This 'Aristocrat' Is an Attractive and Defensive Dividend Growth Stock

Sometimes a good defense is the best offense when it comes to dividend stocks. That has certainly been the case for defense giant General Dynamics , which has increased its dividend each year for over 25 years, earning the exclusive Dividend Aristocrat distinction. General Dynamics has a recession-resistant business model, with a long runway of growth up ahead. It should have little trouble continuing to increase its dividend at a high rate as well, making General Dynamics an attractive dividend growth stock from the defense industry. Business Overview General Dynamics is a global aerospace and defense company with $39.4 billion in revenue and $3.5 billion in net profit last year. The company operates under five segments: Aerospace (25% of 2019 sales), Combat Systems (18%), Information Technology (21%), Mission Systems (13%) and Marine Systems (23%). The company's Aerospace segment focuses on business jets and services, while the remainder of the company is defense. Well-known products include the M1 Abrams tank, Stryker vehicle, Virginia-class submarine, Columbia-class submarine and Gulfstream business jets. Based on revenue, General Dynamics is the third largest defense company. So far in 2020, General Dynamics has generated $27.4 billion in sales and $2.2 billion in profit. Growth Prospects In the 2010 through 2019 stretch, General Dynamics grew its revenue by 2.2% per year, company-wide profits by 3.2% per annum and earnings per share by 6.5% per year. Reasonably slow top-line improvement was aided by a net profit margin that went from 8.1% to 8.9% and a share count that was reduced by 2.7% per year. Moving forward, the share repurchase program ought to continue to boost earnings per share. Results are expected to be down this year due to the coronavirus pandemic. However, the company still has growth avenues ahead. The top line can continue to grow due to increased U.S. defense spending and international sales, which tends to be a relatively consistent industry. The business jet market is being negatively impacted by the Covid-19 pandemic, but we anticipate that this will bounce back as the pandemic subsides. In addition, General Dynamics has established naval and ground platforms that support maintenance and modernization contracts as well as capturing more contracts in the future. To this point, the company's backlog stood at $81.5 billion at the end of the third quarter, up 21% from the year-earlier period. Overall, we are forecasting 6% annual growth for the company over the intermediate term, which is slightly below its average growth rate in the last decade. This steady growth is due largely to the company's competitive advantages. Competitive Advantages General Dynamics is a large, entrenched military contractor, providing the company with its fair opportunity to capture and sustain a large amount of business with the U.S. government. The company has ground and marine platforms that serve as the backbone for the U.S. Army, U.S. Navy and militaries around the world. This leads to a competitive advantage as these platforms have decades long life cycles and General Dynamics has expertise and experience to perform sustainment and modernization. These characteristics lead to a good degree of recession resistance. During the Great Recession of 2008-2009, General Dynamics generated EPS of $6.13, $6.20, and $6.82 during the 2008 through 2010 period, while the dividend kept increasing every year. The company does face risks in the way of program cuts, reduction in federal spending, and cyclicality of the business jet market as we have seen recently. Moreover, General Dynamics is increasing its exposure to information technology and cybersecurity, which are competitive fields with lower margins. However, the company has demonstrated its profitable nature in good times or bad and the significant backlog offers good visibility into the future. Valuation & Expected Returns General Dynamics the business has put together a solid record, but whether or not the security looks attractive depends on expectations moving forward, and the current share price. As mentioned above, 6% annual EPS growth over the next five years coming off $11.05 in EPS would equate to an earnings estimate of about $14.79 per share. Keep in mind that this is one possibility out of many, but it does allow for a starting baseline. Over the past decade shares of General Dynamics have traded hands with an average price-to-earnings ratio (P/E) of about 14. If we use this multiple, that works out to a potential share price of ~$207 in five years' time. The company recently announced a $1.10 per-share quarterly dividend, working out to $4.40 on an annualized basis. Compared to $11.05 in expected earnings, this also works out to a current payout ratio of about 40%. If the dividend were to grow at 8% annually for the next five years -- faster than EPS growth, but slower than the past decade -- the dividend would reach ~$6.50 per share. In total, investors could generate ~$28 in dividend payments over the next five years. If you add together the potential share price and expected dividend, you get a total potential value of ~$235. Once again keep in mind that this is simply a starting baseline and one forecast out of an infinite number of possibilities. As it stands, GD shares have the potential for 9.0% annualized returns over the next half decade, comprised of changes in the valuation multiple, EPS growth, and dividends. This is a reasonable return expectation, which is reinforced by a strong underlying business and solid dividend yield (currently sitting at ~2.9%). Final Thoughts General Dynamics offers a number of attractive characteristics. The company's top-line growth has been mediocre, but the business and security have more than made up for this in consistency and strong growth rates in both EPS and dividends. Indeed, the company's dividend history is a storied topic. The security appears to be reasonably priced today, offering the potential for 9% annual returns over the next five years, stemming from the 2.9% starting yield and 6% anticipated growth rate. Moreover, the nature of the business, especially with the large backlog in place, offers a resilient business model in lesser times. General Dynamics offers an attractive and defensive dividend.

This 'Aristocrat' Is an Attractive and Defensive Dividend Growth Stock

The company has increased its dividend each year for over 25 years.

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