong abilities to
control their costs and keeping their profit
margins steady, even as the government
slowed down its spending on the Defense
sector.
Figu re: 2 -6 Comparison of General Dynamics and competitors gross margin over the past 10 years
General Dynamics and comparables Gross Margins
Years 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Company Gross Margin Average
GD 16.59% 17.14% 17.30% 18.27% 17.60% 18.20% 17.92% 16.19% 18.52% 19.04% 17.68%
LMT 8.02% 9.98% 10.81% 12.01% 9.53% 8.78% 8.26% 8.99% 10.10% 11.79% 9.83%
UTX 27.60% 27.37% 27.10% 26.98% 26.57% 27.45% 27.59% 26.95% 27.63% 27.12% 27.24%
BA 16.11% 18.03% 19.56% 17.33% 17.20% 19.38% 18.72% 15.95% 15.42% 15.44% 17.31%
EBITDA
General Dynamics’ was superior to
its competitors and the industry with the
highest average maintained EBITDA
growth for the ten year historical period.
It and its competitors were hit with
negative EBITDA growth years once the
financial recession hit in 2008. The first
company to experience distress was
Boeing, with a -25.30% decline in EBITDA
growth in that year. Lockheed Martin and
United Technologies showed positive
growth until 2009 and 2010, and just like
Boeing their growth went negative.
General Dynamics’ maintained a positive
growth up until 2011 when they
experienced a small decline in their
EBITDA growth. In 2012 it showed
massive losses on their reported financial
statements to the IRS, and consequently
experienced a -67.11% decline in the
EBITDA growth from the previous year.
Each company, including General
Dynamics’ came out of the recession and
combated the decline in EBITDA growth
and ended the ten year period with
averages ranging from General Dynamics
one of 19.88%, to United Technologies
8.99%
Figu re: 2 -7 Comparison of EBITDA growth between General Dynamics and its competitors over the past 10 years
DIVIDEND GRO WTH
A key performance indicator for
investors is the dividend growth of a
company. General Dynamics’ during the
ten year period increased its dividend
payment to its investors. From 2005 until
2014 its dividend grew on average at
13.28%, from paying out .80 cents per
share to $2.48 per share. It showed a slight
decline in growth during the economic
recession but still maintained a positive
increase in the payment itself. Lockheed
Martin show superior performance in its
ability to return value to investors with
dividends increasing from $1.05 per share
in 2005 to $5.49 per share in 2014. Boeing
Co. began the historical period with paying
out $1.05 per share and increased its
dividend per share to $2.92, making it a
good analytical comparison to General
Dynamics’ in the industry. Across the
board each company in the Aerospace and
Defense industry increased its dividend
payments during the ten year period. This
gives investor’s confidence that even
General Dynamics and comparables EBITDA performance
Years 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Company EBITDA growth Average
GD 10.59% 20.07% 17.51% 15.95% 3.34% 6.54% -2.13% -67.11% 190.02% 4.06% 19.88%
LMT 40.66% 27.80% 13.33% 11.78% -11.83% -3.19% -2.22% 8.70% 1.35% 19.85% 10.62%
UTX 13.67% 16.80% 15.65% 15.31% 8.79% -13.67% 6.64% 1.09% 19.79% 5.86% 8.99%
BA 8.55% 41.13% 35.88% -25.30% -30.81% 78.04% 12.03% 7.96% 3.76% 11.58% 14.28%
though government spending declined the
companies, including General Dynamics’,
are willing to maintain dividend policy
which shows confidence with internal
management.
Figu re: 2 -8 Graph illustrating dividends paid per share and dividend growth over the past 10 years
Figu re: 2 -9 Dividends paid per share and dividend growth over the past 10 years
SUSTAINABLE GRO WTH
Due to constant inflows of
government contracts General Dynamics’
sustainable growth rate was 15.5% on
average over the ten year period. It was
only superior to United Technologies
which was only able to maintain a growth
rate of 14%. General Dynamics’ in inferior
to its two larger competitors Lockheed
Martin and Boeing, their sustainable
growth rates for the period were 66.5%
and 34.10% respectively. The overall
Aerospace and Defense industry generates
billions of dollars in backlogged orders
funded from the U.S. Government so there
is no reason not to expect a constant ability
for all companies to maintain a high
sustainable growth rate.
0.00%5.00%10.00%15.00%20.00%25.00%30.00%
0.000.501.001.502.002.503.00
Dividend Growth
Dividend Paid Dividend Growth
General Dynamics 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 Average
Dividend Paid 0.80 0.92 1.16 1.40 1.52 1.68 1.88 2.04 2.24 2.48
Dividend Growth 11.00% 15.00% 26.09% 20.69% 8.57% 10.53% 11.90% 8.51% 9.80% 10.71% 13.28%
Dividends
Figu re: 2 -9 Comparison of General Dynamics and its competitors Dividend POR, ROE, Growth Rate and Plowback Rate
FINANCIAL PERFO RMANCE
FINANCIAL CO NDITIO N RATIO S
General Dynamics’ is superior with
its liquidity ratios to those of its
competitors. For the historical period it
averaged a current ratio of 1.29. The
industry’s competitor’s lower current
ratios indicate that General Dynamics’ is
more capable of paying its liability
obligations than they are. Another
financial condition ratio analyzed was the
Debt to Equity ratios of each company.
The highest levered company in the
analysis was Lockheed Martin, which
averaged a Debt/Equity ratio of 17.68.
This suggests that it is using debt financing
to fund growth, which represents more
risk for investors but if the cost of debt is
lower than that of equity it can provide
higher returns for the company as a whole.
General Dynamics’ maintained a
debt/equity ratio of .311 on average. It is
relying less on long term bank debt to
finance its operations which lowers the
risk for investors but decreases the
possibility of more earnings to disperse to
its shareholders. General Dynamics’ is
operating at a lower debt/equity ratio
than its other competitors Boeing and
United Technologies Corp.
General Dynamics 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 Average
Dividend POR 22.24% 21.75% 22.55% 22.24% 24.43% 24.39% 26.84% 0.00% 31.60% 30.75% 22.7%
ROE 19.06% 20.65% 19.19% 22.54% 21.42% 20.42% 20.04% 17.80% 19.39% 20.45% 20.1%
Growth Rate 14.82% 16.16% 14.86% 17.53% 16.19% 15.44% 14.66% 17.80% 13.27% 14.16% 15.5%
Plowback Rate 77.76% 78.25% 77.45% 77.76% 75.57% 75.61% 73.16% 100.00% 68.40% 69.25% 77.3%
Lockheed Martin 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014
Dividend POR 25.32% 21.27% 20.17% 22.91% 30.28% 36.78% 40.93% 48.94% 52.00% 48.12% 34.7%
ROE 24.52% 34.29% 36.35% 50.78% 82.09% 74.41% 119.24% 525.47% 129.69% 88.45% 116.5%
Growth Rate 18.31% 26.99% 29.02% 39.15% 57.24% 47.04% 70.43% 268.31% 62.26% 45.89% 66.5%
Plowback Rate 74.68% 78.73% 79.83% 77.09% 69.72% 63.22% 59.07% 51.06% 48.00% 51.88% 65.3%
United Technologies Corp12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014
Dividend POR 27.59% 26.66% 26.81% 26.91% 36.88% 35.29% 34.52% 37.55% 34.78% 34.08% 32.1%
ROE 19.64% 21.77% 21.86% 25.27% 23.62% 21.85% 22.32% 20.37% 19.73% 18.51% 21.5%
Growth Rate 14.22% 15.96% 16.00% 18.47% 14.91% 14.14% 14.61% 12.72% 12.87% 12.20% 14.6%
Plowback Rate 72.41% 73.34% 73.19% 73.09% 63.12% 64.71% 65.48% 62.45% 65.22% 65.92% 67.9%
Boeing Company 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014
Dividend POR 33.61% 44.92% 27.06% 44.72% 92.36% 37.60% 31.49% 34.84% 35.80% 40.58% 42.3%
ROE 23.02% 28.04% 59.29% 0.00% 0.00% 122.14% 114.58% 84.82% 46.64% 46.29% 52.5%
Growth Rate 15.28% 15.44% 43.24% 0.00% 0.00% 76.21% 78.50% 55.27% 29.94% 27.50% 34.1%
Plowback Rate 66.39% 55.08% 72.94% 55.28% 7.64% 62.40% 68.51% 65.16% 64.20% 59.42% 57.7%
Figu re: 2 -1 0 Comparison of financial condition ratios of General Dynamics and its competitors over the past 10 years
PRO FITABILITY RATIO S
Discussed earlier in our analysis
was General Dynamics’ gross margin and
EBITDA ratios. This section focuses on
another profitability ratio known as the
Revenue per employee ratio. General
Dynamics’ recorded the second highest
profit per employee ratio between its
competitors. Boeing Co. generated the
most revenue per employee with an
amount of $431,482.80, while General
Dynamics earned $326,332.70. A lot of
factors go into this ratio so it is important
to mention that each company varies
greatly when it comes to its employee
structure. The analyst team does not
consider this ratio to be an important
variable when calculating the value of the
company.
Figu re: 2 -1 1 Comparison of average revenue per employee of General Dynamics and its competitors
General Dynamics and comparables financial performance ratios
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Average
Quick Ratio 1.08 1.01 1.1 0.91 1 1.01 1.1 1.07 1.19 0.95 1.042
Current Ratio 1.33 1.26 1.34 1.15 1.28 1.27 1.28 1.25 1.47 1.27 1.29
LT D/E 0.34 0.28 0.18 0.31 0.25 0.18 0.3 0.34 0.27 0.29 0.274
Tot. D/E 0.4 0.28 0.24 0.4 0.31 0.24 0.3 0.34 0.27 0.33 0.311
Quick Ratio 0.77 0.72 0.8 0.71 0.79 0.76 0.8 0.7 0.76 0.66 0.747
Current Ratio 1.12 1.06 1.11 1.01 1.17 1.15 1.16 1.14 1.2 1.11 1.123
LT D/E 0.61 0.64 0.44 1.24 1.22 1.35 6.45 157.9 1.25 1.81 17.291
Tot. D/E 0.63 0.64 0.45 1.33 1.22 1.35 6.45 161.74 1.25 1.81 17.687
Quick Ratio 0.62 0.67 0.67 0.69 0.72 0.73 0.83 0.67 0.7 0.72 0.702
Current Ratio 1.12 1.24 1.26 1.24 1.29 1.33 1.38 1.24 1.29 1.3 1.269
LT D/E 0.35 0.41 0.38 0.59 0.41 0.47 0.43 0.83 0.62 0.57 0.506
Tot. D/E 0.48 0.46 0.43 0.72 0.49 0.48 0.47 0.9 0.64 0.63 0.57
Quick Ratio 0.41 0.41 0.49 0.3 0.53 0.46 0.42 0.43 0.43 0.37 0.425
Current Ratio 0.78 0.77 0.86 0.84 1.07 1.15 1.21 1.27 1.26 1.2 1.041
LT D/E 0.86 1.72 0.83 0 5.74 4.15 2.85 1.53 0.54 0.94 1.916
Tot. D/E 0.97 2.01 0.91 0 6.07 4.49 3.52 1.77 0.65 1.05 2.144
General Dynamics
Lockheed Martin
United Technologies Corp
Boeing Co
General Dynamics and comparables Revenue per Employee
Company Average revenue per employee
GD 326,332.70$
LMT 339,102.50$
UTX 259,498.70$
BA 431,482.80$
MANAGEMENT EFFECTIVENESS RATIO S
Management’s ability to build value
for its shareholders is a major driver of
company value. General Dynamics’ Net
Return on Assets for the ten year period
was 7.11% on average, and its Net Return
on Equity was 17.69%. It also shows a
high percentage return for its investments.
Using the Operating Return on Investment
ratio the analyst team concluded that
General Dynamics’ averaged a return of
21.10% for the ten year period.
Figu re: 2 -1 2 General Dynamics management effectiveness ratios over the past 10 years w/ historical average
ASSEST MANAGEMENT RATIO S
A key performance measure of a
companies’ ability to utilize its assets
efficiently is the Total Asset Turnover ratio.
This ratio examines the relationship
between total revenue or sales, and total
assets. General Dynamics’ average asset
turnover ratio of 1.025 for the ten year
period. It is inferior to the majority of its
competitors in the industry. Lockheed
Martin outperformed each competitor
with an average of 1.323. Another
performance measure is the Inventory
Turnover ratio. This ratio examines the
relationship between sales and inventory.
This ratio is difficult to analyze for each
competitor. This is because a high ratio
either means an increase in sales or an
ineffective use of inventory. A low ratio
implies a decrease in sales, therefor an
excess in inventory. General Dynamics’
average over ten years was 12.444, while
its competitor Lockheed Martins is 18.152.
United Technologies Corp and Boeing are
both lower with averages of 5.163 and
3.737 respectively. These averages
suggest that General Dynamics’ is less
efficient with its inventories than Boeing
and United Technologies, but it is more
efficient than Lockheed Martin. Boeings’
average is the lowest but it is not because
of a decrease in sales. Earlier in this report
it is noted that Boeings increase in sales
growth was consistent from 2009. The low
ratio implies that it’s using its inventories
inefficiently, or there is an excess in
relation to its sales. Each company shows
an increase in the Accounts Payable
Turnover ratio, which examines the
relationship between total supplier
purchases and average accounts payable.
General Dynamics Management Effectivness Ratios
GD Year 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 Average
ROA % (Net) 7.16% 6.76% -0.96% 7.49% 8.25% 8.05% 9.06% 8.61% 8.85% 7.87% 7.11%
ROE % (Net) 19.24% 18.21% -2.69% 19.03% 20.39% 21.30% 22.48% 19.19% 20.65% 19.06% 17.69%
ROI % (Operating) 22.78% 21.86% 5.12% 22.72% 24.05% 24.21% 25.44% 22.92% 21.83% 20.04% 21.10%
This ratio demonstrates the companies’
ability to pay its suppliers on time. All
companies in the industry, including
General Dynamics’, increased this ratio by
paying off its suppliers faster. A decrease
in the ratio signals a companies’ inability
to produce enough cash flow to pay its
short term obligations on time, and as a
whole the Aerospace and Defense industry
increased the ratio, signaling strong
growth for the future.
Figu re: 2 -1 3 Comparison of asset management ratios between General Dynamics and its competitors
DUPO NT ANALYSIS
GENERAL DYNAMICS
General Dynamics’ average DuPont
calculated Return on Equity for the ten
year period is 17.54%. It is inferior on
paper to the other companies but it is
important to note that the other
companies experienced financial distress
during the economic downtown and began
to borrow a lot of money to fund growth.
This high levered approach increases the
Equity Multiplier (EM) portion of the
DuPont equation. You can see that in years
2011 through 2012 Lockheed Martin
increased its EM drastically to support
company growth. It grew from 9.21 in
General Dynamics and comparables Asset Management
Years 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Average
Company/Ratios
General Dynamics
Total Asset Turnover 1.14 1.15 1.13 1.08 1.08 1.02 0.97 0.91 0.9 0.87 1.025
Receivables Turnover 4.49 4.21 4.02 3.89 4.01 3.85 3.56 3.35 3.4 3.46 3.824
Inventory Turnover 15.12 15.32 15.54 14.05 12.68 12.4 12.01 10.39 8.86 8.07 12.444
Accounts Payable Turnover 13.2 13.13 12.75 12.27 13.3 12.73 11.61 11.72 13.24 14.33 12.828
Accrued Expenses Turnover 17.93 16.27 15.87 17.51 19.91 20.76 20.05 18.35 18.7 20.2 18.555
Property Plant & Equip Turnover 9.89 11.21 11.74 10.94 11.06 11.04 10.45 9.4 9.16 9.15 10.404
Cash & Equivalents Turnover 12.85 12.23 12.12 12.95 16.47 13.32 12.42 10.57 7.26 6.37 11.656
Lockheed Martin
Total Asset Turnover 1.4 1.42 1.46 1.37 1.32 1.31 1.27 1.23 1.21 1.24 1.323
Receivables Turnover 8.58 8.64 8.79 8.34 7.96 7.75 7.87 7.45 7.32 7.78 8.048
Inventory Turnover 18.32 20.23 22.3 21.04 20.06 18.4 17.61 15.87 13.92 13.77 18.152
Accounts Payable Turnover 19.99 18.78 19.1 20.33 22.26 25.05 23.87 21.85 26.41 30.74 22.838
Accrued Expenses Turnover 26.38 25.9 26.77 26.4 27.12 26.04 26.32 28.41 26.23 25.09 26.466
Property Plant & Equip Turnover 9.89 9.93 10 9.68 10.03 10.1 10.15 10.13 9.67 9.64 9.922
Cash & Equivalents Turnover 22.53 19.07 18.36 17.7 19.82 19.69 15.92 17.17 20.09 22.45 19.28
United Technologies Corp
Total Asset Turnover 0.99 1.03 1.08 1.05 0.94 0.95 0.97 0.76 0.7 0.72 0.919
Receivables Turnover 6.3 6.41 6.63 6.52 6.02 6.25 6.3 5.58 5.55 5.72 6.128
Inventory Turnover 5.8 5.64 5.41 5.18 4.9 5.16 5.42 4.86 4.56 4.7 5.163
Accounts Payable Turnover 11.69 11.83 11.75 11.38 10.73 11.04 10.8 9.59 9.35 9.35 10.751
Accrued Expenses Turnover 4.93 4.96 5.13 5.01 4.44 4.52 4.74 4.17 4.09 4.44 4.643
Property Plant & Equip Turnover 7.87 8.43 9.11 9.26 8.33 8.59 9.32 7.82 7.21 7.18 8.312
Cash & Equivalents Turnover 18.94 19.96 20.1 16.19 12.06 12.73 11.59 10.68 13.27 13.21 14.873
Boeing Co
Total Asset Turnover 0.96 1.1 1.2 1.08 1.18 0.98 0.93 0.96 0.95 0.95 1.029
Receivables Turnover 10.08 10.92 11.33 10.04 11.21 10.84 11.48 13.31 13.47 12.26 11.494
Inventory Turnover 7.58 6.29 6.05 4 3.47 2.51 1.98 1.96 1.82 1.71 3.737
Accounts Payable Turnover 7.05 7.84 6.99 6.26 8.01 8.68 8.53 9.15 9.17 9 8.068
Accrued Expenses Turnover 8 8.35 11.01 10.66 7.48 4.72 4.67 5.01 4.57 4.29 6.876
Property Plant & Equip Turnover 6.5 7.65 8.33 7.13 7.78 7.26 7.54 8.59 8.71 8.55 7.804
Cash & Equivalents Turnover 12.73 10.67 10.09 11.78 10.94 8.82 8.92 7.99 8.92 8.72 9.958
2010 to 73.62 in 2012. This statistical
outlier caused its average ROE to be
115.48 percent for the ten year period.
Another company that’s outlier skewed
the results was Boeing Co. In 2009 it
increased its leverage to where its EM hit
138.89, which increased that years ROE to
314.00%. These outliers skew the overall
DuPont analysis for the industry, but with
the adjusted ROE growth factors in the
sustainable growth section this is
accounted for.
Figu re: 2 -1 4 Historical DuPont Analysis for General Dynamics
CO MPETITO RS
Figu re: 2 -1 5 Lockheed Martin’s DuPont Analysis over the past 10 years
Year Profit Margin Asset Turnover Equity Multiplier Unadjusted ROE
2005 6.97% 1.13 2.43 19.14%
2006 7.10% 1.14 2.34 18.94%
2007 7.61% 1.13 2.23 19.18%
2008 8.39% 1.08 2.48 22.47%
2009 7.49% 1.08 2.65 21.44%
2010 8.08% 1.02 2.47 20.36%
2011 7.73% 0.97 2.54 19.05%
2012 -1.05% 0.91 2.81 -2.68%
2013 7.62% 0.89 2.7 18.31%
2014 8.21% 0.87 2.69 19.21%
Average 6.82% 1.022 2.534 17.54%
General Dynamics DuPont Analysis
Year Profit Margin Asset Turnover Equity Multiplier Unadjusted ROE
2005 4.09% 1.4 3.58 20.50%
2006 6.38% 1.42 3.79 34.34%
2007 7.25% 1.46 3.42 36.20%
2008 7.53% 1.37 4.92 50.76%
2009 6.87% 1.28 9.8 86.18%
2010 6.30% 1.3 9.21 75.43%
2011 5.71% 1.27 16.23 117.70%
2012 5.82% 1.23 73.62 527.02%
2013 6.57% 1.21 15.1 120.04%
2014 7.93% 1.24 8.81 86.63%
Average 6.45% 1.318 14.848 115.48%
Lockheed Martin DuPont Analysis
Figu re: 2 -1 6 United Technologies Corp DuPont Analysis for the past 10 years
Figu re: 2 -1 7 Boeing Co DuPont Analysis for the past 10 years
INDUSTRY
The Aerospace and Defense
industry as a whole shows an adjusted
average ROE of 26.87 percent. The
outliers in the individual DuPont
calculations is accounted for and the
numbers are adjusted to portray the true
ROE of the industry over the ten year
period.
Year Profit Margin Asset Turnover Equity Multiplier Unadjusted ROE
2005 4.80% 0.92 5.2 22.96%
2006 3.60% 1.1 7.08 28.04%
2007 0.06% 1.2 8.06 0.59%
2008 4.39% 1.08 14.63 69.36%
2009 1.92% 1.18 138.89 314.67%
2010 5.14% 0.98 26.69 134.44%
2011 5.85% 0.93 23.65 128.67%
2012 4.77% 0.97 18 83.28%
2013 5.29% 0.95 8.75 43.97%
2014 6.00% 0.95 8.15 46.46%
Average 4.18% 1.026 25.91 87.24%
Boeing Co DuPont Analysis
Year Profit Margin Asset Turnover Equity Multiplier Undjusted ROE
2005 7.18% 0.99 2.76 19.62%
2006 7.80% 1.03 2.71 21.77%
2007 7.71% 1.08 2.63 21.90%
2008 7.85% 1.07 3 25.20%
2009 7.24% 0.94 3.14 21.37%
2010 8.05% 0.95 2.76 21.11%
2011 8.93% 0.93 2.77 23.00%
2012 8.89% 0.77 3.16 21.63%
2013 9.14% 0.7 3.12 19.96%
2014 9.55% 0.72 2.88 19.80%
Average 8.23% 0.918 2.893 21.54%
United Technologies Corp DuPont Analysis
Figu re: 2 -1 9 Industry DuPont Analysis
ALTMAN’S Z-SCO RE ANALYSIS
GENERAL DYNAMICS
The Altman Z-Score analyzes the
potential for a publically traded company
to experience financial distress in the near
future. The score gives an investor an idea
of how stable the company is financially. A
z score of over 2.85 shows that a company
is in no financial distress, while one below
1.80 means that the company is going to
face bankruptcy within the next year. The
middle of the two extremes is considered
the grey area and an investor needs to be
careful and analyze the company in
question to make sure they are confident
in the companies’ chances of growth.
General Dynamics’ Z score is 3.3648, so
according to the Altman analysis it is no
danger of financial distress. Its
competitors Lockheed Martin, United
Technologies Corp, and Boeing all show Z
scores of 3.4141, 2.9248, and 2.4179
respectively. The only companies that are
in the grey range are United Technologies
and Boeing. If you consider the financial
position the companies are in according to
the financial statements, neither United
Technologies nor Boeing are set to
experience financial distress within the
next two years.
Company Profit Margin Asset Turnover Equity Multiplier
GENERAL DYNAMICS CORP 8.21 0.87 2.69
LOCKHEED MARTIN CORP 7.93 1.24 8.81
RAYTHEON COMPANY 9.83 0.85 2.62
BOEING CO/THE 6.00 0.95 8.15
TEXTRON INC 4.32 1.01 3.18
MOOG INC-CLASS A 5.97 0.82 2.24
HEXCEL CORP 11.29 0.96 1.68
NORTHROP GRUMMAN CORP 8.63 0.91 2.97
TELEDYNE TECHNOLOGIES INC 9.09 0.85 1.94
MSA SAFETY INC 7.79 0.91 2.29
PRECISION CASTPARTS CORP 15.29 0.53 1.7
Average Average 8.58 0.90 3.48
Du pont Analysis ROE26.87% 26.87%
Industry Du Pont Analysis
Figu re: 2 -2 0 General Dynamics most recent Z-score evaluation
CO MPETITO RS
Figu re: 2 -2 1 Competitors most recent Z-score evaluation
Factors Ratio Value Weight Z-Score
NWC/Total Assets 0.1034 1.2 0.12408
RE/Total Assets 0.5976 1.4 0.83664
EBIT/Total Assets 0.1108 3.3 0.36564
MV of Equity/BV of Total Liab. 1.9431 0.6 1.16586
Sales/Total Assets 0.8726 1 0.8726
Z-Score 3.36482
General Dynamics Z Score
Factors Ratio Value Weight Z-Score
NWC/Total Assets 0.0328 1.2 0.03936
RE/Total Assets 0.4034 1.4 0.56476
EBIT/Total Assets 0.1523 3.3 0.50259
MV of Equity/BV of Total Liab. 1.7957 0.6 1.07742
Sales/Total Assets 1.23 1 1.23
Z-Score 3.41413
Lockheed Martin Z Score
Factors Ratio Value Weight Z-Score
NWC/Total Assets 0.0752 1.2 0.09024
RE/Total Assets 0.4887 1.4 0.68418
EBIT/Total Assets 0.111 3.3 0.3663
MV of Equity/BV of Total Liab. 1.7851 0.6 1.07106
Sales/Total Assets 0.7131 1 0.7131
Z-Score 2.92488
United Technologies Corp Z Score
Factors Ratio Value Weight Z-Score
NWC/Total Assets 0.1116 1.2 0.13392
RE/Total Assets 0.3647 1.4 0.51058
EBIT/Total Assets 0.0754 3.3 0.24882
MV of Equity/BV of Total Liab. 1.0161 0.6 0.60966
Sales/Total Assets 0.915 1 0.915
Z-Score 2.41798
Boeing Co. Z Score
INDUSTRY
The Aerospace and Defense
industry as a whole gives no inclination
that it might experience any financial
distress in the near future. The industry
average Z score for the period is 3.0304.
The fact that each company backlogs
billions of dollars in funded orders from
the U.S. Government and other affiliates,
gives this analyst team a strong sense of
future industry growth. All these signs
give investors a positive outlook.
Figu re: 2 -2 2 Industry average Z-score evaluation
Factors Ratio Value Weight Z-Score
NWC/Total Assets 0.08075 1.2 0.0969
RE/Total Assets 0.4636 1.4 0.64904
EBIT/Total Assets 0.112375 3.3 0.3708375
MV of Equity/BV of Total Liab. 1.635 0.6 0.981
Sales/Total Assets 0.932675 1 0.932675
Z-Score 3.0304525
Industry Average Z Score
GENERAL DYNAMICS COST OF CAPITAL, CAPITAL STRUCTURE ANALYSIS
AND DISTRIBUTIONS
DEBT
General Dynamics’ ten year average cost of debt is
3.24%. It maintains an average market value Debt/Equity ratio
of 31.16%. Its use of long term debt to finance operations is
minimal compared to its competitors. Lockheed Martin, Boeing,
and United Technologies use a significantly higher amount of
long term debt. Lockheed Martins’ 2014 Debt/Equity ratio is
181.00%; therefore the analytical approach to determine a target
Debt/Equity ratio of 30% was calculated ignoring major
statistical outliers from comparable companies’, it is determined
from General Dynamics’ historical ratio analysis.
EXTERNAL EQUITY
General Dynamics’ market capitalization is $46,198.40
billion dollars. Its shares outstanding decreased from 2007 to
2014, from 402.37 million to 331.39 million respectively. Its
levered cost of Equity is 9.47% with a beta of 1.02. Unlevered its
cost of external equity is 3.39%, with a beta of .19. Comparabl e
companies Lockheed Martin, Boeing, and United Technologies
Corp maintain costs of equity close to General Dynamics’, being
8.68%, 9.56%, and 9.73% respectively.
INTERNAL EQUITY
General Dynamics’ cost of internal equity is 8.30%. Its
calculation is derived from a projected 6% dividend growth, and
a researched flotation cost of 7%. A 6% dividend growth rate is
based off General Dynamics’ historical residual dividend
payment.
COST OF CAPITAL
CAPITAL STRUCTURE
FO RECAST
Cost of Debt 2.20%
Book Value Debt/Equity 7.00%
Mkt. Value Debt/Equity 33.06%
Target 30.00%
General Dynamics Debt Structure
Company Cost of Equity Average
GD 9.47% 9.36%
LMT 8.68%
BA 9.56%
UTX 9.73%
General Dynamics and Comparables External Equity
Estimated Dividend Growth 6.00%
Flotation Costs 7.00%
Internal Cost 8.30%
General Dynamics Internal Cost of Equity
DISTRIBUTIONS TO SHAREHOLDERS
Even though it is apparent that General Dynamics’ yearly
dividends are based on a residual model, and grew at a 10.01%
rate on average since the Great Recession, thus an appropriate
and conservative yearly dividend growth rate going forward is
6%.
UNIT 3 COST OF CAPTIAL, CAP ITAL STRUCTURE ANALY SIS AND DISTRIBUTION
DEBT
RELEVANT CO ST O F DEB T
General Dynamics’ relevant cost of
debt over the ten year period is 3.24% on
average. From 2005 up to 2008 it
maintained a consistent mixture of short
term and long term debt. The short term
debt utilized is an average of 16%,
consequently the long term debt utilized is
84%. In 2008 General Dynamics’ began to
use more short term and long term debt to
finance operations due to the recession in
the contracting economy. The next year its
cost of debt increased to 4.14%, up from
1.64% in 2008. Research into this matter
concludes that the cost of debt drastically
dropped during 2008 due to a sharp
decline in Federal Reserve borrowing
interest rate averages. Interest rates
decreased to a point that it enabled
General Dynamics to borrow a large
amount of short term debt and increase its
long term debt to equity structure. In
2009 when the market began to make its
way back towards equilibrium, General
Dynamics’ was paying a higher interest
rate on debt than when they borrowed in
2008. Its interest expense increased and
caused the increase in the relevant cost of
debt. In comparison to its industry
competitors General Dynamics’ cost of
debt is higher. Lockheed Martin, Boeing,
and United Technologies Corp. borrow at
1.77%, 1.85%, and 1.76% respectively.
This is due to the fact that General
Dynamics’s uses far less short and long
term debt than its competitors, which
directly affects the cost of debt because
companies that borrow more on average
pay a lower cost to borrow.
Relevant cost of debt (in millions)
Short Term Debt Long Term Debt Interest Payments Net Cost of Debt
2005 509.00$ 2005 2,778.00$ 118.00$ 3.59%
2006 7.00$ 2006 2,774.00$ 101.00$ 3.63%
2007 673.00$ 2007 2,118.00$ 70.00$ 2.51%
2008 911.00$ 2008 3,113.00$ 66.00$ 1.64%
2009 705.00$ 2009 3,159.00$ 160.00$ 4.14%
2010 773.00$ 2010 2,429.00$ 157.00$ 4.90%
2011 23.00$ 2011 3,907.00$ 141.00$ 3.59%
2012 -$ 2012 3,908.00$ 156.00$ 3.99%
2013 1.00$ 2013 3,908.00$ 86.00$ 2.20%
2014 501.00$ 2014 3,410.00$ 86.00$ 2.20%
Average 3.24%
General Dynamics Debt
Figu re: 3 -1 General Dynamics cost of debt over the past 10 years
Figu re: 3 -2 Comparison of competitors Total Debt/Equity ratios with cost of debt
DEBT RATIO S
General Dynamics’ debt structure is
different than its competitors. As
mentioned before it uses less debt to
finance operations, and it’s more reliant on
equity to fund growth. Since 2005 it
averaged a Total Debt/Equity ratio of
31.16%, which is far less than Lockheed
Martin and Boeing whose Total
Debt/Equity ratios averaged 173.83% and
208.91% respectively. The high ratios are
due to the decision to use large amounts of
long term debt to fund operations. In
comparison General Dynamics’ is more
efficient in its operations because it
provides value for its investors and it does
so by not requiring the use of such high
volumes of debt. It is far more comparable
but still superior with its Long Term
Debt/Assets ratio. This ratio indicates a
companies’ ability to meet its financial
obligations. A higher percentage means
that the company needs to maintain
greater revenue and cash flow to support
the expenses due the assets being more
encumbered. General Dynamics’ averaged
a 10.66% ratio, and its competitors
Lockheed, Boeing, and United
Technologies were comparable at 15.37%,
13.34%, and 17.19% respectively. This
presents the argument that General
Dynamics’ needs to produce less revenue
to support its liability payments compared
to its competitors in the industry.
Year Lockheed Martin Boeing United Tech. Corp
2005 63.38 97 46.37
2006 64.48 201.27 43.74
2007 44.95 91.26 41.08
2008 132.81 0 68.8
2009 122.35 580.85 45.56
2010 143.52 434 45.43
2011 645.35 342.88 44.27
2012 16174.36 174.44 85.04
2013 125.09 64.25 60.73
2014 181.44 103.19 60.52
Cost 1.77% 1.85% 1.76%
Comparables Total Debt/Equity and Cost of Debt
General Dynamics (GD)
Figu re: 3 -3 Debt ratios for General Dynamics
General Dynamics maintains a
relatively constant debt to equity
structure, unlike its competitors
who use far more long term debt
financing
The small difference in Long Term
Debt/Equity and Total Debt/Equity
is due to the small changes in the
use of short term debt
The Long Term Debt/Assets ratio
suggests that GD is more efficient at
producing revenues to support its
liabilities
Year Long term/Equity Year Long term/Assets
2005 34.11 2005 14.1
2006 28.23 2006 12.4
2007 18 2007 8.23
2008 30.97 2008 10.97
2009 25.43 2009 10.17
2010 18.25 2010 7.47
2011 29.53 2011 11.2
2012 34.31 2012 11.39
2013 26.95 2013 11.01
2014 28.83 2014 9.65
Average 27.461 10.659
Year Total Debt/Equity Year Total Debt/Capital
2005 40.36 2005 28.75
2006 28.3 2006 22.06
2007 23.72 2007 19.17
2008 40.03 2008 28.59
2009 31.1 2009 23.72
2010 24.05 2010 19.39
2011 29.7 2011 22.9
2012 34.31 2012 25.55
2013 26.96 2013 21.23
2014 33.06 2014 24.85
Average 31.159 23.621
General Dynamics Debt Ratios
Comparable Companies Relevant Debt Ratios:
Lockheed Martin (LMT)
Figu re: 3 -4 Debt Ratios of Lockheed Martin
Lockheed Total Debt/Equity and
Long Term Debt/Equity ratios are
larger than GD’s.
It focuses more on the use of debt
to finance its company growth.
The Long Term/Asset ratio is also
higher than GD’s, suggesting that is
less efficient in producing revenues
to support its liabilities.
A noticeably significant ratio is the
one in 2012 when Lockheed
increased their borrowing by over
a 1,000%.
Year Long term/Equity Year Long term/Assets
2005 60.81 2005 17.24
2006 63.99 2006 15.6
2007 43.89 2007 14.88
2008 124.36 2008 10.66
2009 122.35 2009 14.39
2010 143.52 2010 14.29
2011 645.35 2011 17.04
2012 15789.74 2012 15.93
2013 125.09 2013 17
2014 181.44 2014 16.64
Average 1730.054 15.367
Year Total Debt/Equity Year Total Debt/Capital
2005 63.38 2005 38.79
2006 64.48 2006 39.2
2007 44.95 2007 31.01
2008 132.81 2008 57.05
2009 122.35 2009 55.03
2010 143.52 2010 58.94
2011 645.35 2011 86.58
2012 16174.36 2012 99.39
2013 125.09 2013 55.57
2014 181.44 2014 64.47
Average 1769.773 58.603
Lockheed Martin Debt Structure (Book Value)
Boeing Co. (BA)
Figu re: 3 -5 Debt Ratios of Boeing Co
Boeing’s Total Debt/Equity and
Long Term Debt/Equity ratios are
larger than General Dynamics’, but
they are smaller than that of
Lockheed Martins.
Long Term Debt/Asset ratio is
smaller than Lockheed Martin’s,
but 3 points higher on average than
General Dynamics’.
A noticeably significant ratio is the
one in 2009 when it is obvious that
Boeing increased their use of debt
financing to repair any issues from
the recession.
Year Long term/Equity Year Long term/Assets
2005 86.25 2005 15.9
2006 172.12 2006 15.75
2007 82.8 2007 12.64
2008 0 2008 12.93
2009 549.08 2009 19.69
2010 400.87 2010 16.73
2011 277.66 2011 12.52
2012 150.38 2012 10.09
2013 53.82 2013 8.71
2014 92.62 2014 8.21
Average 186.56 13.317
Year Total Debt/Equity Year Total Debt/Capital
2005 97 2005 49.24
2006 201.27 2006 66.81
2007 91.26 2007 13.93
2008 0 2008 13.97
2009 580.85 2009 85.31
2010 434 2010 81.27
2011 342.88 2011 77.42
2012 174.44 2012 63.56
2013 64.25 2013 39.12
2014 103.19 2014 50.78
Average 208.914 54.141
Boeing Co. Debt Structure (Book Value)
United Technologies Corp
Figu re: 3 -6 United Technologies Corp Debt Ratios
United Technologies Corp is the
most comparable to General
Dynamics’ debt structure
Their Long Term Debt/Equity and
Total Debt/Equity ratios are
consistent with how General
Dynamics’ are. That being the
small increase is due to changes in
Short Term borrowing
Unlike Boeing and Lockheed Martin,
United Technologies Corp. did not
increase long term borrowing
significantly after the recession.
Year Long term/Equity Year Long term/Assets
2005 33.4 2005 12.92
2006 38.81 2006 14.93
2007 35.99 2007 14.69
2008 55.16 2008 16.43
2009 38.61 2009 14.81
2010 44.2 2010 17.11
2011 40.99 2011 15.46
2012 79.09 2012 24.16
2013 59.23 2013 21.79
2014 54.65 2014 19.58
Average 48.013 17.188
Year Total Debt/Equity Year Total Debt/Capital
2005 46.37 2005 31.68
2006 43.74 2006 30.43
2007 41.08 2007 29.12
2008 68.8 2008 40.41
2009 45.56 2009 31.3
2010 45.43 2010 31.24
2011 44.27 2011 30.68
2012 85.04 2012 45.96
2013 60.73 2013 37.78
2014 60.52 2014 37.7
Average 54.154 34.63
United Technologies Corp Debt Structure (Book Value)
EXT ERN AL EQ UIT Y
RELEVANT CO ST O F EXTERNAL EQ UITY
General Dynamics’ external cost of
equity is derived from using the Capital
Asset Pricing Model. This model factors in
the current Risk Free Rate, usually based
on Long-Term Treasury Bills, the Market
Risk Premium, and General Dynamics’
Beta.
CAPM:
Cost of Equity = 𝑹𝒇 + (𝑹𝒎 − 𝑹𝒇) ∗ 𝜷
General Dynamics’ Cost of Equity is 9.43%
INPUTS: Risk Free Treasury Rate- 2.21%
Expected Return on the Market- 9.22%
Risk Premium- 7.22%
Beta- 1.03
Figu re: 3 -7 General Dynamics Cost of Equity using CAPM
General Dynamics’ cost of equity is
currently higher than it was for the fiscal
year ending 2014. This is due to the
company becoming more risky in relation
to the market. Its Beta increased from .98
to 1.03 and the risk free rate increased
slightly. In 2013 it was more risky than the
market, its Beta of 1.26 is due to the fact in
2102 it showed great losses on its financial
statements. This adds the perception of
higher risk to investors and the market.
Year 2015 2014 2013
Risk Free 2.21% 2.17% 3.03%
Market Return 9.22% 9.24% 9.77%
Risk Premium 7.22% 7.07% 6.75%
Beta 1.03 0.98 1.26
Cost of Equity 9.43% 9.10% 11.53%
General Dynamics Cost of Equity
Captial Asses Pricing Model
COMPARABLE COMPANIES CAPM:
-Lockheed Martin (LMT)
INPUTS: Risk Free – unchanged
Expected Market Return-unchanged
Risk Premium- unchanged
Beta - .84
Figu re: 3 -8 Lockheed Martin cost of equity using CAPM
-Boeing Co. (BA)
INPUTS: Risk Free – unchanged
Expected Market Return-unchanged
Risk Premium- unchanged
Beta-1.197
Figu re: 3 -9 Boeing Co. cost of equity using CAPM
Year 2015 2014 2013
Risk Free 2.21% 2.17% 3.03%
Market Return 9.22% 9.24% 9.77%
Risk Premium 7.22% 7.07% 6.75%
Beta 0.84 0.953 1.037
Cost of Equity 8.66% 8.91% 10.02%
Lockheed Martin Cost of Equity
Captial Asses Pricing Model
Year 2015 2014 2013
Risk Free 2.21% 2.17% 3.03%
Market Return 9.22% 9.24% 9.77%
Risk Premium 7.22% 7.07% 6.75%
Beta 1.197 0.946 0.914
Cost of Equity 9.60% 8.86% 9.19%
Boeing Co. Cost of Equity
Captial Asses Pricing Model
-United Technologies Corp. (UTX)
INPUTS: Risk Free – unchanged
Expected Market Return-unchanged
Risk Premium- unchanged
Beta- 1.152
Figu re: 3 -1 0 United Technologies Corp cost of equity using CAPM
Analysis:
General Dynamics’ relevant cost of
external equity is comparable to that of its
competitors. This is due to the fact that
each companies Betas’ are not
significantly more or less risky than each
other. General Dynamics’ Beta is higher
than the markets Beta of 1.0, and the same
is true for its competitors.
UNLEVERED AND RELEVERED BETA
The un-levering and re-levering of Beta is
used when a company decides to change
its capital structure to a target ratio.
General Dynamics’ currently operates
with a book value Debt/Equity ratio of
31.17%. The analysis of its historical
Debt/Equity ratios and the projected
target ratios shows a target ratio of 30%
Debt and 70% Equity.
The Market Values of Debt/Equity is
significantly different, so this analyst team
decided to use book values to illustrate the
un-levering and re-levering of Beta. To un-
lever Beta we used Hammadas’ Equation.
Year 2015 2014 2013
Risk Free 2.21% 2.17% 3.03%
Market Return 9.22% 9.24% 9.77%
Risk Premium 7.22% 7.07% 6.75%
Beta 1.152 1.083 1.158
Cost of Equity 9.81% 9.83% 10.84%
United Technologies Corp. Cost of Equity
Captial Asses Pricing Model
Formula: 𝛽𝑢 = 𝛽𝑒
1+(1−𝑡𝑎𝑥 𝑟𝑎𝑡𝑒)∗(𝐷
𝐸)
INPUTS: -𝛽e= 1.03
-𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑇𝑎𝑥 𝑅𝑎𝑡𝑒= 29.19%
-𝐶𝑢𝑟𝑟𝑒𝑛𝑡𝐷𝑒𝑏𝑡
𝐸𝑞𝑢𝑖𝑡𝑦= 31.17%
𝜷u= General Dynamics’ Un-levered Beta is .8438
-To Re-Lever the Beta the new Target Debt/Equity ratio of 30% is used.
Formula: 𝛽𝑢 * [1 + (1- tax rate) * (𝐷𝑛
𝐸𝑛)]
INPUTS: - βu= .8438
- Corporate Tax Rate = 29.19%
- New Target Debt/Equity = 30.00%
𝜷e = General Dynamics’ Re -levered Beta is 1.023
-The new Re-levered Beta is lower than the original levered Beta, due to the target Debt/Equity ratio decreasing from the current ratio.
Figu re: 3 -1 1 General Dynamics historical levered Beta
Year Beta Adjusted
2005 0.662 0.774
2006 0.616 0.744
2007 1.018 1.012
2008 0.826 0.884
2009 1.193 1.129
2010 0.943 0.962
2011 0.853 0.902
2012 1.369 1.246
2013 0.79 0.86
2014 1.112 1.075
Average 0.9382 0.9588
General Dynamics Historical Levered Beta
Figu re: 3 -1 2 General Dynamics’ un-levered and re-levered Beta
INTERN AL CO ST O F EQ U ITY
RELEVANT CO ST O F INT ERNAL EQ UITY
The cost of internal equity is the most
difficult to determine. Several methods
can be used to estimate the internal cost of
equity. One is the Risk premium method
which assumes that General Dynamics’
incurs additional risk by taking on the new
investment using internal funds. The
second, and method that is used in this
analysis is the Dividend-valuation method.
This valuation uses the perspective of its
shareholders to determine the internal
cost of equity. Shareholder wealth is a
function of the dividends General
Dynamics’ pays out and the stock price.
This method is used to determine General
Dynamics’ internal cost of equity and a few
assumptions were used in the calculation.
In this valuation we also chose to calculate
the cost using an historical growth in
dividends, and a more feasible long-term
growth rate. A flotation cost of 7.00% was
also assumed based off of Investment
Banking rates for issuing equity.
FORMULA: 𝐷𝐼𝑉𝑐𝑢𝑟𝑟𝑒𝑛𝑡 ∗(1+𝑔)
𝑆𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒∗((1−𝐹𝑙𝑜𝑡𝑎𝑡𝑖𝑜𝑛)+𝑔)
Historical Dividend Growth
INPUTS: -Current Stock Price = $144.29
-Growth rate = 13.26%
-Flotation Cost = 7.00%
-Current Dividend= 2.86
Historical Dividend Growth Internal Cost of Equity
Ke= 2.27%
Beta 1.03 βu 0.8438
Tax Rate 29.19% Tax Rate 29.19%
Current D/E 31.17% Target D/E 30.00%
βu 0.8438 βe 1.023
GDs'Un-levered and Re-levered Beta
*The internal cost of equity using this
method is lower than the external cost.
This is due to the use such a high dividend
growth rate. In the second scenario
General Dynamics’ payout growth is
5.00%. This analyst team believes that it
cannot maintain such a high dividend
growth rate because this destroys value
for the firm. The internal cost of equity
must always be less than the cost of issuing
it externally. The second valuation of the
internal cost of equity is as follows.
Feasible Growth Rate
INPUTS: -Current Stock Price = $144.29
-Growth Rate = 5.00%
-Flotation Cost = 7.00%
-Current Dividend = 2.86
Feasible Growth Rate
Ke = 2.24%
*This scenario is more economically
feasible and is believed to be the optimal
choice. General Dynamics’ cannot
maintain such a high payout percentage
because it always destroy value for its
shareholders. It needs to keep its internal
cost of equity lower than it’s external,
otherwise the traditional pecking order of
financial structure does not hold. The two
graphs that follow illustrate scenarios
where it changes its flotation costs and
also maintains a constant upward trend
for dividend growth.
*A decreasing Flotation cost
Figu re: 3 -1 2 General Dynamics Cost of Internal Equity w/ decreasing flotation costs
Figu re: 3 -1 3 General Dynamics Cost of Internal Equity illustrated w/ decreasing flotation costs
*A constant flotation cost and increase in dividend growth
Figu re: 3 -1 4 General Dynamics Cost of Internal Equity w/ constant flotation and increased dividend growth
Figure: 3 -1 5 General Dynamics Cost of Internal Equity illustrated w/ constant flotation and increased dividend growth
Most recent dividend per s. 12/31/2014 2.86$ 2.86$ 2.86$ 2.86$ 2.86$ 2.86$ 2.86$ 2.86$
Market Price per share 10/16/2015 144.29$ 144.29$ 144.29$ 144.29$ 144.29$ 144.29$ 144.29$ 144.29$
Flotation cost 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00%
dividend growth rate 5.00% 8.00% 9.00% 10.00% 15.00% 20.00% 25.00% 30.00%
Cost of internal equity 2.2370% 2.3004% 2.3216% 2.3427% 2.4483% 2.5538% 2.6592% 2.7645%
CAPTIAL STRUCTURE
GENERAL DYNAMICS CAPITAL & STRUCURE
General Dynamics’ Market cap is
$43,982.90 Billion dollars. It currently
operates with 316.1 million shares
outstanding, at a market price of $144.29
per share. Its Capital is comprised of 3
major accounts which are, Long-Term
Debt, Common stock and APIC, and
Retained Earnings. General Dynamics’
Deferred Income tax account is quite large
while Short-Term Debt is quite small in
comparison to its amount of debt overall.
These items in the equity section amount
to a Total Invested Capital of $12,732
million.
Figu re: 3 -1 6 General Dynamics invested capital (millions)
General Dynamics’ Capital Structure
\
Figu re: 3 -1 7 General Dynamics Capital Structure
Long Term Debt 2,912.00$
Common Stock and APIC 3,179.00$
Retained Earnings 7,555.00$
Deferred Tax Income (1,415.00)$
Short Term Debt 501.00$
Total 12,732.00$
General Dynamics' Invested Capital (in millions)
Comparable Companies’ Capital Structure
Figu re: 3 -1 8 Capital Structures of General Dynamics’ Competitors
Figu re: 3 -1 9 Chart depicting comparison of capital structures
CO ST O F CAPITAL
WACC
General Dynamics’ cost of capital,
calculated by using the Weighted Average
Cost of Capital equation (WACC), is 9.35%.
The WACC equation accounts for its cost of
equity and the current capital structure is
utilize
FORMULA: 𝑾𝒅 ∗ 𝑲𝒅(𝟏 − 𝒕𝒂𝒙 𝒓𝒂𝒕𝒆) + 𝑾𝒆 ∗ 𝑲𝒆 INPUTS: Wd= Weight of firms debt in capital structure
Kd = Cost of firms debt
We = Weight of firms equity in capital structure
Ke = Cost of equity as calculated from CAPM
Current WACC: 7.88% * 1.79% + 92.12% * 9.99%
WACC 9.35% General Dynamics’ current cost of capital
is a function of its capital structure. It
maintains a relatively constant
Debt/Equity structure. This ratio of 30%
debt and 70% equity keeps its WACC on a
historical linear trend. The exception was
in 2010 when its WACC increased to 11%
due to its increase in borrowing of Long-
Term Debt. Below is a historical analysis
of its cost of capital.
GD LMT
Market Cap 43,982.90$ Market Cap 62,654.50$
Long term Debt 2,912.00$ Long term Debt 7,460.00$
Short Term Debt 501.00$ Short Term Debt 952.00$
Preferred Equity -$ Preferred Equity -$
Total $47,395.90 Total 71,066.50$
UTX BA
Market Cap 78,936.00$ Market Cap 87,862.30$
Long term Debt 19,428.00$ Long term Debt 8,402.00$
Short Term Debt 32,399.00$ Short Term Debt 614.00$
Preferred Equity -$ Preferred Equity -$
Total 101,603.00$ Total 96,878.30$
Capital Structure Comparison (in millions)
Figu re: 3 -2 0 General Dynamics Cost of Capital over past 10 years
Figu re: 3 -2 1 General Dynamics Historical Cost of Capital
Historically its WACC was
relatively constant. This is
again due to its constant
capital structure.
The 2010 increase was due
to the increase in borrowing
which was a consequence of
slowed business and
contraction from the
recession in 2009.
7.00%
8.00%
9.00%
10.00%
11.00%
FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014
Cost of Captial (WACC)
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Weight of Equity 87.41% 91.56% 92.80% 84.70% 87.19% 89.18% 86.28% 86.24% 89.62% 92.12%
Cost of Equity 9.29% 8.45% 9.62% 10.27% 10.05% 12.04% 10.83% 10.25% 10.20% 9.99%
Weight of Debt 12.59% 8.44% 7.20% 15.30% 12.81% 10.82% 13.72% 13.76% 10.38% 7.88%
Cost of Debt 3.95% 4.09% 3.32% 1.67% 2.95% 2.36% 1.65% 0.90% 2.68% 1.79%
WACC 8.62% 8.08% 9.17% 8.95% 9.14% 10.99% 9.57% 8.97% 9.42% 9.35%
General Dyanmics' Historical Cost of Capital (WACC)
GENERAL DYNAMICS FORECASTED VALUATION
FO RECASTED PARAMETER S
ECO NO MIC O UTLO O K
Aerospace and Defense Industry is expected to grow
around 3% in the coming year.
Changing economic environment due to changing
patterns of defense spending by largest contributors.
Aerospace alone is expected to grow by 8% of revenue
due to increasing demand for commercial air travel in
developing countries.
PRO JECTED FINANCIAL RATIO S
RATIO ANALYSIS O F FO RECAST
*The graph above shows ratio calculations for the first year
forecast in 2015, and the horizon point in year 2020.
DUPO NT ANALYSIS
DuPont ROE= PM x Asset Turnover x Equity Multiplier
Over the entire forecast period the lowest calculated
ROE based on the DuPont method is 12.57% in the year
2026.
ALTMAN Z-SCORE
Based upon the Altman Z-Score Analysis General
Dynamics is expected to enjoy good financial standing
under the forecasted assumption.
The lowest Z-score over the forecasted period is, 3.14
and occurs in the final forecast year.
UNIT 4 SECTION 1: FORECAST PARAMETERS
ASSUMPTIO NS
Several assumptions must be
acknowledge prior to presenting the
financial analyses and forecast. The major
assumption of the forecast calculates a
starting weighted average sales growth
rate, based upon 2014 10k financial
performances and firm specific
projections for the fiscal year 2015. This
weighted growth rate for the firm is then
adjusted for current industry and market
predictions. After making assumptions on
short and long term sales growth
projections it is then important to make
assumptions about how different accounts
grow over the projected period. In general,
it is the goal of this analyst team to analyze
and project on current trends that are
justifiable by the historical analyses.
ECO NO MIC O UTLO O K
DEFENSE O UTLO O K
Overall global defense spending is
declining, resulting mainly from the
reduced armed conflict in Iraq and
Afghanistan and affordability concerns in
many traditional militarily active
government. The U.S. spends by far the
most on defense with 39% of the total
global spending. Considering that General
Dynamics’ earned over 60% of its revenue
in 2014 through U.S. government
contracts, decreases in U.S. defense
spending is going to disproportionately
affect General Dynamics’ in the short term.
While this potential reduction in revenue
is concerning, analyst are optimistic
because of GD’s consistent ability over the
past three years to increase operating
margins across all business units. In 2012
operating margins, 2.5%, were low due to
a significant impairment in goodwill
associated with the Information and
Technology business unit, baring this set
back, operating margins increased to
12.6% by 2014. Many within the defense
industry are taking the same approaches
as GD to ensure high operating margins in
the face of reducing revenues. The graph
below illustrates that on average
operating margins across the Defense
industry increased significantly in
comparison to the declining revenues in
terms of U.S. dollars. Looking forward, it’s
up to GD’s management to secure
footholds in developing foreign markets
that fuel long term growth if U.S. spending
trends decrease drastically.
Figu re: 4 -1 Graph from Deloitte 2014 Aerospace/Defense industry outlook comparing industry revenue growth and operating margin
AERO SPACE O UTLO O K
Commercial Aerospace global revenue as a
percent of kilometers traveled increased
significantly over the last 30 plus years,
resulting in greater utilization of aircraft
and more sold out flights. Passenger travel
demand is expected to increase 5% every
year over the next 20 years, contributing
to increases in aircraft production. The
graph below illustrates this trend. While
GD’s Gulfstream division constructs
aircraft for personal and corporate uses
rather than commercial uses, GD still
experienced revenue growth in its
Aerospace division due to additional
deliveries of large-cabin aircraft and
increases in demand for maintenance
work. In 2015 firm projections expected
the Aerospace division to grow by 8% of
revenues
Figu re: 4 -2 Graph from Deloitte 2014 Aerospace/Defense industry outlook illustrating growth of key metrics in the Aerospace sector
SECTION 2: PRO FORMA FINANCIAL STATEMENTS
RATIO S TO CALCULATE O PERATING PRO FIT
SALES GRO WTH RATE
Consistent with any company that is highly
correlated to the market, the ability for GD
to grow and obtain new contracts is
paramount to company success. To
forecast the sales growth rate for GD
required analysis of two sets of
information. First, was the analysis of firm
specific information and projections, the
chart below displays growth projections
for the year 2015, pulled from General
Dynamics’ 2014 10k. The chart also shows
the average percentage of total revenue
that each business unit contributed over
the past five years. By multiplying each
projected business unit growth rate by its
respective weight of total revenue, then
summing the products, the resulting
calculated growth rate is .098% of total
revenue. Second, analysis of industry
conditions is important to consider.
Reviewing both Deloitte’s and KPMG’s
projected reports for the Aerospace and
Defense industry, both reports were
consistent in speculating the Aerospace
and Defense industry is projected to grow
between three and four percent in the
coming years. Using both the firm specific
projection of .098% and a conservative
industry projection of 3%, each projection
was equally weighted to arrive at an
average growth rate of 1.55% for the short
term.
Figu re: 4 -3 Chart depicting firm specific and industry projections for revenue growth in the year 2015
In the forecast, the long term
growth rate is set to 4% which is justified
because both General Dynamics and the
S&P 500 grew at 4% on average over the
analyzed historical period. While this
seems curious to forecast a lower short
term growth rate in comparison with the
long term growth rate, the reason is due to
the short term volatility in the Aerospace
and Defense Industry. Due to General
Dynamics’ ability to increase its overall
operating margin, the company is in a
good financial standing to weather the
change in the current economic
environment. A .10 fade was added to the
graph to incorporate awarded contracts to
GD that are currently under or not funded,
but are projected to vest in full.
Figu re: 4 -4 Comparison of historical sales growth rate and projected sales growth rate
CO GS/SALES
After reviewing the historical analysis,
COGS as a percent of sales is projected to
be 79.36% in the short term and 79.78%
over the long term forecast. The trend
from the historical data shows COGS/Sales
decreasing from around 81.5% in 2005 to
its lowest in 2014 of 79.36%. While it is
justifiable to assume this trend is
projected to continue in the short term but
in the long term a stable COGS/Sales shall
be reached. Given the large spike in
COGS/Sales due to a large impairment
write off in 2012, it is believed that COGS
as a percent of total revenue is set to level
out over the long term at 79.8%, due to
conflicting forces of rising cost and
management’s goals of increasing
operating margins.
Figu re: 4 -5 Comparison of historical and projected COGS/SALES
SGA/SALES
Historically as a percent of total revenue,
SGA costs fluctuated around 6% over the
past 10 years. While SGA/SALES did
increase to 7.2% in 2012, this was also due
to the large impairment of goodwill that
occurred during the fiscal year 2012. SGA
returned to normal historical levels since
2012 and this trend is expected to
continue, thus SGA/SALES is forecasted at
6.43% in the short term and 6.27% in the
long term.
Figu re: 4 -6 Comparison of historical and projected SGA/SALES
DEPRECIATIO N/NET PPE
Unfortunately historical fluctuation and
volatility of Depreciation as a percent of
Net PPE makes it difficult to identify any
existing trend that can be projected into
the future. Thus, it is the assumed that the
short term rate is set to the most recent
fiscal years percent of revenue, 11.26%
and the 10 year historical average of
Depreciation/Net PPE is projected over
the long term. The historical 10 year
average is 11.37% Depreciation/Net PPE.
Figu re: 4 -7 Comparison of historical and projected Depreciation/Net PPE
RATIOS TO CALCULATE OPERATING CAPITAL
CASH/SALES
After experiencing a 10 year low in
2009, cash as a percent of revenue sharply
increased over the past few years to a high
of 17% of sales in 20143. Considering this
increase, cash as a percent of sales in the
short term is held at the most recent
percentage of 14.22%. As cash is an
expensive asset due to its lower return
than invested capital, it is expected that GD
management intends to apply strategy to
reduce the cash account to 13.80% of sales.
It is believed that this ratio trends to the
long term projection quickly thus a .50
fade rate is set.
Figu re: 4 -8 Comparison of historical and projected CASH/SALES
INVENTO RY/SALES
After experiencing a 10 year low in
2009 of 20.6%, inventory as a percent of
total revenue steadily increased over the
past 5 years to a high of 25.3% in 2014.
Due to this consistent increase it is
believed this trend continues on into the
future. Thus, the short term inventory as a
percent of sales is projected at the most
recent valuation of 25.3% and long term
projections expect inventory to increase to
27% of sales. Considering General
Dynamics’ ability to increase efficiencies
and operating margins over the past few
years can offset the increasing trend of
inventory costs thus capping the long term
projection at 27% of sales.
Figu re: 4 -9 Comparison of historical and projected INVENTORY/SALES
ACCTS REC/SALES
Considering accounts receivables as a
percent of sales steadily increased over
the historical analysis, it is expected that
this trend continues in the projected years.
Thus, short term Accts Rec/Sales is
projected to remain at the current level of
13.13% and grow in accordance with the
trend to 14.75% over the long term
forecast.
Figu re: 4 -1 0 Comparison of historical and projected ACCOUNTS RECEIVABLES/SALES
O THER SHO RT TERM O PERATING ASSETS/SALE S
Due historical fluctuation and volatility of,
other short term operating assets/Sales,
makes it difficult to identify any existing
trend that can be projected into the future.
Considering that other short term
operating assets as a percent of revenue
increased significantly from 1.5% to
3.75% over the past two years it is
assumed that this account is to remain
constant around 3.8% of revenue over the
short term projection. For the long term, it
is projected that other short term
operating assets as a percent of sales
decreases back to closer to historical levels
but is believed to level out at 3.20%.
Figu re: 4 -1 1 Comparison of historical and projected OTHER SHORT TERM OPERATIN ASSETS/SALES
NET PPE/SALES
Net PPE as a percent of sales increased
since 2010 from around 9% to a consistent
10.79% during 2012, 2013 and 2014. It is
assumed that this trend continues on into
our projected time frame thus short term
projection is set to 10.79% of revenue. Due
to the uncertainty of the Defense industry
in the coming years, General Dynamics is
expected to increase R&D spending in the
hopes of capturing different market shares.
Therefore, long term projection is set to
11.10% of revenue with a .10 fade rate to
indicate the likelihood that the ratio is
going to transition quickly.
Figu re: 4 -1 2 Comparison of historical and projected Net PPE/SALES
O THER LO NG TERM O PERATING ASSETS/SALE S
Based upon the past 10 year historical
trend, other long-term operating assets as
a percent of revenue in most regards
increased, barring a few dips over that
period. It is the belief of this team that this
trend continues. Therefore, short term
projections are set to equal the most
recent valuation in 2014, whereas long
term projections are set a little higher than
the calculated trend of 55.8% provided
from the historical analysis sheet. A time of
5 years is set until the long term with a .10
fade rate, indicating the need for General
Dynamics to increase spending to support
revenue growth and market share capture.
Figu re: 4 -1 3 Comparison of historical and projected OTHER LONG-TERM OP. ASSETS/SALES
ACCO UNTS PAYABLE/SALE S
Accounts payable as a percent of revenue
are projected to remain at its most recent
valuation in the short term of 6.67%. In the
long term, Accounts payable are projected
to return to its historical average of 7.92%.
It is important for the firm to maintain
consistent accounts payable to ensure
strong supply chain management and
good relations with suppliers
Figure: 4-14 Comparison of historical and projected ACCOUNTS PAYABLE/SALES
ACCRUALS/SAL ES
Much like the accounts payable ratio,
accruals as a percent of revenue are
projected to maintain their most recent
valuation of 6.05% in the short term. In the
long term accruals as a percent of revenue
are projected to remain at their historical
10 year average
Figu re: 4 -1 5 Comparison of historical and projected ACCRUALS/SALES
O THER CURRENT LIABILITIES/SAL ES
Based upon current trends and recent
historical data the starting rate for Other
Current Liabilities as a percent of sales is
set to equal the accounts most recent
valuation of 30.22%. While this account
experienced a large increase in the past
five years, long term projections are set to
retract toward 26% of sales. Current
historical trends indicate this account
fluctuates around 28.3% of revenue. For
the intent and purpose of this model, our
projections reflect the long term rate
decreases to more historical levels.
Figu re: 4 -1 6 Comparison of historical and projected OTHER CURRENT LIABILITIES/SALES
RATIO S TO CALCULATE O PERATING TAXES
DEFERRED TAXES/NET PPE
Deferred taxes as a percent of Net PPE
fluctuated in a peculiar pattern over the 10
year historical analyses. At the beginning
of the analyzed period deferred taxes
remained constant at approximately 39%
of Net PPE from 2005 to 2007. During the
fiscal years 2008 to 2010 deferred taxes
fluctuated a lot, 3.4% in 2008, 12.2% in
2009 and finally -4.7% in 2010. After 2010,
deferred taxes returned to a constant rate
approximately around 4% of Net PPE,
dipping to the most recent rate at 2.5% in
2014. Due to these large changes in the
rate of the ratio, using the 10 year
historical average for the long term
projection is inaccurate due to the amount
of volatility. Thus, the short term rate is
projected for the most recent firm data at
2.5%. Whereas the long term rate is set to
the average of the 2008-2014 rates,
because these were the most consistent
periods.
Figu re: 4 -1 7 Comparison of historical and projected DEFERRED Taxes/Net PPE
AVERAGE/MARGINAL TAX RATE
Projected long term and short term marginal tax rates are 29%.
DIVIDEND AND DEBT RATIO S
DIVIDEND PO LICY: GRO WTH RATE
General Dynamics observes a residual
growth dividend policy, making future
dividends difficult to predict moving
forward. A starting rate of 10% is
projected for the short term, it is very
possible that dividends grow faster or
slower based upon the needs of internal
funds to generate future growth. A long
term rate of 11% is set with a -1.00 fade
rate since the residual dividend policy
makes it nearly impossible to predict long
term dividend growth rates with any
certainty, it is important to focus on the
short term rate.
Figu re: 4 -1 8 Comparison of historical and projected DIVIDEND POLICY GROWTH RATE
LO NG TERM DEBT/MARKET VALUE O F THE FIRM
General Dynamics maintained a consistent
capital structure over the historical
analyses period and did so before. It is
believed that these consistencies continue
over our forecasted period of time. It is
assumed that LTD/Market Value of the
Firm is projected to be 6.9% in the short
term and grow slightly to 7% as the target
capital structure is reached.
RATIO S TO CALCULATE REST O F INCO ME STATEMENT AND BALANCE SHEET
The following ratios are projected to
maintain their most resent valuation as
their starting rate. All ratios are projected
to trend to their historical 10 year average
over the long term projection. Each ratio is
set with no fade rate and a long term
forecast of 10 years.
Figu re: 4 -1 9 Ratios to calculate rest of the income statement and balance sheet
FO RECASTED FINANCIAL STATEMENTS
FO RECASTED INCO ME ST ATEMENT S
Figu re: 4 -2 0 Forecasted Income Statements for 2015-2020
Figu re: 4 -2 1 Forecasted Income Statements for 2021-2026
Figu re: 4 -2 2 Forecasted Income Statements for 2027-2034
\
FO RECASTED BALANCE SHEETS
Figu re: 4 -2 3 Forecasted Balance Sheet for 2015-2020
Figu re: 4 -2 4 Forecasted Balance Sheets for 2021-2026
Figu re: 4 -2 5 Forecasted Balance Sheets for 2027-2034
SECTIOIN 3: PRO FORMA RATIO ANALYSIS, DU PONT AND ALTMAN Z-SCORE
PRO FITABILITY RATIO S
The chart below lists forecasted profitability ratios for General Dynamics up to the
year 2020.
Figu re: 4 -2 6 Graph of profitability ratios over the first five projected years
Figu re: 4 -2 7 Graph of profitability ratios over the first five projected years
O PERATING MARGIN
The operating margin is calculated as
Operating Profit (excluding interest, tax,
and non-operating income) over gross
sales. This measure shows how the
company performs in its core business
units without the effects of financing and
ancillary business activities. Due to
General Dynamics ability to increase and
maintain operating margins over the
historical analyses this ratio is expected to
remain constant in the coming years.
PRO FIT MARGIN
The profit margin is the bottom line
profitability ratio, assessing the effects of
all operating, non-operating activities as
well as interest and tax effects. It is
calculated as net income over gross sales.
Even though revenues are projected to not
be as strong as recent years, GD’s ability to
increase operating margins is great for
maintaining the firm’s bottom line over
the forecasted period.
RO IC
The return on invested capital
reveals the annual performance from
management’s allocation of funds to
investment opportunities. This ratio can
be compared to the company’s weighted
average cost of capital to see whether
management is creating or destroying
value.
If the ROIC is maintained above
WACC, then wise investment decisions are
being executed, and the shareholders and
bondholder’s funds are in the right place.
It is expected that long term ROIC trend
toward the value of the firm’s WACC.
LIQ UIDITY RATIO S
The chart below lists the forecasted liquidity ratios for General Dynamics in the
coming years.
Figu re: 4 -2 8 Graph of liquidity ratios over the first five projected years
Figu re: 4 -2 9 Graph of profitability ratios over the first five projected years
CASH RATIO
The cash ratio is the most basic measure of
a company’s ability to cover short-term
obligations with its most liquid asset, cash.
It is calculated as cash and cash
equivalents over current liabilities. It is
curios that the cash ratio grows so quickly,
but that is largely due to the increase in
short term investments over the
forecasted period. The increase in short
term investments is the plug that makes
our forecast balance, realistically this
surplus funding is used to pay off short
term debt and then is distributed to
shareholders as increased dividends.
Q UICK RATIO
The quick ratio also measures a firm’s
ability to cover short term obligations
using the most liquid current asset
accounts (excluding inventories).
Converting inventories into cash is more
difficult than collecting an outstanding
A/R. Therefore, in a crunch, the quick ratio
is what a company uses to evaluate its
ability to handle a coverage crisis.
CURRENT RATIO
Lastly, the current ratio is calculated as
total current assets over total current
liabilities. This is the standard measure of
short-term liquidity and General
Dynamics is expected to strengthen this
ratio over the next 5 years.
LEVERAGE RATIO S
The chart below lists the forecasted liquidity ratios for General Dynamics in the
coming years.
Figu re: 4 -3 0 Graph of leverage ratios over the first five projected years
DEBT/EQ UITY:
General Dynamics is expected to maintain
its consistent capital structure,
predominantly financed by equity rather
than debt. Over the historical analyses
long term debt as a percent of the market
value of the firm was approximately 6.9%.
It is assumed that this capital structure is
going to continue into the forecasted
period. The reason for the drastic decrease
in the Debt/Equity ratio is due to the large
increase in equity over the projected
period due to additions to retained
earnings. It is more reasonable that this
ratio remain consistent over the projected
period because additional funding is
expected to be paid out in the form of
dividends, which is consistent with GD’s
residual dividend policy.
INTEREST CO VERAGE RATIO
Simply put the interest coverage ratio
indicate the company’s ability to satisfy
the interest payments on its long term
debt. The ratio is calculated by dividing the
year’s interest expense by the operating
profit.
As anyone can clearly see, the ratio is
increasing over the projected period
indicating General Dynamics’ ever
increasing ability to satisfy its interest
payments on long term debt.
EFFICIENCY RATIO S
The chart below lists the forecasted efficiency ratios for General Dynamics in the
coming years.
Figu re: 4 -3 1 Graph of efficiency ratios over the first five projected years
INVENTO RY TURNO VER
Figu re: 4 -3 2 Graphs comparing historical and projected inventory turnover
The inventory turn over ratio illustrates
how well a company manages its
inventory levels. It is clear from the above
graph that the projected inventory
turnover in the coming years is consistent
with the historical analyses over the past
10 years. Inventory turnover is expected
remain constant around 3.0 for the entire
forecasted period.
ACCO UNTS RECEIVABLES TURNO VER
The accounts receivables turnover ratio
indicates the effectiveness of the
companies credit policies to collect
payment on outstanding balances. All else
equal a higher turnover ratio, because this
ratio is calculated by Sales/Accounts
Receivables, thus a lower ratio indicates
less outstanding balance.
General Dynamics’ projected receivables
turnover is consistent with the companys
historical data, both projected and
historical numbers approximate around 7.
ASSET TURNO VER
Total asset turnover is a catch-all
efficiency ratio that highlights how
effective management is at using both
short-term and long-term assets. All else
equal, the higher the total asset turnover,
the better.
Figu re: 4 -3 3 Graphs comparing historical and projected Total Asset Turnover
It is clear from the above line charts that
the projected asset turnover ratio is
declining along company trends
consistent with historical data. The larger
decline is due to the increase level of short
term assets in the projected statements. As
previously discussed, the short term
investments account is merely a plug to
balance the sheet. In reality this additional
funding is to be paid out to investors
consistent with GD’s residual dividend
growth policy. The pay out of these
additional fund is going to keep the Total
Asset Turnover ratio consistent into the
projected period.
MARKET VALUE RATIO S
The chart below lists the forecasted market value ratios for General Dynamics
in the coming years.
Figu re: 4 -3 4 Market Value Ratios for the first five projected years
PRICE TO EARNINGS
This ratio shows how much
investors are willing to pay for one unit of
a company’s earnings. General Dynamics,
is expected to maintain a fairly constant
P/E ratio because earnings are forecasted
to increase in stride with the stock price
over the next five years. There are no
expected stock repurchases or new
issuances in the coming years, thus the
shares outstanding are projected to
remain constant throughout these initial
projections. This increases individual net
asset value for common stockholders, and
therefore increased earnings divided by
fewer shares outstanding increases the
EPS and hold the P/E at bay
MARKET TO BO O K
This ratio shows how much an
investor is willing to pay for the residual
assets of the business in the event of
liquidation. General Dynamics’ is showing
a slight forecasted decline in this ration
which indicate the market price and book
value of shares are converging toward
each other. This indicates the company is
converging toward a fair valuation,
whereas right now it is overvalued in the
market.
EARNINGS PER SHARE
EPS is a standard measure of
profitability assigned to individual owners
of common stock. Analysts are tasked with
projecting this metric in addition to
guidance given by management. Missing
this target usually leads to a sharp decline
in share price because the investment
community relies on the forecast and
guidance of the firm. Earnings per share
are expected to increase in a fairly linear
fashion over the next 5 years. This ratio
obviously is distorted if a stock repurchase
or issuance occurs, because this affects the
denominator of the equation causing the
ration to fluctuate.
DUPO NT ANALYSIS
Recall from the historical ratio analysis that the three components of DuPont are:
1. Profit Margin (NI/Sales)
2. Asset Turnover (Sales/Average Assets)
3. Equity Multiplier (Average Assets/Average Equity)
The identity is as follows:
DuPont ROE = (Profit Margin) x (Asset turnover) x (Equity Multiplier)
DuPont ROE = (Net Income/Sales) x (Sales/Total Assets) x (Total Assets/Total Equity)
DuPont ROE = (ROA) x (EM)
Calculated ROE DuPont
Figu re: 4 -3 5 Calculated first year and final year ROE DuPont
First Year Forecasted DuPont (2015):
In the first year forecasted, we see the ROE
drop slightly from its most recent level of
19.58% in 2014 to 17.53% in the
forecasted year. This is certainly
consistent with recent trends occurring
within General Dynamics. ROE steadily
declined over the past years from 21.30%
in 2009 to 19.24% in 2014. This decline in
the ROE can be attributed to the declining
Asset Turnover and Equity Multiplier
ratios, due to the increase in both the
assets and equity accounts. This increase
is attributed to the short term investments
plug used to balance the forecasted
statements. The profit margin of GD is
projected to increase over the forecasted
period due to General Dynamics’ ability to
increase overall operating margins. From
the graphs below, we can see that in the
beginning of our projected period ROE is
driven by Profit Margin. As the projection
reaches the long term forecast we see a flip
Final Year Forecasted DuPont (2034):
The decrease in ROE in the beginning of
our projected period is completely due to
the declining Asset Turnover and Equity
Multiplier ratios. The sharp decrease in
Asset Turnover during the forecasted
period is completely attributed toward the
short term investments plug that is used to
balance the forecasted statements.
Additional funds are to be paid out to
shareholders under the residual dividend
policy rather than being plowed back into
short term investments. The same can be
said for why the equity multiplier
decreases so quickly, due to the large
increase in the equity account from future
retained earnings being plowed back into
the equity account, this action drives down
the equity multiplier skewing future
projected ROE. The graphs below display
the forecasted components of the DuPont
ROE analyses. Given the likelihood that
additional funds are to be paid out in the
form of dividends, and not plowed back
into short term investments, it is expected
that ROE remain consistent over the
forecasted period.
Figu re: 4 -3 5 Graphs depicting forecasted components of ROE and ROE DuPont calculation
ALTMAN’S Z-SCO RE FO RECAST
FO RMULA, CO MPO NENTS & INDICATO RS
Figu re: 4 -3 6 Z-score calculation, components and indicators
FO RECASTED Z-SCO RE
Figu re: 4 -3 7 Forecasted Z-score
General Dynamics most recent Z-score is
calculated at 3.15, by the indicators of the
z-score test the company is in good
financial standing and no financial distress
is imminent. Looking now at the
forecasted z-scores for the companies
projected data, the z-score of GD rises
quickly over the first five years before
leveling out at around 3.4 until the year
2026. The graph then illustrates the z-
score declining over the last seven forecast
years until it reaches a final low of 3.14 in
2030. By breaking down the z-score into
components over the forecasted period a
clear understanding of what drives the z-
score’s fluctuation over the forecasted
period is achieved. Considering that the z-
score calculation does not drop below 3.14
over the entire forecasting period, by the
indicators of the test, General Dynamics is
not projected to not experience financial
distress under the current assumptions
about future growth prospects. Over the
historically analyzed period General
Dynamics’ enjoyed a z-score of well above
three, consistent with the projections,
indicating its strong financial standing.
Only in the year 2013, after declaring a
large impairment of goodwill in its
Information Technology business unit did
General Dynamics’ z-score drop to its
lowest of 2.14, GD continued to remain in
the “Grey” zone on financial distress
throughout 2013. General Dynamics’ since
regained its financial strength to the levels
seen today.
WO RKING CAPITAL/TO TAL ASSETS
Over the beginning of the projected period
Working Capital over Total Assets
increases as a component of the z-score.
This is due to working capital growing
faster in comparison to total assets. This
component then reaches a terminal value,
remaining at approximately .15 over the
remainder of the forecasted period. Due to
the lack of any significant decrease in
Working Capital over Total Assets it
indicates this component drives the z-
score over the entire forecasted period.
Figu re: 4 -3 8 Forecasted Working Capital/Total Assets
RETAINED EARNINGS/TO TAL ASSETS
Retained Earnings as a percent of
Total Assets increases at first, but then
declines over the forecasted period due to
Total Assets increasing faster in
comparison because of the company’s high
dividend distribution policy. This
component is weighted high in the z-score
calculation meaning that its stability is
important for minimizing long term
financial distress. This component is
another key driver of the good financial
standing that General Dynamics is
expected to experience under current
financial assumptions.
Figu re: 4 -3 9 Forecasted Retained Earnings/Total Assets
EBIT/TO TAL ASSETS
While EBIT over Total Assets
decreases over the projected period, it
does not appear to be a major driver of
General Dynamics’ z-score. It appears
from the graphs of the z-score and
EBIT/Total Assets that they are inversely
correlated. Meaning as EBIT/Total Assets
decrease the z-score and as the ratio
increases the z-score decreases. This ratio
is an indicator of the management’s
effectiveness to drive operating profit by
implementing assets to their optimal use.
It is up to management to ensure that
assets are utilized appropriately to ensure
that operating margins are optimized over
the forecasting period, if management can
effectively increase the firms overall
operating margin then the z-score
improves as does the company’s financial
standing.
Figu re: 4 -4 0 EBIT/Total Assets
MARKET VALUE O F EQ UITY/TO TAL LIABILITIES
While Market Value of Equity over Total
Liabilities is the component with the
smallest weighting in the z-score formula,
it is still important to recognize the ability
of the financial forecast to generate overall
consumer wealth in comparison to
increasing levels of debt financing. This
indicate that General Dynamics’ is in a
financial position of positive leverage and
can increase equity returns by taking on
more debt. This option can only be
pursued if General Dynamics’ potential
investment opportunities generate
returns greater than the cost of debt that
are to be incurred upon the debt financing.
Figu re: 4 -4 1 Forecasted Market Value of Equity/Total Assets
SALES/TO TAL ASSETS
Sales over Total Assets is an important
component of a company’s financial
standing because it indicate
management’s effectiveness in
implementing assets and capital to drive
revenues. Under the current financial
assumption sales do not increase as fast as
total assets due to increases in the
retained earnings and short term
investments accounts over the forecasted
period. A more likely outcome is that sales
over total assets is set to remain more
consistent due to increased distributions
to shareholders when available in
accordance with General Dynamics’
residual dividend policy.
Figu re: 4 -4 2 Forecasted Sales/Total Assets
UNIT 5 SUMMARY VALUATION METHODS
Three different methods were used to value the
estimated share price for General Dynamics’. They are the
Entity Valuation, Adjusted Present Value, and Modified Free
Cash Flows to Equity methods. Each method gave us
different estimated share prices and provided us with
insight into why General Dynamics’ is currently selling for
its market price of $145.
ENTITY VALUATIO N
This method assumes the General Horizon Value
Method for calculating the horizon value. The long-term
Return on Invested Capital is a key driver is this calculation.
This valuation method estimates a share price of $70.42,
overvaluing it in the market by 48%.
ADJUSTED PRESENT V ALUE
This method assumes the use of debt financing to
take advantage of the interest and debt tax shield savings.
The key drivers of this calculation is the 6.9% of leverage
financing General Dynamics’ uses. With an estimated share
price of $72.27, it puts it overvalued in the market by 49%.
MO DIFIED FREE CASH FLO WS TO EQ UITY
This method assumes the standpoint from the
shareholder and focuses on how much wealth can be
distributed to equity holders only. The key drivers of this
calculation are the changes in capital expenditures, net
operating working capital, and net borrowing. With an
estimated share price of $134.11 it is the closest price to
that currently for General Dynamics’. This team believes
this to be a driver in the overvaluing of its stock in the
market.
Each method over values General Dynamics’
Free Cash Flow to Equity most skewed
Most important key driver is use of debt
Year 2014
Value of operations adj. half year 33,585.54$
Value of firms investments -$
Total Value of Firm 33,585.54$
Interest Bearing Debt & Pref Stock 10,196.00$
Value Of Equity 23,389.54$
Shares Outstanding 332
Estimated Value Per Share 70.42$
*Current Market Price 145.71$
Entitiy Valuation
Year 2014
Unlevered Value of Ops. Half year 33,847.51$
Interest expense tax shield
Value of tax shield 338.03$
Value of firms investments -$
Total Value of firm 34,200.44$
Interest Bearing Debt & Pref Stock 10,196.00$
Value of Equity 24,004.44$
Shares Outstanding 332
Estimated Value Per Share 72.27$
*Current Market Price 145.71$
Adjusted Present Value
Year 2014
Net Income 2,654.00$
Depreciation 375.00$
∆ in Capital Expenditures (1,745.00)$
∆ in NOWC 737.00$
Net Borrowing 33.00$
Free Cash Flow to Equity 4,070.00$
Horizon value 74,004.26$
Value of operations 44,524.24$
Shares Outstanding 332
Estimated Share Price 134.11$
*Current Market Price 145.71$
Modified FCFE
CASH FLOW VALUATION VALUATION METHODS
Cash flow valuation for a firm can
be calculated with three different methods.
The Entity Valuation method, Adjusted
Present Value method, and the Modified
Free Cash Flows to Equity method. Each of
these valuation methods used to calculate
General Dynamics’ cash flow shows a
different projected price per share. Below
is a representation of each method and
what key drivers influence them to arrive
at different values per share.
ENTITY VALUATION
General Dynamics’ estimated value per
share using the Entity Valuation method is
$75.31 on the target date of November 9,
2015. For the purposes of this valuation, a
Horizon Value calculation was
accomplished using the General Value Horizon Formula.
FORMULA: HVt = (𝑹𝑶𝑰𝑪 𝑳𝒐𝒏𝒈−𝒈)∗𝑪𝒂𝒑𝒕𝒊𝒂𝒍 𝑻.
𝑾𝑨𝑪𝑪−𝒈 +
(𝑹𝑶𝑰𝑪 𝑻.−𝑹𝑶𝑰𝑪 𝑳𝒐𝒏𝒈−𝒈 )∗𝑪𝒂𝒑𝒕𝒊𝒂𝒍 𝑻.
𝑾𝑨𝑪𝑪
The key drivers in this formula for
General Dynamics’ are its Return on
Invested Capital Long term growth (ROIC Long), and its WACC. In the Aerospace and
Defense industry competition drives
General Dynamics’ sales, which is why this
method uses a sustainable ROIC versus
one that constantly grows and stays about
WACC. We started with the Value of
Operations adjusted for the half year, then
added the value of the firms projected
investments. By subtracting out the value
of Interest Bearing Debt and Preferred
Stock we arrived at a Value of Equity for
2014 of $23,389.54 billion. The number of
shares outstanding is 332,000,000, which
calculates a stock price of $70.42, for the
year ending 2014.
Figu re: 5 -1 Entity Valuation Cash Flow years 2014 and 2015
Year 2014 2015E
Value of operations adj. half year 33,585.54$ 34,097.02$
Value of firms investments -$ 191.26$
Total Value of Firm 33,585.54$ 34,288.28$
Interest Bearing Debt & Pref Stock 10,196.00$ 9,001.72$
Value Of Equity 23,389.54$ 25,286.56$
Shares Outstanding 332 332
Estimated Value Per Share 70.42$ 76.13$
Entity Valuation Cash Flow
FORMULA: HVt = (𝑹𝑶𝑰𝑪 𝑳𝒐𝒏𝒈−𝒈)∗𝑪𝒂𝒑𝒕𝒊𝒂𝒍 𝑻.
𝑾𝑨𝑪𝑪−𝒈 +
(𝑹𝑶𝑰𝑪 𝑻.−𝑹𝑶𝑰𝑪 𝑳𝒐𝒏𝒈−𝒈 )∗𝑪𝒂𝒑𝒕𝒊𝒂𝒍 𝑻.
𝑾𝑨𝑪𝑪
KEY D RI V ERS OF ENT I T Y VALUAT I ON
Long Term Return on
Invested Capital
General Dynamics’ terminal
growth rate
The increased funding
surplus is to be paid out due
to our residual dividend
policy
ADJUSTED PRESENT VALUE
General Dynamics’ uses small
amounts of debt financing to fund its
operations. Due to this, the Adjusted
Present Value method of Cash flow
valuation can be used to represent the
differences between the uses of leverage
versus an all equity financing policy. In
this APV method the Net Present Value of
cash flows is adjusted for the interest and
tax shield savings due to debt financing.
FORMULA: APV = NPV + PV of debt financing advantages
Advantages: Interest savings Debt Tax Shield savings
In this APV method there is a slight
difference in the ending value of equity,
which increases the target share price
value. This is due to the fact that General
Dynamics’ is not highly levered to begin
with so the debt tax savings increase the
value of equity. The ending Value of Equity
using the APV method is more than that of
the Entity Valuation method stated above.
Figu re: 5 -2 Adjusted Present Valuation for the years 2014 and 2015
KEY DRIVERS
Use of leverage to fund operations
Tax Shield savings, which increase
the value of the firm in comparison
to the Entity Valuation method
The interest expense tax shied,
which increases the value of the
firm in comparison to the Entity
Valuation method
Year 2014 2015E
Unlevered Value of Ops. Half year 33,847.51$ 34,425.63$
Interest expense tax shield 25.29$
Value of tax shield 338.03$ 343.19$
Value of firms investments -$ 216.81$
Total Value of firm 34,200.44$ 35,000.75$
Interest Bearing Debt & Pref Stock 10,196.00$ 9,027.27$
Value of Equity 24,004.44$ 25,973.48$
Shares Outstanding 332 332
Estimated Value Per Share 72.27$ 78.19$
Adjusted Present Value
FORMULA: APV = NPV + PV of debt financing advantages
Advantages: Interest savings Debt Tax Shield savings
MODIFIED FCFE
Using the Modified Free Cash Flow
method (FCFE), General Dynamics’
projected value per share is significantly
different than the Entity, and Adjusted
Present Value methods. General Dynamics’
is levered at a lower rate than its
competitors, therefore the change due to
Net Borrowing is not significant enough to
provide a relative valuation in comparison
to the Entity and APV methods. The FCFE
method also skews the data enough that
this analyst team does not believe it’s a
valuable addition to valuing General
Dynamics’. Below is a three year
projection of the value of General
Dynamics’ using the FCFE method.
Figu re: 5 -3 Modified Free Cash Flow To Equity
KEY DRIVERS
The decrease in the change in
capital expenditures
General Dynamics’ leverage
repayments
New debt issue
COMPARISON WITH MARKET VALUE
Conducting the different valuation
methods puts General Dynamics’ highly
overvalued in the market. General
Dynamics’ current stock price during the
analysis is $144.29. The Entity Valuation
method puts the target stock price at
$75.31, and the Adjusted Present Value
method sets a target price of $77.39. The
Modified Free Cash Flow to Equity
valuation method skewed our results.
This methods puts the target stock price at
$134.11, which is closer to the current
market price, but significantly higher than
that of our other two methods. This team
believes this FCFE is possibly be a reason
that the market price is higher than our
other valuation methods. Investors are
possibly more interested in how the
company uses its free cash flows to equity,
hence why the Entity method and APV
methods are lower in comparison. For this
reason the FCFE method is not weighted as
Year 2014 2015E 2016E
Net Income 2,654.00$ 2,686.41$ 2,780.09$
Depreciation 375.00$ 380.81$ 391.40$
∆ in Capital Expenditures (1,745.00)$ 304.70$ 653.31$
∆ in NOWC 737.00$ 80.04$ 848.89$
Net Borrowing 33.00$ (1,291.00)$ 135.00$
Free Cash Flow to Equity 4,070.00$ 1,391.47$ 1,804.30$
Horizon value 74,004.26$
Value of operations $44,524.24
Shares Outstanding $332.00
Estimated Share Price $134.11
Modified Free Cash Flow to Equity
high in determining the value of General
Dynamics’, the information is just too
statistically different.
Figu re: 5 -4 Comparison of valuation methods
Our analyst team also predicts that
the significant difference in our calculated
valuation of General Dynamics’ compared
to the market is due to market forces and
speculation within the Aerospace and
Defense Industry. These speculations
cannot be accounted for in a financial
model and can skew results. Our analysis
is based on historical financial data, and no
data to support the current stock price is
available due to the speculation
transparency of the market itself. The
rapid growth in the industry is the cause of
such speculation and valuation differences.
General Dynamics’ is not highly levered,
therefore not as risky as its competitors,
and its constant influx of Government
contracts cause the significant fluctuations
in the market price of its stock.
Year 2014 Year 2014
Value of operations adj. half year 33,585.54$ Unlevered Value of Ops. Half year 33,847.51$
Value of firms investments -$ Interest expense tax shield
Total Value of Firm 33,585.54$ Value of tax shield 338.03$
Interest Bearing Debt & Pref Stock 10,196.00$ Value of firms investments -$
Value Of Equity 23,389.54$ Total Value of firm 34,200.44$
Shares Outstanding 332 Interest Bearing Debt & Pref Stock 10,196.00$
Estimated Value Per Share 70.42$ Value of Equity 24,004.44$
*Current Market Price 145.71$ Shares Outstanding 332
Estimated Value Per Share 72.27$
*Current Market Price 145.71$
Entitiy Valuation
General Dynamics' Current Market Price/ Comparison to Valuation Methods
Adjusted Present Value
Year 2014
Net Income 2,654.00$
Depreciation 375.00$
∆ in Capital Expenditures (1,745.00)$
∆ in NOWC 737.00$
Net Borrowing 33.00$
Free Cash Flow to Equity 4,070.00$
Horizon value 74,004.26$
Value of operations 44,524.24$
Shares Outstanding 332
Estimated Share Price 134.11$
*Current Market Price $145.71
Modified FCFE
EXECUTIVE SUMMARY
MULTIPLES ANALYSIS
CO MPARABLE FIRMS & PRICE MULTIPLES
In order to complete the multiples analysis it
was imperative to pick ten comparable companies that
operate in the same industry in order to accuratel y
capture the value of General Dynamics. The companies
that were chosen, were selected if they were a
domestically based firm, produced products in the same
industry and captured a significant amount of the
industries market share because General Dynamics
holds the industries fourth largest market cap.
Six different price multiples for those ten comparabl e
firms were then chosen in order to calculated the value of
General Dynamics. These six ratios are commonly used
determinants in determining whether a particular security is
over or undervalued. The above Price to Book exhibit
demonstrates that the price multiple averages are subject to
deviation, thus it was more appropriate to conduct the
analysis using the median sample in order to mitigate the
skew present in the average.
IMPLIED SHARE PRICE
Upon completing the relative valuation for the
comparable firms, it is evident that the intrinsic share price of
$139.73 is undervalued compared to the market value of
144.29 as of November 9, 2015. However, this implied share
price does not capture all of the market sentiment pertaining
to General Dynamics’ fair value. Thus, in order to accuratel y
capture this information, it was necessary to average the
averaged median implied price with those of the industry,
sector and the S&P 500. This implied share price of $141.26
indicates that General Dynamics is undervalued compared to
the current market price of 144.49 as of November 9th, 2015.
Implied Value P/E
Price to
Sales
Price to
Book
Price to
Cash Flow
Price to
Free Cash
Flow
Price to
EBITDA Average
Median 17.16 1.53 3.49 14.48 18.26 9.06
Value 7.73 90.27 34.93 10.91 9.38 12.83
Implied Price 132.71 138.36 121.77 157.99 171.39 116.18 139.73$
Name Ticker
P/E
Ratio Beta
Price to
Sales
Price to
Book
Price to
Cash
Flow
Price to
Free
Cash
Price to
EBITDA
GENERAL
DYNAMICS
CORP GD 17.45 1.07 1.50 3.86 12.37 14.38 10.52
BOEING CO BA 17.61 1.01 1.04 10.60 10.68 14.28 10.08
LOCKHEED
MARTIN CORP LMT 16.88 0.91 1.34 17.78 15.78 20.19 9.26
UNITED
TECHNOLOGI
ES CORP UTX 17.96 0.95 1.59 3.35 14.08 18.37 8.85
RAYTHEON
COMPANY RTN 15.89 0.99 1.48 3.49 15.45 18.16 9.33
NORTHROP
GRUMMAN
CORP NOC 15.50 1.09 1.28 4.05 11.87 15.15 8.41PRECISION
CASTPARTS
CORP PCP 17.44 1.08 3.02 2.69 17.78 24.26 10.33
TRANSDIGM
GROUP INC TDG 37.81 0.92 4.43 - 19.41 20.72 10.26
ROCKWELL
COLLINS INC COL 15.77 0.95 2.09 5.74 14.89 20.84 8.06
TEXTRON INC TXT 18.58 1.47 0.85 2.73 9.75 15.13 7.58
HARRIS CORP HRS 15.51 1.03 1.62 2.83 9.62 11.64 8.59
S&P 500 18.27 1.00 1.80 2.82 11.08 18.38 9.75
Sector 18.24 1.10 1.65 3.62 12.21 20.67 9.79
Industry 17.49 1.07 1.44 4.46 13.35 18.17 9.71
Average 18.89 1.04 1.87 5.92 13.93 17.87 9.07
Median 17.44 1.00 1.59 3.42 14.08 18.37 9.26
P/E Ratio
Price to
Sales
Price to
Book
Price to
Cash Flow
Price to
Free Cash
Flow
Price to
EBITDA Average
146.12 169.10 206.70 151.96 167.72 116.43 159.67
132.71 138.36 121.77 157.99 171.39 116.18 139.73
141.29 162.49 98.49 120.86 172.47 125.09 136.78
141.06 148.95 126.43 133.18 193.96 125.61 144.86
135.28 130.26 155.67 145.64 170.50 124.57 143.65
141.26$
Average
Implied Price
Industry
Median Sample
S&P 500
Sector
Estimated Value Using:
UNIT 6 MULTIPLES COMPARABLES
The Bloomberg Industry
Classification (BICS) was the primary tool
used to identify and further classify the list
of comparable competitors, which share
similar financial characteristics to General
Dynamics Corp. in order to perform the
multiples valuation analysis. BICS
classifies companies by tracking their
primary business as measured first by
source of revenue and second by operating
income, assets, and market perception.
The comparable companies were chosen
because they are US based and traded on
major the US stock exchanges such as the
NASDAQ and the NYSE. Members of
groupings exhibit similar behavior in
market cycles and companies in the
grouping are relatively correlated.
Companies are classified by their principal
business operations. “Sector” is the
broadest classification and represents
general business activities. Its
sophisticated breakdown structure
provides better universality to meet the
needs of any classification of investment
industry.
General Dynamics and its
competitors fall under the Industrial
Goods sector. Each Sector is further
broken down into “Industry Groups,”
which are classified by more narrowly
defined business activities. All of General
Dynamics’ closest competitors belong to
the Aerospace & Defense industry. The
Aerospace & Defense Industry is broken
down further into Aircraft & Parts and
Defense Primes.
The companies that make up for the
Aerospace & Defense industry principally
produce a broad array of defense, and
weapon systems, as well as planes and
plane parts. Their products are mostly
used by the United States Armed Forces as
well as commercial airliners and
corporations and they include:
BO EING CO . (B A )
Market Capitalization - $ 97.80 Billion
Boeing is a global leader in designing and
manufacturing commercial jets airplanes,
rockets, rotorcraft and satellites. Boeing is
well known for their commercial airplanes,
most notably, the 747 jet airliner. Boeing is
also well known for their defense and
rotorcraft systems, such as the CH-47
Chinook helicopter and the Hughes
Satellite systems. The company is based in
Chicago, Illinois. Boeing is the largest
exporter by dollar value in the United
States and holds the largest market cap of
all the competitors in the industry.
Figu re: 6 -1 Boeing Co. Multiples
UNITED TECHNO LO GIES CO RP. (U T X )
Market Capitalization - $ 88.40 Billion
United Technologies Corp. is an
international developer and manufacturer
of aircraft engines, helicopters, fire,
security and military missile systems.
United Technologies Corp. holds the
industry’s second largest market cap of
public US aerospace and defense firms.
UTX is headquartered out of Hartford,
Connecticut.
Figu re: 6 -2 United Technologies Corp. Multiples
LO CKHEED MARTIN CO RP. (L M T )
Market Capitalization - $ 65.98 Billion
Lockheed Martin is a global manufacturer
and developer of aerospace defense
security and advanced technology systems.
Lockheed Martin is the world’s largest
defense contractor by 2014 fiscal year
revenues. It produces the FA fighter jets,
ballistic missiles and was commissioned to
lead the development for the Orion
Spacecraft command module, which is
designed to take astronauts to explore
asteroids and Mars. Lockheed is
headquartered out of Bethesda Maryland.
It holds the third largest market cap in the
industry.
Figu re: 6 -3 Lockheed Martin Corp. Multiples
RAYTHEO N CO MPANY (R T N )
Market Capitalization - $ 35.29 Billion
Raytheon is a multinational manufacturer
and defense contractor. It produces
weapons and missile systems but also
produce semiconductors, radars and
sensors. The company is headquartered
out of Waltham, Massachusetts. Raytheon
is the fourth largest defense contractor in
the world and in the United States by
revenues. Additionally, Raytheon holds
the fifth largest market cap behind Boeing,
United Technologies Corp., Lockheed
Martin and General Dynamics.
Figu re: 6 -4 Raytheon Company Multiples
NO RTHRO P GRUMMAN CO RP. (N O C )
Market Capitalization - $ 33.13 Billion
Is a global aerospace and defense
technology company. It manufactures
military aircraft and spacecraft, such as the
B-2 Spirit bomber. Additionally, Northrop
Grumman produces military radar systems
and the major components and assemblies
for jet fighters such as the F/A-18 Hornet
and the F-22 raptor. It is the fifth largest
defense contractor in the world by
revenues but hold the sixth largest market
cap in the US market. It is headquartered
out of West Falls Church, Virginia.
Figu re: 6 -5 Northrop Grunman Multiples
PRECISIO N CASTPARTS CO RP. (P C P )
Market Capitalization - $ 31.73 Billion
Precision Castparts Corp. is one of the
world's leading suppliers to the aerospace
(civil and military) and power generation
industries. PCP specializes in the
manufacturing complex metal
components that can be used for a wide
variety of applications, particularly in
engines and airframes. PCP provides these
parts to the larger aerospace and defense
firms such as Boeing, Airbus, GE, Rolls-
Royce and many of the other leading firms
in the industry. It is the seventh largest
firm by market cap. It is headquartered out
of Portland, Oregon.
Figu re: 6 -6 Precision Castparts Corp. Multiples
TRANSDIGM GRO UP INC. (T D G )
Market Capitalization - $ 11.54 Billion
Transdigm Group is a manufacturer and
distributor of military and commercial
aerospace components. It produces
hardware for fluid controls, cockpit
security systems, mechanical actuators
and ignition systems. Transdigm Group is
the eighth largest public US aerospace
and defense firm by market cap. Its
headquarters are located in Cleveland,
Ohio.
Figu re: 6 -7 Transdigm Group Inc. Multiples
RO CKWELL CO LLINS INC. (C O L )
Market Capitalization - $ 11.43 Billion
Rockwell Collins Inc. is US based producer
and manufacturer of aerospace and
defense components and parts. It
produces in-flight entertainment systems,
communication and networking systems,
precision guided weapons, radar and
surveillance systems and flight control
components. It is the ninth largest public
US aerospace and defense firm by market
cap. It is headquartered out of Cedar
Rapids, Iowa.
Figu re: 6 -8 Rockwell Collins Inc. Multiples
TEXTRO N INC. (T X T )
Market Capitalization - $ 11.28 Billion
Textron Inc. is a US based industrial
conglomerate. It produces helicopters and
rotorcraft, light transportation vehicles,
tools, tractors, aircrafts, and electronic
and unmanned systems for the US
military such as the RQ-7B Shadow UAV.
Textron Inc. is the 10th largest public US
aerospace and defense firm by market
cap. Its headquarters are located in
Providence, Rhode Island.
Figu re: 6 -9 Textron Inc. Multiples
HARRIS CO RP. (H R S )
Market Capitalization - $ 9.89 Billion
Harris Corp is a defense,
communications and IT services
company. It produces and provides
communication systems, components for
the F/A-18 Hornet Aircraft, sensors and
cell-site simulator products. It is the 11th
largest public US aerospace and defense
firm by market cap. Its headquarters are
located in Melbourne, Florida.
Figu re: 6 -1 0 Harris Corp. Multiples
MULTIPLES BREAKDOWN & ANALYSIS
Below are breakdowns of each multiple with respect to General Dynamics and its comparable firms. Only equity
multiples were chosen for the relative valuation because they are more relevant to equity valuation, they are more familiar
to investors and they are more reliable than enterprise multiples due to the fact that EV multiples are subject to a high degree of subjectivity and is more susceptible to accounting manipulations. In order to keep all things consistent
between the discounted cash flow, the adjusted present value and the modified free cash flow to equity models the 2014 price multiples were used to perform the relative valuation.
MUTLIPLES USED
P/E MULITPLE
The P/E multiple is one of the most accurate ratios used in relative valuation. Its relevance is attributed to the earnings per share as a value driver. It is subject to distortion from differences in capital structures and accounting rules between companies. Price/Earnings is a multiple that analyze the relative value of General Dynamics because it provides insight to how investors view the company when compared to its bottom line. General Dynamics recorded a P/E ratio of 17.45 which falls just below the average of 18.01, signifying that investors possess relatively similar levels of confidence in
the firm when compared to its industry and competitors, and are willing to earnings to own the company.
PRICE TO SALETop-line performance is closely tied to the demand for a company's particular products from specific markets
served. This ratio is usually less affected by accounting measures making it a more reliable valuation tool. This ratio compares the value of the company to the revenue it generates. The advantage of using these type of revenue multiples is that it becomes far easier to compare different aerospace and defense firms with different business activities. General Dynamics possesses a Price/Sales ratio of 1.50 falls below the average of 1.93 for the comparable firms, which is a sign that the stock is inflated. General Dynamics Price to Sales
multiple of 1.50 is just below the S&P 500’s of 1.80 which indicates that investors are paying less on average for each dollar of sales than they are for most securities in the market. This indicates that the stock is undervalued.
PRICE TO BO O K
Investors often look at the relationship
between the price they pay for a stock and
the book value of equity as a measure of
how overvalued or undervalued a stock is.
The domestic market
for aerospace and
defense is largely
mature. The majority
of the
companies in this group
capitalized on the growth
opportunities and steadily
diversified operations by
developing far flung production
facilities. This means that
growth in this sector is overall
predictable and not supposed to
be largely volatile, therefore,
being a reliable standard
measure for the aerospace and
defense industry valuation
The price to book ratio varies across
industries depending upon the growth
potential and the quality of the
investments in each. General Dynamics
Price to Book multiple hovers just below
the industry average but the industry
average is skewed by Lockheed Martin and
Boeings high price to book multiples
which can be seen as a warning sign to
potential investors. The skewed average
value indicates that the stock is inflated
when compared to the actual level of
assets held by General Dynamics’. When
benchmarking it to the sector and the S7P
500, General Dynamics is overvalued.
PRICE TO CASH FLO W
The Price to Cash
Flow ratio takes into
consideration a
stock’s operating cash
flow, which adds non
cash earnings such as
depreciation and amortization to net
income. A low ratio indicates the stock is
undervalued, while a higher ratio suggests
potential overvaluation. It is especially
useful for valuing stocks that generate
positive cash flows but are not profitable
because of large non-cash
expenditures. Fixed costs are
significant in this industry. Cash flow
and earnings gain accelerate as sales
steadily rise. Larger industry
members produce more consistent
returns over time. Capital spending to
maintain operations can use up a
large portion of annual cash flow.
General Dynamics Price to Cash Flow
multiple of 12.37 lies slightly below
the competitors and industry average of
13.93, which indicates that investors are
paying less for Cash flow than they are for
companies in the same industry, however,
investors are paying more for General
Dynamics’ cash flows than for securities in
the sector or overall market. This
indicates that GD’s stock is undervalued in
comparison with its industry but
overvalued in the overall market.
PRICE TO FREE CASH F LO W
Price to Cash Flow is similar to the
valuation measure of price to cash flow but
reduces operating cash flows by capital
expenditures. Debt funding is common in
the industry, and obligations must be large
at times. Reducing operating cash flows by
capital expenditures is important for the
Basic and Diversified Chemical industry
because of its need to maintain or expand
their asset bases (capital expenditure) to
either continue
growing or maintain
the current levels of
free cash flow. Price to
Free Cash Flow is used
to determine how much of a premium
investors are paying for the firm’s cash
stream that is gradually returned to them.
General Dynamics’ Price to Free Cash Flow
of 14.38 indicates that investors
are paying less on average for the
company’s cash flows than they are
for its competitors, with an average
multiple of 17.87. General
Dynamics’ lower ratio of 11.25, far
below the market level of 17.87,
indicates that investors pay
significantly less for free cash flows
than investors who hold
competitor securities.
PRICE TO EBITDA
Price to Free Cash
Flow similar in
concept to the Price to
Earnings Ratio. It
measures the
amount shareholders pay for a given
amount of earnings, and is therefore a
measure of how expensive a stock is.
By excluding interest and taxes makes
it a better way to compare the
underlying businesses of companies
with different amounts of debt, or
which require big upfront capital
investments. Individual profitability
notably strays away from the overall mean,
depending on an aerospace and defense
company's product mix, competitive
position, contracts with the department of
defense and overall expense structure.
General Dynamics’ Price/EBITDA multiple
of 10.52 is higher than that of the average
at 9.07 and is the largest multiple among
the 10 comparable companies, the
industry, the sector and the S&P 500. This
indicates that investors are paying more
for earnings than for other stocks in the
market. This indicates that General
Dynamics’ stock is overvalued in
comparison to its competitors and the
market.
BETA
Beta is a good measure of the systematic
risk of a security or a portfolio in
comparison to the market as a whole. It is
very helpful to identify companies in the
industry, which stand
out of range regarding
risk in the multiple
valuation.
General
Dynamics holds a similar risk
profile to both the market and
comparable firms. General
Dynamics’ beta of 1.07 comes in
above the S&P 500 market beta
of 1. General Dynamics’ beta
indicates that the firm shares a
similar risk profile of that of the
industry which is a beta of 1.04
as well.
RELATIVE VALUATIO N
Below is the set of comparable
company multiples alongside those of the
industry as a whole, the sector and the S&P
500. The standard deviation of each of the
ten companies averaged multiples didn’t
exceed more than 6.76, thus it was
appropriate to use both the average and
median to find a reliable implied share
price for General Dynamics. Even though
the average is a relatively accurate
measure of the implied share price, the
median is a more accurate representation
of the stock.
Figu re: 6 -1 1 Relative Valuation using Multiples
ANALYSIS AGAINST CO MPARABLE CO MPANIES
Figu re: 6 -1 2 Implied pricing based upon median multiples
Using the above six key rations
(Price/Earnings, Price/Sales, Price/Book,
Price/Cash Flow, Price/Free Cash Flow,
and Price/EBITDA) the implied value of
General Dynamics was calculated based on
the average multiples of the comparable
firms. The implied price is determined by
multiplying the relevant value per share
by the average of each of the ten
comparable firms’ multiples. The implied
prices for each of the six multiples are then
averaged to find the average implied price
of General Dynamics. Based on the relative
valuation analysis of the ten comparable
firms, the intrinsic share price of General
Dynamics ranges between $116.43 and
$206.70. The average intrinsic share price
based off the $116.43-$206.70 range is
$139.73. As of November 9th, 2015 General
Dynamics was trading at a market value of
$144.29. This suggests that General
Dynamics is relatively overvalued when
compared to its comparable firms.
P/E Ratio Beta
Price to
Sales
Price to
Book
Price to
Cash Flow
Price to
Free Cash
Flow
Price to
EBITDA
Average 18.89 1.04 1.87 5.92 13.93 17.87 9.07
STD DEV 6.74 0.16 1.08 5.11 3.37 3.80 0.95
Median 17.16 1.00 1.53 3.49 14.48 18.26 9.06
Implied Value P/E
Price to
Sales
Price to
Book
Price to
Cash Flow
Price to
Free Cash
Flow
Price to
EBITDA Average
Average 18.89 1.87 5.92 13.93 17.87 9.07
Value 7.73 90.27 34.93 10.91 9.38 12.83
Implied Price 146.12 169.10 206.70 151.96 167.72 116.43 159.67$
ANALYSIS AGAINST INUDSTRY, SECTO R AND TH E S&P 500
Upon comparing General Dynamics
to the comparable firms’ price multiples’
median samples’ averaged implied share
price of $139.73 it is evident that General
Dynamics is overvalued by about $5 us
dollars. General Dynamics is undervalued
when compared to the implied S&P 500
share price of $136.78, however it is
overvalued compared to both the
Aerospace & Defense industry’s and the
Industrial Goods sector’s implied share
prices of $144.86 and $143.65
respectively. This gives us insight on the
fair
value of General Dynamics but it does not
give us the full picture. In order to get a
better grasp of the true fair value of
General Dynamics it’s imperative to
average the median sample, the S&P 500,
the sector and the industry because they
capture more of the overall market
characteristics and provides a more
accurate representation of General
Dynamics implied share price. Once all
these prices are averaged, it reveals that
General Dynamics is slightly undervalued
when compared to its current market
value of $144.29.
P/E Ratio
Price to
Sales
Price to
Book
Price to
Cash Flow
Price to
Free Cash
Flow
Price to
EBITDA Average
132.71 138.36 121.77 157.99 171.39 116.18 139.73
141.29 162.49 98.49 120.86 172.47 125.09 136.78
141.06 148.95 126.43 133.18 193.96 125.61 144.86
135.28 130.26 155.67 145.64 170.50 124.57 143.65
141.26$
Estimated Value Using:
Median Sample
S&P 500
Sector
Industry
Implied Price
Figu re: 6 -1 3 Graph Illustrating Estimated Stock Price based on multiples analysis
SUMMARY AND CONCLUSIONS SUMMARY OF VALUATION METHODS
ENTITY, ADJUSTED PRESENT VALUE, MO DIFIED FREE CASH FLO WS TO EQ UITY
According to these analysis, General Dynamics’ is
overvalued in the market. Our implied price per
share using the Entity and APV methods is $70.42
and $72.27 respectively. Based upon this implied
share price, the market is significantly
overvaluing the stock price of General Dynamics’.
The modified FCFE method produces a price per
share within a closer relation to the current
market share price. For general purposes the
Entity Valuation method is most accurate for
firms with consistent capital structures, for this
reason the Entity valuation is the main focus for
valuing General Dynamics’. The Adjusted Present
Value method is widely used when firms plan to
change capital structure because it more
accurately represents the use of leverage
financing, since General Dynamics’ is not highly
levered and won’t change its Debt/Equity mix
anytime soon, this method comes second in
weight for our valuation. The modified free cash
flows to equity implies a much higher share price
for General Dynamics’. The FCFE valuation
method is a measure of the cash flows that can be
paid back to shareholders in the form of stock
dividends or repurchases. It is the belief of this
team that the market is heavily considering FCFE
as the appropriate valuation for General
Dynamics’, thus the reason for the large disparity
in the implied market value and the firm’s actual
stock price.
Figu re: 7 -1 Comparison of valuation methods
MULTIPLES ANALYSIS
In comparison with the APV, Entity and FCFE
valuation methods, the multiples analysis
produced an implied price consistent with the
FCFE and the market. For the purposes of
analyzing General Dynamics’ the analyst team
does not weight much value to the multiples
analysis. The reason for this is due to the
inconsistent nature of General Dynamics’ capital
structure in comparison with the company’s
competitors. It is believed this inconsistency
skews the multiples analysis in favor of a higher
price due to General Dynamics’ lack of debt
financing. The fact that using multiples provided
us with the closest implied price in comparison to
the current market price was taken into
consideration, but for many reasons was not used
for the final decision in valuating General
Dynamics intrinsic stock price.
Figu re: 7 -2 Comparison of Multiples Valuation
Estimate of General Dynamics Value: $34.004 Billion
Estimated Value of Equity: $25.002 Billion
General Dynamics Intrinsic Stock Value: $75.31/share
RECOMMENDATION: Sell!
(Overvalued by $68.98)
Sell!!
Estimated Value Using: P/E Ratio Price to Sales Price to Book Price to Cash Flow Price to Free Cash Flow Price to EBITDA Average
Median Sample 132.71 138.36 121.77 157.99 171.39 116.18 139.73$
S&P 500 141.29 162.49 98.49 120.86 172.47 125.09 136.78$
Sector 141.06 148.95 126.43 133.18 193.96 125.61 144.86$
Industry 135.28 130.26 155.67 145.64 170.50 124.57 143.65$
*Implied Price 141.26$
Implied Price using Mulitiple Analysis