Defense company shares rose when Russia attacked Ukraine. They repeated after the Israel-Hamas conflict. Another spike fueled by Europe's ambition to expand military spending raises questions about going too far, too fast.
The seven largest European publicly traded military gear producers, including Rheinmetall AG, BAE Systems Plc, and Saab AB, fell on Tuesday as investors panicked at record share prices. Despite the dip, their stock market value rose $30 billion in 2024.
The advance reflected Europe's new geopolitical reality amid Russian aggressiveness and American delaying over Ukraine assistance. As nations restructure their militaries, investors expect orders to flood in. Some analysts are doubtful, and European leaders disagree on how to proceed.
Germany is overhauling its military with orders worth up to €7 billion ($7.6 billion), sources revealed this week. They include a 2025 Rheinmetall armored transporter contract. However, Leopard 2 tank producer shares fell 7% from a record on Tuesday. Goldman Sachs Group Inc. said European defense stock valuations “likely present more downside than upside risk.” Six of the seven firms traded above analysts' average price targets until this week.
Even after this week's hiccup, Goldman Sachs' defense-exposed European share basket is up 40% year-to-date. Bloomberg figures reveal that the corporations are priced at 20 times their expected earnings a year from now, up from 8.6 before Russia invaded Ukraine in February 2022. A March EU agreement on a “defense industrial strategy” to boost military readiness and the arms sector fueled recent successes.
US presidential candidate Donald Trump threatened to leave NATO countries that don't satisfy defense expenditure standards, fueling Europe's rearming effort. Security officials warn military budgets may need to reach Cold War levels of 4% of GDP, twice NATO's aim.
“European countries in NATO are being forced to move toward agreed levels of defense spending,” said Plurimi Wealth LLP chief investment officer Patrick Armstrong, who holds BAE Systems shares. “The defense industry will benefit from a structural tail wind in coming years.”
Some barriers remain. EU members debate how to boost Ukraine aid. Former Russian allies like the Baltic states want to buy arms quickly to help Ukraine oppose Vladimir Putin's forces as they gain momentum, even if it means buying outside. France wants to develop its defense industry.
Where the money comes from may be more important. Due to EU fiscal limitations, many NATO European countries still spend less than 2% of GDP. However, the EU has only allocated €1.5 billion for its new defense plan. Tapping blocked Russian assets to finance Ukraine supplies or issuing joint debt to form an EU defense fund are problematic ways to strengthen Europe's military.
Ross Law of Morgan Stanley noted that “limited fiscal headroom in Europe means the rhetoric for higher defense spending is not matched by budgetary reality.” Ross and colleagues argued defense business equities require earnings boosts to survive. Some are coming. This month, Rheinmetall, which makes Fuchs armored transporters, predicted 2024 revenues of €10 billion, up from €7 billion. But some are wary.
After its February financial update, BAE Systems, which builds Typhoon fighter planes and warships for the Royal Navy, claimed recruitment hurdles will slow output growth. According to CEO Charles Woodburn, increasing UK manufacturing of crucial 155 millimeter shells might take two years.
For the rise to continue, expenditure evidence and geopolitical certainty may be needed. That will happen, according to B Metzler Seel Sohn & Co AG analyst Alexander Neuberger, who raised his Rheinmetall price target last week.
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