Four years after Russian special forces invaded Ukraine, annexing Crimea and prying loose much of eastern Ukraine from Kiev's control, thousands of Russian soldiers continue to unofficially occupy Ukrainian territory. That's bad news for Ukraine's neighbors, who have to at least consider the possibility that Russian forces may have further ambitions farther west -- but it's good news for General Dynamics (GD 0.44%).
Last week, one such neighbor -- Romania, which shares hundreds of miles of border with Ukraine -- signed a contract ordering 227 new "Piranha 5" armored personnel carriers (APCs) from General Dynamics' European Land Systems subsidiary. At $1 billion in value, the purchase will consume nearly 25% of Romania's annual defense budget .
What General Dynamics is selling
Initially designed to serve in the British Army, General Dynamics' Piranha V today serves in the Danish, Spanish, and Romanian armies. It's the fifth generation of a successful design that has seen "more than 11,000 systems fielded" around the globe, according to the company, since its introduction in 1972.
An eight-wheeled, 30-ton armored beast, Piranha is as big as a light tank, and can even carry a tank-like 105 mm cannon (although it's more commonly equipped with auto-cannons, grenade launchers, and/or TOW antitank missiles ). Its armor is designed to stand up to everything from IED mines up to and including 30 mm cannon fire and RPGs.
Piranha won't be able to stand toe to toe with a main battle tank. Then again, at an average unit cost of just $4.4 million, Romania will be able to buy a lot more of them with $1 billion than it could tanks -- and load each Piranha with a tank-destroying TOW missile to even the odds.
What else General Dynamics has been selling
I've been predicting a boom in defense spending in Europe for... well, for some years now -- ever since Russia's extracurricular activities in Ukraine made the need for a beefed-up defense frighteningly obvious to its near neighbors. In actual fact, however, although General Dynamics has enjoyed a burst of new business for its armored vehicles segment, much of its recent sales success has come from buyers outside Europe.
Over just the last two years, we've seen General Dynamics secure contracts to sell:
- 141 upgraded LAV 6.0 light armored vehicles to Canada (in a deal valued at $309 million)
- 178 reconditioned Stryker armored personnel carriers to Peru ($668 million)
- 218 recapitalized Abrams M1A2 main battle tanks to Kuwait ($1.7 billion)
- 153 M1A1/A2 Abrams main battle tanks to Saudi Arabia ($1.15 billion)
And of course, all this comes on top of the deal that really got General Dynamics' armored ball rolling, its 2014 contract to supply nearly 3,000 LAV light armored vehicles to Saudi Arabia for $13 billion -- which is now at full-rate production.
Thus, while it's curious that General Dynamics hasn't won many big contracts on the Continent itself, where the Russian threat appears so severe, the company doesn't seem to be doing all that awfully bad regardless. And, there's still the possibility that Europe's slower-rolling bureaucracies may eventually get around to ordering tanks and APCs of their own, given enough time. For example, Poland -- also a Ukraine neighbor -- is currently exploring a deal that could see it acquire as many as 1,000 new main battle tanks.
What it means to investors
General Dynamics investors can certainly hope that those tanks will come from General Dynamics. But the simple truth of the matter is that, whether or not GD wins the Poland tank contract, successful sales in Romania and elsewhere are already all but certain to lift its business.
For most of the past decade, you see, sales at General Dynamics' flagship Combat Systems division have been sagging. Combat Systems -- primarily, tanks and APCs -- generate 16.3% operating profit margins for General Dynamics, according to data from S&P Global Market Intelligence. That makes this division, now General Dynamics' smallest by revenue, its second most profitable division by profit margin -- second only to the company's wildly profitable Gulfstream Aerospace division.
Simply put, with the exception of airplanes, there's no other product General Dynamics can sell that drops more dollars to the bottom line faster than tanks and APCs. And now we know that General Dynamics will be selling a lot more of them.
Just to be clear, at a valuation of nearly 20 times earnings, I still don't think that General Dynamics' stock is enough of a bargain to justify buying at today's elevated prices. But if GD keeps on signing lucrative armored vehicle contracts at the rate it's been doing lately, I reserve the right to be proven wrong about that.