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On Feb 4, 2013, we downgraded defense and aerospace operator, General Dynamics Corporation (GD - Analyst Report) to Underperform based on the company’s dismal fourth quarter and full year 2012 financial results. The company currently has a short-term Zacks Rank #5 (Strong Sell).

Why the Downgrade?

General Dynamics recently reported lackluster 2012 results. The company posted fourth quarter 2012 earnings of $1.39 per share, missing the Zacks Consensus Estimate of $1.90 per share. Reported quarter revenue of $8.08 billion failed to meet the Zacks Consensus Estimate by $731 million. The downside reflects huge charges at its information systems business and a revenue decline at European Land Systems.

Currently, the Zacks Consensus Estimate for 2013 is $1.61, an estimated decline of 5.29% year over year.

Cause for Concern

The company’s Gulfstream business is facing lower demand and the Jet Aviation business is not doing too well either. The Jet business has particularly been hit by the economic crisis in Europe. To add to the woes of Jet Aviation, the competitive scenario has become more intense with original equipment manufacturers now grabbing contracts and taking away a slice of the business pie.
 
Meanwhile the Information Systems & Technology (IS&T) segment is experiencing top-line pressure as a result of defense spending cuts and margin compression from an unfavorable mix shift and cost performance. Going forward, continuing growth in the IS&T segment is critical, since it has the potential to be the primary growth driver in situations where cuts in defense spending could hinder growth in other operating segments.

Though the company is working on a restructuring plan to eliminate excess capacity and align the size of its European business with future demand, uncertainty related to the defense budget and U.S. debt situation remains an overhang.

Other Stocks to Consider

While we prefer to avoid General Dynamics until we see signs of improvement in the company's performance, other defense stocks worth a look are Huntington Ingalls Industries, Inc. (HII - Snapshot Report) and Esterline Technologies Corp. (ESL - Snapshot Report) with a Zacks Rank #1 (Buy), and Lockheed Martin Corporation (LMT - Analyst Report) with a Zacks Rank #2 (Buy).

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