It's been a few days now since General Dynamics (NYSE:GD) reported its fiscal fourth-quarter and full-year 2016 earnings. By now, you've read all the commentary on the quarter, and gotten a good idea of how things are going in broad strokes. Now it's time to start digging into the details -- in particular, details on the company's all-important business selling Gulfstream business jets into the civilian market.
Fair warning: The news isn't good.
What's going on at Gulfstream
When General Dynamics reported its earnings last week, investors were generally pleased to learn that the company had:
- kept sales declines to a minimum,
- expanded profit margins modestly,
- grown earnings (and beat earnings estimates), and
- promised to resume growing sales modestly in 2017 -- and to keep on growing those sales at a steady 5.6% pace through 2020.
As The Wall Street Journal pointed out at the time, it was "an unusual move for a defense company" to venture to project sales growth several years into the future, given the vagaries of defense budgets in Congress. On the other hand, given that General Dynamics has $59.8 billion worth of funded contracts in its backlog, and the potential for a further $25 billion in work if funding comes through, management's confidence in its future may be justified.
This could be particularly true if things go well for General Dynamics on the civilian side of things at its Gulfstream business jets business. After all, Gulfstream boasts an average operating profit margin of 20.5%, and is far and away the company's most profitable segment. With nearly $8.4 billion in trailing sales, Gulfstream is also General Dynamics' biggest business driver.
But here's the problem: Gulfstream produced $8.4 billion in sales for General Dynamics in 2016 -- but it produced more than $8.8 billion in 2015, and more than $8.6 billion in 2014.
Happy talk from management
In other words, while Gulfstream remains a great business for General Dynamics, it's not quite as great as it once was -- and that's bad news. General Dynamics CEO Phebe Novakovic reassured investors that Gulfstream is making progress on development of its two new large-cabin business jets, while sales were "solid" during the quarter. But actual deliveries continue to lag.
General Dynamics delivered 30 "green" large-cabin aircraft during the fourth quarter, a nice 20% uptick from the 25 units delivered in Q4 2015. ("Green" here is an industry term of art referring to an airplane that can fly, but is delivered without avionics or furnishings installed.)
Total deliveries of green aircraft dipped modestly in Q4, from 37 to 36 aircraft delivered. Fully outfitted Gulfstreams, on the other hand, declined sharply, from 38 down to just 27 airplanes delivered -- a 29% decline, which was worse than for the year as a whole.
These problems aren't limited to General Dynamics. Both Embraer and Bombardier have lamented weak sales lately. And at Textron, which also reported earnings last week, Citation and King Air deliveries were down 7.5% year over year in Q4, with sales, profits, and backlog also declining modestly. Meanwhile, Honeywell blamed "lower volumes in Business and General Aviation" for a 5% decline in revenue at its aerospace division in Q4. (Honeywell supplies all the major business jet manufacturers, providing "cabin management and entertainment systems" to Gulfstream for example, engines for Textron's Cessnas , and avionics for Embraer's business jets.)
That said, while problems selling business jets are widespread, this doesn't change the fact that in the near term, they will have an outsized effect on General Dynamics, which depends on Gulfstream to provide 40% of its profits. Long-term, I still expect that General Dynamics will dominate the business jet market, as weaker competitors suffer disproportionately from the supply glut in business jets and begin to fall away.
But until they do, General Dynamics stock won't be able to fly very high, either.