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Why Shares of General Dynamics Climbed in May

By Lou Whiteman - Jun 3, 2020 at 6:02PM

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Analysts pound the table on the shares after a steep decline earlier in the year.

What happened

Shares of General Dynamics (GD 1.25%) gained 12.4% in May, according to data provided by S&P Global Market Intelligence, as investors warmed to defense contractors as a relative safe haven in a volatile market. General Dynamics also made progress in securing a lucrative submarine contract.

So what

It's been a wild year for General Dynamics holders, with the shares falling more than 40% from mid-February to mid-March, along with the broader markets, as the full impact of the COVID-19 pandemic became more apparent.

General Dynamics is primarily a defense contractor and most of its operations were not impacted by the stay-at-home orders, but the company still faced some supply-chain disruptions. General Dynamics also owns Gulfstream, and investors were concerned business jet orders were likely to be impacted if the economy falls into a recession.

A submarine breaking the ocean's surface.

Image source: General Dynamics

As markets began to settle in May, a number of analysts took a fresh look at General Dynamics and liked what they saw. On May 19, Seaport Global analyst Richard Safran initiated coverage on the company with a buy rating, calling General Dynamics an "underappreciated defense story" driven down by "excessive fears" over the economic impact of the pandemic on Gulfstream.

Two days later, RBC Capital analyst Michael Eisen struck a similar tone, initiating General Dynamics with an outperform rating and saying the company's submarine business is among the most attractive franchises in defense with solid visibility. Eisen also noted General Dynamics' "hard to pass up" valuation as a reason to like the stock.

The submarine franchise could become a little more valuable if the Pentagon decides to do a bulk order for Columbia-class ballistic missile submarines. Contractors like the certainty of multiple-boat orders for planning purposes, especially in a year when the overall Pentagon budget could come under pressure.

Now what

General Dynamics for years now has traded at a discounted multiple to contractors, including Lockheed Martin and Northrop Grumman, largely due to Gulfstream. Today General Dynamics trades at 13 times earnings, well shy of Lockheed's 25 times earnings multiple and Northrop's 18 times multiple.

As the analysts note, unless you believe that the business jet industry will never recover, that's a substantial discount for what is otherwise a top-notch portfolio. General Dynamics also has a substantial government IT business that could benefit from months of government employees working from home and future outsourcing opportunities.

General Dynamics remains one of the better buys in the defense sectors. It's not too late to buy in even after May's stock surge.

Lou Whiteman owns shares of General Dynamics and Lockheed Martin. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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