General Dynamics' Q2 2025 Outperformance and Strategic Growth Levers: Is the Defense Giant Undervalued Amid Risks?

General Dynamics (NYSE: GD) has delivered a standout Q2 2025 performance, with 8.9% year-over-year revenue growth, expanding margins, and a $103.7 billion backlog that underscores its long-term resilience. However, investors must weigh these strengths against macroeconomic headwinds and supply chain risks. This analysis evaluates the sustainability of GD's growth, margin resilience in its Aerospace segment, and the value embedded in its backlog, while addressing key risks.

Revenue Growth: Sustained Momentum or Cyclical Tailwind?

General Dynamics reported $13 billion in Q2 revenue, driven by robust demand across all four segments: Aerospace, Marine Systems, Combat Systems, and Technologies. The 8.9% growth outperformed the S&P 500 Industrials sector, which grew 3.2% YoY. The company's backlog of $103.7 billion—up 13.6% year-over-year—provides significant visibility, with Marine Systems leading the charge.

The Marine Systems segment's backlog of $52.97 billion, including $39.3 billion in funded contracts, is anchored by multi-decade submarine programs like the Virginia and Columbia classes. These long-term contracts insulate the segment from short-term economic volatility, ensuring steady cash flow. Meanwhile, the Aerospace segment's $19.9 billion backlog, bolstered by Gulfstream's G700 and G800 deliveries, reflects strong demand for business aviation despite macroeconomic uncertainty.

Margin Resilience: Aerospace as a Strategic Anchor

The Aerospace segment's operating margin expanded to 13.2% in Q2 2025, up from 10.9% in Q2 2024, driven by improved supply chain reliability and higher aircraft delivery volumes. Gulfstream delivered 38 aircraft, including 32 large-cabin models, with G700 retrofit deliveries completed and initial G800 deliveries expected in Q3.

While the G800 model initially carries lower margins due to production ramp-up costs, management anticipates margin recovery as scale improves and higher-margin variants gain traction. This aligns with historical patterns in aerospace, where new aircraft programs often see margin compression early but stabilize over time.

Backlog Composition: Quality Over Quantity

The company's $103.7 billion backlog is not just large—it is high-quality. Funded contracts account for $74.9 billion, while unfunded and estimated potential contract value add $52.6 billion in upside. This structure provides flexibility to capitalize on unexercised options and IDIQ contracts, particularly in the Marine Systems and Technologies segments.

Notably, the Technologies segment's backlog includes $32 billion in estimated potential value, driven by IT services and mission-critical systems for defense and federal clients. This segment is transitioning to higher-margin programs, such as unmanned platforms and advanced encryption, which could boost profitability in the medium term.

Supply Chain and Macroeconomic Risks: Navigating the Storm

General Dynamics faces three key risks:
1. Supply Chain Disruptions: Rerouted shipping lanes around Africa, Panama Canal delays, and inflationary pressures on materials are increasing costs. However, the company has mitigated these risks through a 90-day supplier assessment cycle and a “customer zero” approach, treating its own operations as a testbed for risk management strategies.
2. Interest Rate Sensitivity: With $8.7 billion in debt, rising rates could pressure cash flow. Yet GD's strong operating cash flow ($1.6 billion in Q2) and debt reduction of $897 million demonstrate disciplined capital management.
3. Geopolitical Uncertainty: While defense spending remains elevated, trade wars or policy shifts under a potential Trump 2.0 administration could disrupt demand. GD's diversified international footprint, including growing European Combat Systems contracts, offers some insulation.

Valuation and Investment Case

General Dynamics trades at a forward P/E of 21x, below the 27x average for defense peers like Lockheed Martin (LMT) and Northrop Grumman (NOC). Its free cash flow yield of 6.8% and 10.8% EBITDA margins suggest undervaluation relative to its growth profile.

The company's strategic focus on margin expansion, backlog durability, and supply chain resilience positions it to outperform in a high-defense-spending environment. However, investors should monitor near-term margin pressures from the G800 ramp and potential inflationary headwinds.

Conclusion: A Buy for Long-Term Growth

General Dynamics' Q2 2025 results validate its strategic positioning in a defense sector poised for sustained growth. The $103.7 billion backlog, expanding margins, and proactive risk management justify a bullish outlook. While macroeconomic risks persist, GD's disciplined capital allocation and operational leverage make it a compelling long-term investment. For investors seeking exposure to the defense industrial base with a margin of safety, General Dynamics offers an attractive risk-reward profile.