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General Dynamics Cuts Radar Deal

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General Dynamics Corporation (GD - Free Report) has been awarded a contract to develop and deploy modernized range instrumentation radars, replacing an aging and outdated fleet of radar systems currently operating at U.S. Army test ranges. The Range Radar Replacement Program (RRRP) has a total potential value of $385 million over ten years if all options are exercised. The initial award, valued at $29 million, provides funding for the engineering, manufacturing and development phase of the program and initial production and integration of the new radar systems at White Sands Test Center, New Mexico; Yuma Test Center, Arizona; Aberdeen Test Center, Maryland; and Redstone Test Center, Alabama.

Work will be performed in Scottsdale; Kilgore, Longview and Richardson, Texas; State College, Pennsylvania; Hilliard, Ohio; Reston, Virginia; Fort Walton Beach and Melbourne, Florida; and Atlanta.

Earlier, General Dynamics posted mixed results for the March quarter, surpassing the Zacks Consensus Estimate on the top line but missing the forecast at the bottom. Looking forward, key drivers include the improving business jet market, its stable business of U.S. military vehicles, a backlog of over $55 billion, an ongoing share repurchase program and strong cash flow generation.

However, the company is largely tied to the U.S. defense budget, where the threat of budget cut is looming. Also, we have turned slightly cautious about the company’s steadily dropping order backlog, and risks related to the execution of key projects.

Headquartered in Falls Church, Virginia, General Dynamics engages in mission-critical information systems and technologies; land and expeditionary combat vehicles, armaments and munitions; shipbuilding and marine systems; and business aviation. The company operates through four segments: Information Systems & Technology (IS&T), Combat Systems, Marine Systems, and Aerospace.

General Dynamics was the third largest U.S. defense contractor in terms of revenue in fiscal 2011, after The Boeing Company (BA - Free Report) and Lockheed Martin Corporation (LMT - Free Report) . The company is one of two contractors equipped to build nuclear-powered submarines in the U.S.

General Dynamics continues to benefit from strong congressional support for its programs in the 2012 defense budget. The U.S. defense budget for 2012 was $645.7 billion, with the base budget at $530.6 billion and $115.1 billion approved for Overseas Contingency Operations (“OCO”) as supplementary defense spending, mainly to fund ongoing wars.

In February this year, the Department of Defense (DoD) requested a Pentagon base budget of $525.4 billion for 2013, which is approximately $5.1 billion or 1% less than what is approved for fiscal 2012, with $88.5 billion earmarked for OCO spending. The significant reduction in OCO funding is mainly due to the decline of U.S. military operations in Iraq in 2011. Going forward, OCO funding is expected to continue to decline as troops redeploy out of Afghanistan.

For the future, the company’s focus will be on the revival of the business jet market (Gulfstream) along with programs such as the Warfighter Information Network Tactical (WIN-T) program and Joint Tactical Radio System (JTRS) in the IS&T division.

Similarly, the Combat Systems and Marine Systems segments will receive a boost from higher volumes in the U.S. military vehicle business (Stryker combat vehicles and Abrams tanks) and ship programs DDG-51, Virginia class submarines and the Mobile Landing Platform program.

General Dynamics has one of the strongest balance sheets among its peers with a low long-term debt-to-capitalization of 20.5% at the end of the first quarter of 2012 (Zacks Industry Average was 44.3%). Earlier, General Dynamics’ free cash flow from operations reached $2.8 billion in fiscal 2011. Management returns a substantial portion of its free cash flow to shareholders through share repurchases and incremental dividends. The company repurchased 18.9 million shares during fiscal 2010 and 20 million shares during fiscal 2011. Also, in March 2012, the company raised its regular quarterly dividend by 8.5% to $0.47 per share.

General Dynamics’ total order backlog steadily decreased to $55.2 billion at the end of the first quarter of 2012 from $59.6 billion at fiscal-end 2010. Going forward, the U.S. economic fundamentals are basically being kept on a leash as the Euro-crisis continues to cast its spell over the financial markets, keeping risks of further cutbacks in future defense budgets at a high level. Our apprehension is fueled by $15 trillion of national debt and an unemployment rate hovering around 8.1% which would lead to the Budget Control Act’s dictum of automatic cutbacks across the board going forward.

Going by the pulse of the economy and given the pros and cons, we prefer to maintain our long-term Neutral recommendation on the stock. Moreover, General Dynamics holds a Zacks #3 Rank that translates into a short-term Hold rating.

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