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High-flying European defence stocks are taking a knock. Shares in German arms manufacturer Rheinmetall tumbled 5 per cent in early trading on Monday, while the UK’s BAE Systems lost 2.5 per cent. Investors took fright at reports that Germany’s finance minister planned to veto new military aid to Ukraine.
Perspective is in order. The Euro Stoxx Aerospace and Defense index has roughly doubled since Russia invaded Ukraine in February 2022, putting it in a different league to the 7 per cent rise notched up by the broader Stoxx 600 benchmark.
Swelling sales, order books and profits justify much of that. Valuations for the likes of Rheinmetall and BAE have roughly doubled as a multiple of total enterprise value to ebit, based on S&P Capital IQ data.
Monday’s jitters look like little more than an excuse. Germany had already hinted at reducing spending in Ukraine. If victorious in the US presidential election, Donald Trump could well do likewise. Of course, at some point there will be no more requirement for spending. Ultimately, wars end, albeit not always with a formal declaration of peace.
Yet that does not leave the world a less bellicose place. There are 110 armed conflicts under way today, including seven in Europe, according to monitor Geneva Academy. Virtually all Nato members are on a mission to increase military spending. The proportion of spend going on kit has more than doubled in the past decade.
European defence companies’ latest numbers reflect that. Scale, both via increased sales and acquisitions or expansion, is boosting profitability. Rheinmetall, which bought Rheinmetall Expal Munitions last year, lifted operating margins to 10.6 per cent at the half-year, more than 3 percentage points up on the year-ago level. Earlier this month, it added to its arsenal with the $950mn purchase of US military vehicle parts maker Loc Performance.
For sure, there are some caveats to this seeming super cycle. Constraints on growth include supply-chain reconfiguration and financing. The latter is of less immediate concern to the big listed groups, but highly relevant to the sprawling web of SMEs upon which they depend.
That in turn hobbles plans — both at state and corporate level — to beef up use of SMEs and strengthen domestic supply chains.
European governments are taking piecemeal steps towards helping on this score. Technology should provide another spur, such as using 3D printing to save labour and time.
There will inevitably be wobbles as governments across the globe seek to make savings. But demand suggests the defence sector’s rally is not over yet.
