General Dynamics vs. the Recession

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Make no mistake -- General Dynamics (NYSE: GD) is a terrific defense contractor, and yes, a dynamic company in general. But matched against a global , General D has come away looking like the proverbial 98-pound weakling.

For the third quarter, the General did what it did best: grew sales at its combat systems division by 27%, at marine systems by 8%, and at information systems and technology by 9%.

Operating profit climbed at all three business units as well. Yet Wednesday morning, none of that was enough to save General Dynamics' stock from joining the general rout in defense contracting; Boeing (NYSE: BA) is down 10% since mid-month, and Lockheed Martin (NYSE: LMT) is down 7% compared with a market that has ebbed only a couple percent. And while each company has its quirks, General Dynamics' post-earnings decline can be traced to one single, sad fact: In the middle of a recession, money's tight, and people don't want to buy planes.

Give me a ticket for an aeroplane (please)
Specifically, business jets. You see, for all the success of its trademark defense businesses, General Dynamics was laid low this morning by news that its business jet division (you remember -- the one that was supposed to be going gangbusters just three months ago?) is imploding. And sure, it's General D's smallest division by revenue, but even so, the aerospace unit's 18% decline in Q3 sales, and 56% decrease in profits, sent this company into a tailspin. (Shades of Textron (NYSE: TXT), I know.)

Gone are the days of a rapidly growing backlog. While overall backlog improved, it was thanks to a doubling of the more dubious "unfunded" variety. Now we're looking at a funded backlog down 6% from last year's third quarter -- a neck-snapping turnaround from the second  quarter, and one almost entirely because of a drop-off in business jet orders. Meanwhile, free cash flow has taken a tumble. Whereas General Dynamics has historically won commendations for generating cash profits equal to or exceeding reported net earnings, today we're seeing the company generate just $0.90 per dollar of GAAP profit.

What's it mean to you?
From a valuation perspective, this means the company is marching toward perhaps $1.5 billion in free cash flow by year's end. That's more than a private's paycheck, sure, but I'm not at all certain it can support the General's $25 billion market cap.

Long story short, if you took my advice and bought General Dynamics last quarter, by now you're probably sitting on a 19% gain. My advice? Do not consider today's minor sell-off a "buying opportunity." It isn't. Instead, it's time to count your winnings and sit pat.