General Dynamics: A defensive dividend play
I’ve wanted to add a defense sector stock like General Dynamics (GD: 73.94 0.00%, yld: 2.06%) to my dividend stocks portfolio for some time, but each time I looked it was simply too expensive - having more than tripled in value in the years following the 2002-2003 market lows. Not any more.
Fears over the global recession (specifically relating to the company’s Gulfstream business jet unit) and reduced defense spending have sent it - and other defense stocks - retreating back to levels approaching their ‘02-’3 lows. So I thought it was time to take another look.
A dynamic dividend grower
General Dynamics is a member of the Dividend Achievers - companies that have increased annual regular dividends for at least the past 10 consecutive years, and that are considered to have strong cash reserves, solid balance sheets and a proven record of consistent earnings growth. In fact, the company recently announced an 8% increase in its quarterly dividend from $0.35 to $0.38.
According to DividendInvestor.com, GD’s five-year average dividend growth rate is almost 17%. A low payout ratio of 22% and strong free cash flow suggest that the dividend - currently yielding about 4.2% with the stock trading at $36 - should be safe.
Lowered guidance, but stock still seems cheap
Not helping the stock price was the company recently cutting its guidance for 2009 earnings - to a range of $6.00 to $6.10 per share from $6.70 to $6.75. Taking the low end of this range and an estimated earnings growth rate of 10% and plugging them into a DCF calculator gives a fair value estimate of about $81 - considerably above where the stock is currently trading.
Clearly the market is pricing in far worse expected results. Dropping the earnings by 50%(!) and using a 5% five-year earnings growth rate gives a conservative fair value estimate of about $33 per share.
A check with Ockham Research also suggests that GD is somewhat undervalued here. Its price/sales and price/cash earnings ratios are neutral or positive when compared with recent historical values, while its dividend yield is significantly higher than average - all suggesting that the stock is, on the whole, undervalued at these levels based on current fundamentals.
Getting extremely oversold as it nears ‘03 lows
A 32-year price chart of GD (below) shows that the stock is currently trading well below its long-term linear regression trendline and is rapidly approaching its ‘03 lows (at around the $25 level):
The long-term price oscillators - shown in the middle two graphs - are at extreme oversold readings, suggesting a potential long-term buying opportunity in the making. It’s important to note that these are indicators of significant strength in the direction of the move that caused the extreme reading and very often do not coincide with actual price bottoms (or tops).
In fact, the current downside momentum suggests that a further price drop is likely. Near-term support appears to be at about the $35-$36, $30, $26 and $23 price levels.
Bottom line
The shares of General Dynamics appear to be fast approaching attractive price levels from a long-term fundamental and dividend investing perspective. If they fall to about $30 (or lower) - which the technical picture suggests is likely - they’ll be offering what should be a safe dividend yield of 5% (or higher) as well as good long-term price appreciation potential.
Last week I sold some $30-strike May put options against GD, meaning that I’m willing to buy (be put) shares of the stock at $30 between now and when the options expire in May. If the stock remains above $30 until expiration and the options expire worthless, I’ll make 4% (in 10 weeks) on the put option sale.
If GD is below $30 and I’m put the stock, my net cost basis for the shares will be under $29. If GD drops substantially more than I’m expecting before May options expiration, I’ll consider rolling over the options to a later date and lower strike price.
