Reports of the US-driven Russia-Ukraine peace deal triggered a downturn in European defense stocks, with names under our coverage down between 10%-20% since October highs.
Why it matters: The market reaction is overstated. European defense valuations are anchored in structural budget increases rather than short-term Ukraine revenue, and rearmament plans are unlikely to reverse even in the event of a peace agreement.
- Under the terms of the deal, Ukraine would reportedly cede remaining eastern Donbas territory, halve its armed forces, abandon key weapon classes, not host foreign troops, and lose access to Western long-range systems that reach deep into Russia.
- With US support already rolled back and Europe focused on national capabilities, Ukraine faces pressure to find a deal, but the current terms have been previously rejected. Such concessions would erode its security and could prompt Europe to accelerate defense spending in response to a stronger Russian position.
The bottom line: We see European defense stocks as undervalued after the recent correction. The selloff reflects short-term headlines, not fundamentals. We maintain our fair value estimates across the sector, with Rheinmetall as our top pick and current levels a compelling entry point.
- European governments’ long-term demand reflects inventory rebuilding, capability and platform scale-up, and autonomy from US support, with US pressure to reach 3.5% of GDP on defense spending. These fundamentals remain intact and support order visibility, backlog conversion, and cash generation.
- Ukraine procurement is marginal for most contractors. Germany is now the largest single supporter of Ukraine. Yet, Rheinmetall has only EUR 1.7 billion of Ukraine orders within an EUR 64-billion backlog, underscoring the sector’s long-run domestic and NATO-driven demand.
