Faced with the prospects of slowing revenues and declining profits for the foreseeable future, defense contractor Northrop Grumman recently announced a plan to boost its earnings -- by buying back its own stock. But Northrop's hardly the only defense contractor facing a tough spending environment. And this raises the question: Could General Dynamics (NYSE: GD ) stock be next in line for a big buyback?
Where Northrop treads...
Northrop upped its planned stock buyback program to $5 billion, effectively assuring investors that even if its earnings as a company should decline, it can still make its earnings per share grow.
How? Well, assume that Northrop earns (hypothetically) $1 million and divides this profit among (still hypothetically) 1 million shares. This results in $1 profit for each Northrop share outstanding. But if you shrink the share count to 750,000 -- on the same $1 million, firmwide profit -- then each remaining share owns $1.33 of the profits. Presto change-o -- Northrop produces 33% profits growth!
... should General Dynamics follow?
In Northrop's case, this makes sense. Analysts think Northrop's profits will decline by about 2.6% on average over the next five years. But a 33% boost to per-share earnings could cancel out these declines and even get Northrop growing again.
In the case of General Dynamics stock, though, a big buyback could do even more good. Right now, you see, General Dynamics shares are expected to earn more than peer armored vehicle manufacturers:
And yet, this picture isn't really as pretty as it looks, because if General Dynamics stock earns more per share than its peers, it also carries a higher price per share.
Don't get me wrong -- on a forward earnings basis, General Dynamics stock is still cheaper (11.1 times earnings) than either Textron (NYSE: TXT ) at 11.4 times earnings or Oshkosh (NYSE: OSK ) at 12.2 times earnings. That being said, General Dynamics stock isn't quite as great a bargain relative to its rivals as first meets the eye. But a big stock buyback could change that equation.
General Dynamics can and should follow Northrop's example
General Dynamics is also in a better position -- financially -- to fund a big stock buyback. Of the three big armored vehicle manufacturers, GD has the least net debt on its balance sheet. Oshkosh's balance sheet shows a bit more than $500 million more debt than cash, while Textron has more than $3 billion more debt than cash in the bank.
General Dynamics stock, in contrast, shows a net cash deficit of only $170 million.
Cash is king
GD is also doing the best job of these three companies at generating cash from its business -- cash that can be used to pay a big dividend, to pay off debt, and yes -- to do a big buyback. Again, putting things in perspective:
As it turns out, of course, General Dynamics is buying back stock. In fact, just last month the company confirmed that it repurchased 1 million shares in Q1. But it can do better. Ample free cash flow and a robust balance sheet -- plus modest growth prospects that could benefit from a boost to per-share earnings -- all argue in favor of upping the tempo of General Dynamics' stock repurchases.
It's time to buy back some (more) General Dynamics stock.