General Dynamics' (NYSE:GD) Lima, Ohio-based tank-building factory is back from the dead (the rest of General D was already doing just fine). But it's still a complicated situation -- so let me explain.
Last quarter, General Dynamics reported a 3% decline in sales across its four major divisions. Combat systems, the division that builds Abrams main battle tanks, LAV light tanks, and Stryker armored personnel carriers took it on the chin, with sales down 7% year over year. This obviously was not great news for the company's Lima plant, which builds both the Abrams and the Stryker, and where the payroll has been slashed from a high of 1,200 employees 10 years ago, to about 400 today.
But there's better news rumbling down the pike.
A big new order from Saudi Arabia
Last week, the U.S. Defense Security Cooperation Agency -- the arm of the Pentagon responsible for coordinating foreign arms sales -- announced that it has notified Congress of a big new order for Abrams main battle tanks for Saudi Arabia. According to DSCA, Saudi wants to buy 153 M1Al/A2 "tank structures" from General Dynamics.
Of those tanks, 133 will then be converted into the M1A2S "Saudi Abrams" configuration, being equipped in the process with a battery of smoke grenade launchers and 0.50-caliber and 7.62-mm machine guns to supplement their main guns -- and stocked with 6,650 rounds of tank ammo. The remaining 20 tank bodies will be used as "battle damage replacements" for Saudi tanks lost in the fighting in Yemen.
Additionally, with casualties mounting in Yemen, the Saudis have placed an order for 20 of General Dynamics' M88A l/A2 Heavy Equipment Recovery Combat Utility Lift Evacuation System (HERCULES) Armored Recovery Vehicles -- used to recover damaged tanks from the battlefield, and return them to base for repair.
Total cost for Saudi Arabia's shopping list: $1.15 billion.
A boost from the Obama Administration?
Nor is Saudi Arabia the only good news General Dynamics (might) get in 2016. Earlier this year, the Obama Administration requested funding for $480 million worth of tank upgrades from General Dynamics, and a further $591 million in upgraded Stryker APCs -- all built at General Dynamics' Lima plant -- in this year's fiscal 2017 defense budget.
Now, this budget is still pending before Congress. But if it passes, and is signed into law, it will add a further $1.1 billion in new armored vehicle orders for General Dynamics. So all together, we're looking at probably something on the order of $2.2 billion worth of new work for the Lima plant -- serious job security for the 400 workers who still have jobs there.
What it means to investors
That's great news for the workers, but what does it mean for investors? Actually, it's pretty good news for us, too. You see, currently, combat systems is General Dynamics' smallest business unit, with just $5.6 billion in revenue booked in 2015. At the same time, combat systems is the company's second-most-profitable unit, with an operating profit margin of 15.6% -- just behind the uber-profitable aerospace business that builds lucrative Gulfstream business jets.
Apply that 15.6% margin to the $2.2 billion in revenue coming Lima's way, and General Dynamics stands to make an extra $346 million or so in profit from these tank and APC orders. That's about $1.13 per share, or 12% of trailing profits.
Not bad work for just a couple of contracts, coming out of the company's smallest business unit. Not bad at all.