Key Takeaways
- European defense budgets are set to grow 6.8% annually by 2035.
- Analysts forecast increased revenue and profitability for defense giants.
- Four European defense stocks are screening as undervalued despite strong gains this year.
Geopolitical tensions, including Russia’s invasion of Ukraine and Indo-Pacific conflicts, are fueling a new global defense supercycle.
European defense budgets are set to grow 6.8% annually from 2024 to 2035, outpacing the United States (1.7%), Russia (3.2%), and China (3.1%) as Europe addresses decades of underinvestment and seeks greater independence from the US. Europe’s share of global defense spending is projected to increase from 16% to 22% by 2030, stabilizing through 2035.
The increase in defense spending is expected to boost revenue and profitability for US and European companies, driven by economies of scale from increased production and higher-margin aftermarket services like maintenance and upgrades.
Undervalued Defense Stock Picks:
Key Morningstar Metrics For Rheinmetall
- Fair Value Estimate: EUR 2220.00
- Morningstar Rating: ★★★★
- Morningstar Uncertainty Rating: Medium
- Economic Moat Rating: Wide
Rheinmetall has a well-diversified portfolio across geographies and platforms, with 80% of its revenue from its defense business and 20% from its civil one.
As Germany’s top defense contractor, Rheinmetall stands to gain Germany’s major defense spending shift, with Parliament approving proposal to exempt defense spending above 1% of GDP from debt limits, effectively removing any cap on future military budgets.
Key Morningstar Metrics For Leonardo
- Fair Value Estimate: EUR 62.60
- Morningstar Rating: ★★★★
- Morningstar Uncertainty Rating: High
- Economic Moat Rating: Narrow
Leonardo has a well-diversified portfolio across geographies and platforms, with 83% of its revenue from defense and 17% from civil.
The US offers Leonardo significant opportunities through its partnerships, including in the F-35 fighter jet program. In the European defense market, which represents 53% of Leonardo’s defense revenue, we anticipate budgets to increase by nearly 62% over the next five years. This will benefit Leonardo as the European leader in warfare electronics, with key projects like the Eurofighter Typhoon, the land vehicle joint venture with Rheinmetall, and the MBDA consortium.
Key Morningstar Metrics For BAE Systems
- Fair Value Estimate: GBP 2250.00
- Morningstar Rating: ★★★★
- Morningstar Uncertainty Rating: Medium
- Economic Moat Rating: Wide
BAE Systems is strategically positioned to benefit from the structurally higher growth in the defense market, given its significant stakes in a broad array of major international defense projects.
In air, the Eurofighter Typhoon, manufactured by a consortium of BAE, Airbus, and Leonardo, has a current order log of 94, with commitments from countries such as Spain, Germany, Kuwait, and Qatar. Additionally, the Eurofighter group has expressed optimism about securing as many as 200 more orders in the next two years, targeting both current and potential new clients. Were it able to secure the extra orders, it would provide a substantially higher base for aftermarket services.
Furthermore, BAE is well aligned with US Defense Department growth programs, from which it derives 45% of its revenue.
The military collaboration among Australia, the UK, and the US will benefit BAE, as it is the prime contractor in Australia and the UK and has been selected to build Australia’s nuclear submarine fleet.
Key Morningstar Metrics For Thales
- Fair Value Estimate: EUR 308.00
- Morningstar Rating: ★★★★
- Morningstar Uncertainty Rating: High
- Economic Moat Rating: Wide
Thales’ business is well diversified with 48% of revenue coming from civil and 52% from defense.
Thales derives approximately 68% of its defense revenue from Europe, and we expect the collective defense budget there to increase by almost 35% in the next five years.
As a premier global avionics supplier, Thales is strategically positioned to capitalize on the expanding civil aerospace market. The company’s strong alignment with the growing narrow-body segment is notably due to its long-standing relationship with Airbus platforms.
This article is an edited version of the Defense Industry Landscape report published on Morningstar Direct, written by Loredana Muharremi, Nicolas Owens, Andrea Burigana.
