The defense budget is shrinking, but General Dynamics Corp still sees growing demand for its combat vehicles and warships, coupled with unprecedented opportunities to sell its popular Gulfstream business jets in China and other emerging markets.
Chief Executive Jay Johnson, a former F-14 fighter pilot and chief of naval operations, shies away from phrases like “off the charts,” but his steep hand gesture depicts a bright future for the commercial aerospace sector, and he’s not too worried about the defense outlook, at least for now.
In fact, tighter U.S. defense budgets will generate good acquisition opportunities for General Dynamics in coming years, Johnson told Reuters in a rare interview at the company’s headquarters in Falls Church, Virginia, Reuters reports.
“We don’t have time to wring our hands. For us it’s all about performing for the customer and delivering to the shareholder,” says Johnson, who said the company remained committed to paying strong dividends, but would also keep enough cash on hand to take advantage of possible acquisitions.
The company’s strategy seems to be paying off, with Warren Buffett’s Berkshire Hathaway recently making a significant investment in GD after selling its stake 10 years ago.
“It’s the Warren Buffett seal of approval, which I think counts for a lot,” he said. Buffett has not disclosed the size of his holding, he said.
U.S. defense companies are scrambling to cut costs and find alternate revenue sources as they brace for a big decline in spending after a decade of double digit growth.
Many analysts consider GD the best-positioned company in the sector, given the mix of its weapons expertise and red-hot prospects for its Gulfstream business, which already has 200 orders for the new GS650 jet entering service next year.
STILL GENERATING “CONSIDERABLE” CASH AND EARNINGS
Analysts expect General Dynamics, one of the five largest U.S. arms makers, to boost revenues by about $1 billion to over $33 billion in 2011, with sales growing modestly over the next two years. Revenues will be buoyed by an order backlog of over $58 billion and rising international sales.
“We still will generate considerable earnings and cash in the defense space,” said Johnson, noting GD would benefit from continued demand for upgrades to tanks and other ground combat vehicles, even as U.S. forces withdrew from Iraq.
Demand from military commanders would ensure continued shipbuilding sales “as far as the eye can see,” said Johnson, who met with top Navy officials in Hawaii last month on the sideline of the Asia-Pacific Economic Cooperation meeting.
GD is one of two builders of Virginia-class nuclear-powered submarines, and recently won praise from Defense Secretary Leon Panetta for building the latest submarine, the USS Mississippi for $50 million below target and a year ahead of schedule.
The company is also “very excited” about the prospects for its commercial aerospace division, Johnson said, adding that demand from emerging markets was fueling growth “in a way that I don’t think we’ve ever seen before.”
In time, the division could generate about 30 percent of revenues, up from 20 percent now, Johnson said.
Analysts say GD’s earnings potential is excellent, given growing demand from China and other emerging markets for its Gulfstream jets, which Morgan Stanley analyst Heidi Wood calls “one of the world’s sexiest and most respected brands.”
GD has forecast that operating earnings from commercial aerospace could grow to over 35 to 40 percent of company-wide operating earnings in the next five years, from 20 percent now. Wood says they could reach as high as 50 percent.
Not surprisingly, Johnson said he has no plans to sell Gulfstream, despite repeated suggestions from outsiders that the company should sell the unit to monetize its success.
In fact, GD plans to invest about $500 million in the Savannah, Georgia plant where it builds the jets, and just opened a new business office in Beijing on December 7.
Although Johnson says analysts are “just gaga” about Gulfstream’s prospects, he prefers a more measured approach, especially since GD still has to establish relationships in new countries for long-term maintenance of the business jets. “I don’t like overdriving our headlights,” he says.
APPETITE FOR ACQUISITIONS
At the same time, Johnson says declining defense spending could generate interesting acquisition opportunities for GD, and the company is keeping sufficient cash on hand to pounce if it sees good prospects in cyber security, health care information technology (IT), intelligence or aerospace.
GD in August acquired Vangent, a health care IT company that together with an existing unit, will make the company a top tier provider in that sector, Johnson said.
Johnson said GD would use its cash reserves to find companies like Vangent that fit with or enhance an existing business area, or allow it to more into an adjacent area.
He declined to give details on how large of a deal might be considered, but said he did not expect mergers and acquisition activity to involve top tier companies, at least for now.
At the same time, GD is continually looking for ways to restructure, divest and save money in other ways, Johnson said. Already lean and decentralized, the company has fewer than 200 people at its leased corporate headquarters site.
For now, Johnson said he was happy with that structure, and the 13 separate business units GD has, but he said there could those structures could change in the future, if it made sense.
As GD braces for defense cuts, Johnson is drawing on his experiences overseeing the last downturn in defense spending while serving as chief of naval operations from 1996 to 2000.
Back then, Johnson strongly backed the E/F variant of the Boeing Co (BA.N) F/A-18 fighter jet to ensure that the Navy had sufficient fighters for its carriers, rather than waiting for the development of the Joint Strike Fighter, a new fighter being developed by Lockheed Martin Corp (LMT.N).
Johnson says he expects Pentagon officials to pursue a similar approach this time around, with more money to flow into upgrades and incremental improvements than into new programs.
The Pentagon has already canceled one big GD program to develop a new amphibious vehicle, the Expeditionary Fighting Vehicle or EFV, for the Marine Corps, and it may delay work on two new Army vehicle programs that GD had hoped to bid for.
There has been some talk of the Navy slowing work on development of a replacement for the strategic Ohio-class of nuclear submarines, but Johnson said he expects that program to continue, albeit possibly at a slower pace.
He said Panetta understands how devastating wholesale program cuts would be for the industrial base, and will keep those issues in mind. “Mr. Panetta gets it,” he said.