General Dynamics lands a $6.75 billion Navy contract — and it’s not for warships

When you think about General dynamics (G.D -0.12%)what is the first thing that comes to my mind?

Tanks, probably. Seventy-ton armored cars roam the plains.

Image source: Getty Images.

In fact, however, while tanks are the product for which General Dynamics is best known, the production of such “combat systems” is General Dynamics. the smallest business, accounting for just $8.3 billion of GD’s more than $42 billion in sales in one year. Bigger by far is General Dynamics’ “marine systems” business, which brought in $12.5 billion in revenue last year — nearly 50 percent more business than combat systems.

Even more surprising, however, for a company known as a defense contractor, is that not all of General Dynamics’ maritime systems products are warships. While the company specializes in building nuclear-powered submarines and conventionally powered destroyers, General Dynamics also builds several ships that are more focused on keeping the US Navy fueled and supplied than actually conducting combat operations.

Image source: US Navy.

$6.8 billion for tankers

Case in point: General Dynamics’ latest naval contract, a $6.8 billion award to build tankers for the Navy.

On Sept. 13, the Pentagon awarded General Dynamics a single-source, “bulk buy” contract to build eight John Lewis-class fleet replenishment oilers, T-AO numbers 214 through 221, between now and January 2035. San from General Dynamics National Steel and Shipbuilding Co. Branch. (NASSCO) based in Diego will do the work, and once built, the ships will enter service at the Military Sealift Command, where they will be manned by civilian sailors.

This is, of course, a sizable contract, amounting to more than half a year’s worth of average revenue for the marine systems division. Receiving this one contract win isn’t necessarily a great reason for investors to flock to GD stock, however.

Warnings and caveats

Why not? Well, first of all, consider the timeline. $6.8 billion may sound like a lot of money, but spread over 10 years until the contract is up, it’s actually more like $675 million a year. That’s still a nice 5% increase in average revenue for the division — but closer to a 1.6% increase in annual revenue for the company as a whole.

In other words, probably not enough to move the needle much.

A second reason to be less excited about this news is that while General Dynamics’ second largest division by revenue, Marine Systems is the company’s. least profitable division in terms of profit margins. Last year, for example, marine systems operating profit margins came in at just 7 percent according to data from S&P Global Market Intelligence, compared to the 10 percent margins GD earns overall.

Simply put, if maximizing profits is your goal, adding revenue to General Dynamics’ marine systems division is literally the worst way to do it.

What it means for investors

Perhaps that’s why General Dynamics stock didn’t rise as much as you might expect on the news that it won a “$6.8 billion contract.” In the 10 days since the oil contract was announced, GD stock has actually gained only about 2.6% — not much better than the 2% gain in S&P 500 index.

It doesn’t help, of course, that General Dynamics remains an expensive stock. Valued at 24 times trailing earnings, the stock can Look as a bargain in a market where the average S&P stock costs closer to 30 times earnings. However, General Dynamics’ price-to-sales ratio of 1.9 times is historically expensive. From 2011 to 2020, for example, a P/S ratio of 1.4x was more common. Plus, the company’s profit margins have been slowly shrinking for years, meaning those sales aren’t worth as much, profit-wise, as they once were.

Despite its size, this latest NASSCO award for low-margin oils won’t make this trend look any better.