What General Dynamics needs to do improve profit

A favorable sales mix will drive General Dynamics IS&T’s strong profitability into 2017, says Joey Cresta, analyst at TBR.

IS&T is a cash generator for General Dynamics, with high margins on C4ISR solutions enabling concurrent pursuit of lower-margin IT deals.

Information Systems and Technology (IS&T) is living up to its reputation as a cash generator for General Dynamics. In Q3 2016 IS&T was also the company’s growth engine, generating 5.5 percent year-to-year expansion to $2.3 billion, the only General Dynamics business to grow in the quarter. Operating margin of 10.9 percent was 100 basis points higher than in 3Q15 and the fourth straight quarter above 10 percent.

Sustained profitability well above the peer average in TBR’s Public Sector IT Services Benchmark reflects a favorable business mix including an increased component of C4ISR solutions. Strong order activity as U.S. Armed Forces refresh equipment bolsters IS&T’s overall performance and enables pursuit of lower-risk, yet less-profitable, IT deals such as work supporting the U.S. Census. Although General Dynamics did not raise IS&T’s operating profit guidance for a second straight quarter in Q3 2016, order trends suggest it will likely outpace the current guidance midpoint and sustain double-digit margins heading into 2017.

Cloud-certified resources are a necessary investment in next-generation IT services

Attracting relevant resources is critical to General Dynamics Information Technology (GDIT) remaining competitive against rivals such as CSRA amid the rising influence of digital transformation in the public sector. Committing to next-generation IT services will increasingly require IS&T to grow its bench of cloud experts certified by partners such as Amazon Web Services (AWS). Skills in designing, deploying and operating solutions in cloud or hybrid IT environments will become more important as governments look to the cloud for more cost-effective hosting of data, which grows exponentially as connectivity spreads and provides opportunities to leverage analytics to extract value.

IS&T’s strong reputation with the U.S. Armed Forces will likely help it attract veterans incentivized to pursue AWS certifications through a U.S. Department of Veterans Affairs reimbursement program. Although hiring talent with certifications is a priority for GDIT, TBR’s 2Q16 Cloud Brokerage & Integration Benchmark indicates these individuals are in high demand, driving M&A of smaller firms focused on services around a single cloud vendor. Additionally, in the federal market, it is challenging to win over these resources, which typically can find better compensation elsewhere.

IS&T is building a robust UUV portfolio to capture lucrative growth opportunities

Autonomous systems are core to the DOD’s Third Offset Strategy to maintain technological superiority over global adversaries. The Bluefin Robotics purchase in early 2016 enhances IS&T’s position in the burgeoning market for unmanned undersea vehicles (UUVs), which represent an opportunity for the DOD to offset the significant Anti-Access/Area Denial capabilities of nations such as China.

IS&T’s investments position it to capitalize as U.S. Navy officials seek to speed up adoption of UUVs, which lag behind unmanned aerial vehicles in development and implementation by around 20 years. UUVs are transformative for naval asset and personnel risk management, but also provide significant cost savings through automation, providing substantial benefit in the context of tight defense budgets.

IS&T followed up the launch of the SandShark UUV in June with the unveiling of Bluefin’s hovering-autonomous underwater vehicle (H-AUV) in September. The H-AUV is designed to automate ship hull inspection, but is applicable across uses ranging from port and harbor security to academic research. TBR’s public sector research indicates the most successful vendors apply strengths as broadly as possible, and use cases across defense, public safety, commercial and academic markets place IS&T’s UUV portfolio in line with this trend, supporting expectations for business unit growth into 2017.

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