Defense Rebalanced – These defense stocks are worth checking out

EThe message should be clear: US Secretary of Defense Lloyd Austin promises that heaven and earth will be set in motion to help Ukraine. Representatives from more than 40 western countries met at the military base in Ramstein, Palatinate. Words won’t stop there – more than $5 billion worth of equipment for Ukraine has already been pledged. Germany also dared to take cover: Defense Minister Christine Lambrecht announced the delivery of Gepard anti-aircraft tanks. The federal government is thus moving away from its position of not supplying heavy weapons to the war zone.

The Putin shock is having an effect: after the Russian attack on Ukraine, the investment bank JP Morgan expects the largest increase in defense spending in Europe for 30 years, i.e. the end of the Cold War. If all European NATO members invest the two percent of their gross domestic product required by the alliance in the military, defense spending on the continent would increase by 25 percent.

New rules also apply in Germany. For decades, the Ministry of Defense was primarily concerned with relieving the government budget. The consequence is a Bundeswehr whose infrastructure is “partially in a dilapidated state”. is, as stated in the report by the military commissioner Eva Högl. Suddenly there is money. The government has approved a special fund of 100 billion euros. In addition, the defense budget is to rise above the two percent threshold. The order form includes F-35 fighter jets from Lockheed Martin and Eurofighters, which are being produced by a consortium led by Airbus. In the search for a transport helicopter, the Bundeswehr will, according to reports, opt for the Boeing Chinook.

Triple digit gains

As always, the stock markets reacted quickly. Above all, the companies that are heavily dependent on the German budget are among the winners: The shares of Rheinmetall, the most prominent German armaments group, have risen by around 120 percent since the outbreak of war. The market value of Hensoldt, a specialist in radar and sensor technology, has roughly doubled.

The companies themselves try to use a factual tone in their external presentation. Nobody wants to appear as a war profiteer. It is in the nature of the industry that weapons are not seen as a problem, but as part of the solution: “Security – as the current conflict shows – is the basis for our life in peace and freedom. Rheinmetall is particularly involved in this of duty,” explained CEO Armin Papperger at the presentation of the annual report in March.

Rheinmetall recently announced a new order for the delivery of 100 Boxer wheeled armored vehicles to the British army and an order for ammunition worth several hundred million euros from Hungary. The turnover of the Düsseldorf-based company is expected to increase by 15 to 20 percent this year alone, with an operating margin of eleven percent. But that should only be the beginning. Rheinmetall has offered products worth 42 billion euros to the German government alone.

lack of ammunition

Since many of the projects are long-term and the awarding of contracts has to clear bureaucratic hurdles, the effects on the consolidated balance sheet will initially be unspectacular. As a first step, Rheinmetall is likely to replenish the Bundeswehr’s meager ammunition stocks. 400 to 500 million euros extra sales are expected in the current year. The 2023 financial year will be more important, the analysts at Deutsche Bank calculate. On May 6, Rheinmetall wants to present the report on the first quarter and also comment on the business outlook and the order backlog.

One day before Rheinmetall, Hensoldt gives an insight into its business figures. The company from the Bavarian town of Taufkirchen was spun off from the Airbus Group a little over five years ago. As an electronics specialist, the focus is on larger projects such as the Eurofighter. Hensoldt is also a supplier for the Puma infantry fighting vehicle. This transaction should not be immediately visible in the balance sheets, but is already being priced in by the stock exchange. The armaments business at Airbus and MTU Aero Engines is only a side area. The two DAX corporations focus primarily on civil aviation – Airbus as an aircraft manufacturer, MTU as a specialist in engines. However, the armaments business is a lucrative niche that the two companies do not want to miss out on.

defensive investing

The arms business has its own dynamic. Large projects run for many years, sometimes decades, and provide a company with a reliable stream of revenue, including for maintenance and parts. The willingness of states to put money into new military projects fluctuates with the geopolitical situation. After the end of the Cold War, budgets shrank sharply. The terrorist attacks on New York and Washington in September 2001 were a turning point. The brief phase of detente in the middle of the last decade was quickly over. Last year, countries around the world spent more than two trillion dollars on weapons for the first time.

The sum of 2,113 billion dollars calculated by the Swedish SIPRI Institute corresponds to an increase of more than six percent over the previous year and around 2.2 percent of global economic output. While Putin is spreading terror in Europe, the focus in Asia is on China. In response to the red giant’s rearmament, Japan and Australia in particular have increased their defense budgets.

The giants of the armaments industry such as Lockheed Martin and Raytheon come from the USA, after all the world’s largest military budget is allocated there. In Germany, the industry is still in the shadows. The local financial industry has found that investment products sell better if they are sustainable. For its DAX 50 ESG, Deutsche Börse excludes, among other things, the manufacturers of “controversial” weapons. In addition to Airbus, the ban also affects Rheinmetall – by far the best share of the year from the broad German stock market is therefore not included.

The major shareholder KKR used the price jump at Hensoldt at the beginning of April to exit. That put a damper on the stock. The quarterly results announced for May 5 could bring new impetus. In addition to the current figures, the longer-term business outlook should also play an important role in view of the special budget of the Bundeswehr. Investors should wait and see at the current valuation level.

In the case of the US armaments giants, the leverage effect of NATO build-up is not as strong as in the case of the German competitors. Lockheed Martin, the world’s largest defense company, missed analysts’ expectations in the first quarter in terms of sales and operating profit, among other things due to problems in the supply chain. The group known for the F-35 fighter jet remains a strong defensive investment in the current environment as the market leader.

The share of the industrial group is clearly driven by the armaments business. The rearmament of the Bundeswehr and other NATO countries will give a strong boost to sales and profits. According to the company, which is listed on the MDAX, it has no problems expanding capacities quickly. The volume of orders is likely to increase over several years. We see further potential for surprises at Rheinmetall.

Image sources: Lockheed Martin