Equity research note links Republican control to increased US defense spending and benefits for General Dynamics

Catalysts: Stable Aerospace earnings & US defense spending Operating weakness for Bombardier’s Global family, which competes with the Gulfstream family, has weighed down investor sentiment for large cabin business jets and General Dynamics. However, Gulfstrear’s more conservative production rates, attractive product positioning, higher quality backlog, and better operating performance compared to Bombardier lower Gulfstream’s near- and medium-term earnings risks, in our view. The key catalyst for General Dynamics is the upcoming earnings result that demonstrates how EBIT in the Aerospace segment remains stable despite a more tepid market outlook from Bombardier. We continue to view GD as a beneficiary of positive inflection in US defense spending. We expect the recent Republican victory in the White House and the Senate to be seen as incrementally positive for defense. Political control is a key driver of defense spending, and defense stock valuations are tied to changes in defense spending related to the modernization accounts. Our Political Control Model (PCM) analysis highlights a Republican President and Republican Senate is the best case for Budget Authority in defense modernization accounts. Our PCM analysis suggests that the Republican sweep could increase the Budget Authority for defense investment accounts by a CAGR of 12- 13% (FY17E-21E). This compares to the BofAML forecast of a 5% CAGR and the FY17 Green Book forecast of a 1% CAGR. Additionally, GD’s Marine Systems segment is a direct beneficiary of the US pivot to the Pacific. The Pacific is a hotbed of maritime activity particularly as China expands its territorial waters. As the US focus on naval superiority strengthens, we might see upside to shipbuilding spending. Latest report: General Dynamics: Gulfstream still undervalued; raise PO to $200 and reiterate Buy 30 November 2016 1Q risks: large cabin business jets market deterioration and US defense spending There is risk of market deterioration in large cabin business jets that could increase earnings risks for Gulfstream. Additionally, delays in government contracting or lower than expected increase in US defense spending could provide downside risks to our estimates. Company Description General Dynamics is a major US government contractor engaged in combat vehicles and systems, armaments, munitions, ordnance, shipbuilding and information systems and technologies. It is also the parent company of Gulfstream in its Aerospace segment, which is the most profitable airplane manufacturing company in the world. Consolidated Edison (ED) Brian Chin +1 646 855 5855 Research Analyst, MLPF&S Underperform, PO $59 1Q17 investment thesis Since the November elections, utility valuations have not adequately adjusted to the rapid shift towards a rising-rate environment and have decoupled from historically predicative valuation patterns. Looking at studies of 10yr Yields v. Utility PEs, BBB Yields v. Utility PEs, and Utility Div. Yields v. Rates are the best examples of this BankofAmerica <2” 6 Top 10 US Ideas Quarterly | 03 January 2017 Merrill Lynch HOUSE_OVERSIGHT_014627