Europe defense stocks face rearmament test
After years of military budgets, urgent Ukrainian spending and rising defense stockpiles, Europe’s rearmament effort must now prove it can turn hundreds of billions of euros into weapons, factories and usable military capacity.
The question for investors no longer seems to be defense demand or political ambition, but whether valuations are ahead of the industry’s ability to execute.
This test becomes more critical ahead of the exam next week NATO Summit in AnkaraWhere leaders will review progress since last year’s summit and set out a roadmap to achieve new spending targets to “translate allies’ commitments into tangible results”.
But the path from higher budgets to weapons delivery appears uneven. Supply delays, fragmented national programs, labor shortages and strained supply chains are raising doubts about how quickly Europe can rebuild the industrial base depleted by decades of low defense spending.
Pressure is mounting from both sides of the Atlantic. NATO allies agreed at last year’s summit to a dramatic increase in defense spending; This reflects growing concern that Europe can no longer live under US protection
The pressure intensified when U.S. Secretary of War Pete Hegseth earlier this month announced a review of American forces in Europe and warned that allies were failing to meet spending commitments. may face consequences. The review, which is expected to last up to six months, has added new urgency to a debate already transformed by Russia’s war in Ukraine and the changing US approach to NATO.
“There is no question that the evolving geopolitical posture of the United States is a real moment of truth,” Hugues Lavandier, a senior partner at McKinsey, told CNBC. This has accelerated the realization that Europe’s “era of peacemaking is over” and that governments need to reinvest in defense capabilities, he said.
Defense trade is developing
This change has already transformed investors’ expectations. European defense companies Rheinmetall with BAE Systems, Leonardo, ThalesAnd saab They have benefited from a growing order book since Russia invaded Ukraine in 2022 as governments increase military spending.
McKinsey calculates that European NATO core defense spending has doubled since 2019 and could reach around 800 billion euros ($912 billion) by the end of the decade. This would put us on track for NATO’s new benchmark of each member spending 3.5% of its GDP on defence. Venture funding is also flowing into European defense technology such as unmanned aerial vehicles and autonomous systems.
Lavandier said the market is in a “moment of price discovery.” Backlogs were initially the clearest indicator of growth, he said, but investors are now getting a better read on which companies can turn those order books into production, revenue and margins.
Last week, Germany canceled its multi-billion-euro F126 frigate program after delays and expected cost increases and announced it would purchase eight smaller Meko A-200 frigates from Germany. ThyssenKrupp Marine Systems (TKMS) instead. Shares of Rheinmetall, which was expected to be the lead contractor for the abandoned program, fell sharply.
“This news reminded us of this” [governments] “They can and do change their minds,” JP Morgan analysts said.
Performance of defense stocks over the last five years.
But Germany’s defense budget is still growing rapidly. Lavandier said the cancellation was an example of governments reevaluating priorities such as acquisition costs, delivery timelines and military strategy.
But for investors, the Rheinmetall selloff is “a stark reminder that despite various governments promising to increase defense spending over the last few years, this sector is starting to experience delays and disruptions,” AJ Bell’s head of markets Dan Coatsworth said in an emailed comment.
What is holding back Europe’s rearmament effort?
Building the capacity Europe needs to achieve strategic autonomy has proven difficult.
Although defense investments have increased sharply, equipment stocks in European NATO countries remain below 2021 levels; This reflects military contributions to Ukraine, retirement of legacy systems, and long delivery times for new equipment. McKinsey’s February report.
It also turns out that platform fragmentation in Europe is four times greater than in the US, with consequences for interoperability, logistics and industrial scale.
Lavandier said the biggest bottlenecks are labor and supply chains. He added that Europe’s defense industry “has not been used to producing large quantities for a very long time.” The industry depends on layers of suppliers beyond large contractors, many of which are small family businesses, and all of whom must grow together.
“If one or two parts are missing, your new jets cannot be delivered,” he said.
How supply chains are slowing defense production
S&P Global Ratings found the same constraint. He said European defense suppliers are often small businesses with limited ability to raise equity capital for expansion, leaving larger contractors facing bottlenecks in complex supply chains.
The credit rating agency also warned that higher defense spending would not be uniform across Europe. Poland and the Baltic countries are moving fastest; Germany has more fiscal space to step up; France, Britain, Belgium and parts of southern Europe face greater debt constraints and competing political priorities.
S&P said higher defense spending could bolster the credit quality of defense companies, but could put pressure on country budgets and force politically difficult trade-offs.
It was also noted that Europe remains structurally dependent on US suppliers for warplanes, air defense systems, precision weapons, electronics, software and strategic enablers such as intelligence, surveillance, airlift and command-and-control.
This means that larger European budgets will not automatically create a more independent European defense base.
Lavandier said about half of Europe’s defense spending now flows to Europe, with the rest going to suppliers elsewhere, including the United States, Israel and South Korea. He expects more governments to opt for home-designed and manufactured equipment, not as an anti-U.S. move but on the grounds that “if you want the productivity machine to work, you need to reinvest a lot of that money back into your own country.”
Stefan Wintels, managing director of German state bank KfW, told CNBC: Annette Weisbach said on Friday that growth in the defense industry was “not a short-term event” but said Europe needed scale, price competitiveness and a more supportive policy framework for the transition to work.
Wintels also said the planned joint ownership of tank manufacturer KNDS was a potential model for deeper European cooperation. France and Germany have agreed to become equal shareholders of 40% of the Leopard 2 maker ahead of a planned Paris and Frankfurt listing.
He suggested that KNDS could eventually become a smaller-scale version of KNDS. Airbus As proof that Europe can turn national champions into globally competitive defensive groups.
But the comparison also highlights the difficulty of such a goal: Airbus was decades in the making, and Europe’s security problem cannot wait decades.
