The rally of European defense companies has stalled. Where should we shift our attention?

Shares of European defense companies paused their rapid growth in the summer: after a record rally since the beginning of the year, investors began to doubt when the military budgets of the EU countries will turn into real orders. The Bloomberg index, which tracks the sector, sagged amid weak reports and concerns that the market is overvalued. By contrast, defense companies in the other two markets posted solid quarterly results.

The rally in European defense stocks has stalled this summer, reports Bloomberg. The Bloomberg Index of European military companies has slipped 3.8% since hitting an intraday high in June - amid U.S. pressure on Russia to stop fighting in Ukraine and EU promises to buy U.S. military equipment, the publication explained. Although since the beginning of the year this index has grown by almost 75%, and the securities of German tank and missile manufacturer Rheinmetall have jumped by 190% (and by 1700% since the beginning of the war in Ukraine), investors are getting nervous: the growth of budgets has not yet turned into real orders, emphasizes Bloomberg.

In Europe, quarterly reports of defense companies turned out to be ambiguous. For example, Norwegian Kongsberg fell after weak results for the second quarter, French Dassault Aviation fell short of revenue and profit forecasts, and British BAE Systems disappointed by failing to update key financial targets. At the same time, Italy's Leonardo and Sweden's Saab raised their forecasts. Investors are now looking ahead to Rheinmetall's report on Thursday: as Alphavalue's Saima Hussain noted in a Bloomberg story, any slippage in orders - due to supply chain disruptions or EU contract delays - could put pressure on the stock, even despite optimistic consensus forecasts.

"The problem is that markets were hoping for more and early on," Will McIntosh-White of Rathbones Asset Management explained  in a Bloomberg statement, adding that investors should be wary of expensive securities whose growth is based only on hopes of future orders.

In addition, the problem for investors is too high valuations in the sector, especially in Europe, emphasizes Bloomberg. According to Goldman Sachs, a basket of defense stocks in Europe trades at a price-to-earnings multiple of about 31. This is more than double the market average for the region and comparable to the performance of U.S. companies.

"If this is all based on the expectation that NATO will bring [EU] defense spending to 5% of GDP by 2035, the market could be seriously disappointed," McIntosh-White noted. Morningstar analyst Loredana Muharremi agreed: "Much of the expected growth has already been built into the forecasts, now comes the stabilization phase."

The US defense sector is showing clear signs of recovery: Northrop Grumman, L3Harris and General Dynamics reported better-than-expected results for the second quarter and raised forecasts for 2025, Bloomberg notes. However, Lockheed Martin is still among the laggards - the stock has slipped 13% since the beginning of the year after statements about $1.6 billion in write-offs and potential tax risks.

In Asia, South Korea stands out confidently, with major contractor Hanwha Aerospace beating forecasts. "South Korea's defense industry is expected to post record results for the second quarter of 2025," Jeong In Yoon, CEO of Fibonacci Asset Management in Singapore, said in a Bloomberg statement. - We believe this trend will continue."

In addition, analysts still recommend not to write off the European defense sector, despite the pause in growth. Union Investment portfolio manager Vera Diehl expects an influx of orders to EU defense companies as early as fall. "Any weakening [in European defense stocks] now is a chance to build up positions. The need is there, budgets are increasing," said Diehl, who was quoted by Bloomberg.

This article was AI-translated and verified by a human editor