Europe’s arms stocks send a geopolitical distress signal
The world looks like an increasingly dark place — especially when viewed from Europe. President Donald Trump’s diesel deal with Russia is as stark a reminder as one could wish for that the continent should be looking to increase its self-reliance when it comes to geopolitics. So why are Europe’s arms stocks so unloved?
BAE, Thales, Dassault Aviation and Leonardo have fallen 15-20 per cent in the past six months and Germany’s Rheinmetall has sunk by more than a third. Taken as a basket, their premium to the Stoxx Europe 600 index has shrunk to a mere 12 per cent, viewed as a multiple of forecast operating profit, Bernstein analysis shows. That looks astonishingly low.
Between 2025 and 2030, their profit is expected to grow at 17 per cent a year on average, according to estimates collected by Visible Alpha — much faster than European companies as a whole.
Investors tend to be once bitten, twice shy. Those who got caught up in the Rheinmetall frenzy are still smarting. The defence contractor’s stock rose more than 20-fold between Russia’s invasion of Ukraine in 2022 and October last year, only to halve since. In June, Berlin scrapped a shipbuilding programme that Rheinmetall had been tipped to win.
That debacle showed there are real constraints to how quickly defence spending can grow. Money is the obvious one. Analysts polled by Visible Alpha expect defence groups to increase revenue by over a tenth a year to 2030. Yet higher borrowing costs have blown a hole in the UK and French budgets, and German Chancellor Friedrich Merz, who has pushed through higher spending on defence and infrastructure, has seen his popularity nosedive.
The other constraint is the time it takes to sweep the cobwebs from sluggish procurement machinery. Governments that have grown used to devoting little time and attention to defence infrastructure are finding it hard to get projects off the ground.
Such choices are complicated by the changing nature of war. The US Department of Defense’s Project Meridian, a 120-day review of military technology involving Anduril’s Palmer Luckey and SpaceX boss Elon Musk, points to how quickly current tools of war risk becoming obsolete.
Diverting money from, say, tuition to tanks is risky if the future is drones and software. That helps explain why companies with long-life projects such as BAE have outperformed their peers over the past year.
Even when governments do sign big cheques, it takes a while for defence contractors’ rusty supply chains to crank back into action. Panmure Liberum strategist Joachim Klement has referenced a study by the Economics and Econometrics Research Institute that suggests that, for countries in the Nordics, SouthWest Mediterranean region and the Baltics, the main constraints to defence spending are supplier depth and procurement bottlenecks.
Sometimes, necessity breeds nimbleness. Ukraine shows how quickly defence capabilities can be developed when decision-making is unshackled. Eastern Europe, more broadly, has prioritised defence spending in a way the western side of the continent is yet to do. For a while, Europe’s defence stocks were an indicator of its noble intentions. Now they are a dispiriting manifestation of its inability to get things done.
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