Russia’s attack on Ukraine is leading Europe to increase defense spending.
Courtesy of Rheinmetall
Russia’s attack on Ukraine means Europe’s military capabilities are in focus, and as a consequence of President Vladimir Putin’s aggression, some defense stocks may be set to benefit.
Germany said last month that it will create a 100 billion euro ($110 billion) fund to ramp up military spending, going above the North Atlantic Treaty Organization’s commitment to a minimum of 2% of gross domestic product for defense spending. Cristophe Menard, an analyst at Deutsche Bank, has calculated that NATO members would spend an extra €75 billion.
“European budgets may witness greater upside versus the U.S. given their closer proximity to Russia and Ukraine and the relative underinvestment of European nations” for defense in recent years, says Ross Law, an analyst at Berenberg.
Two companies that derive the greatest share of their revenue in terms of weapons and ammunition—areas that traditionally benefit from increased demand during conflicts—are German arms manufacturer
Rheinmetall
(ticker: RHM: Germany), at 22%, and British defense giant
BAE Systems
(BA:U.K.), at 20%. Law also cites U.K. defense firm
Chemring Group
(CHG), a maker of flares that act as decoys for heat seeking missiles, as having indirect exposure to the conflict since it provides parts for weapons but not the actual weapons themselves.
Dusseldorf-based Rheinmetall employs 23,268 staff and has a market value of €7.1 billion. In addition to weapons, it makes defense equipment such as tanks, infantry equipment, and automotive parts such as pistons and ball bearings.
Rheinmetall fetches 14.4 times this year’s expected earnings and is valued at a 30% discount to its peers. While the shares have gained 83% so far this year to €151.95, Alexander Neuberger, an analyst at Metzler, predicts it could rise to €210.
A key indicator is its geographical breakdown of revenue. Berenberg’s Law says Rheinmetall derives 64% of revenue in Europe, making it well placed to benefit from any increase in military spending in the region.
But modern wars are also being fought away from the front lines. Law screened defense stocks that derived revenue in 2021 from both weapons and ammunition as well as cybersecurity divisions that battle the spread of disinformation and electronic warfare. The top three were BAE, with 34% combined revenue, Chemring, at 31%, and Rheinmetall, at 23%.
Rheinmetall says preliminary figures for 2021 show an operating profit of €595 million, up €149 million from the prior year, on sales of €5.65 billion, up by €253 million from the year before.
London-listed Chemring employs 2,300 workers and has a market value of £1.2 ($1.6 billion). Shares in the maker of missile components, and sensors able to detect explosive, biological, chemical, radio, or cyber threats, are up 20.6% on the year to £3.35. Investec rates the stock a Buy with a price target of £4.30. Chemring fetches 18 times this year’s expected earnings and is valued at a 10% premium to its peers.
CEO Michael Ord in a statement says that “the outlook for Chemring remains strong.” A BAE spokesperson tells Barron’s that “we’ve seen increased spending in Europe over recent years and expect to see that continuing.” Rheinmetall didn’t respond to requests for comment.
BAE, which helps make the F-35 combat aircraft, is one of Europe’s largest defense companies. It employs 81,000, and has a market value of £29 billion. The company fetches 13.7 times this year’s expected earnings and is valued at a 20% discount to its peers. Shares up 39% this year at £7.34.