With peace deals around the war between Russia and Ukraine being floated again following talks in Geneva over the past few days, which both the US and Ukraine called ‘highly productive’ has left defence back in the spotlight. In this update Loredana Muharremi, equity analyst at Morningstar, has shared the following insight on the future of European defence stocks in the light of these latest moves.
Muharremi said“The market reaction to potential peace deals have been overstated thus far. Even if there is a deal agreed, the sector should not see a market shock drop, as European defence valuations are underpinned by structural increases in defence budgets across Europe, rather than by short-term revenues from Ukraine. Ukraine-related orders currently represent only a modest share of contractors’ sales. Even under a peace agreement, European governments’ rearmament plans are unlikely to be reversed. Not only do countries need to replenish what they have given away, which could take close to a decade for some systems at current capacity, but they also need to ramp defense spending to the new NATO targets commitments of 3.5% defence increase in order to build credible deterrence, as geopolitical tensions remains high. Moreover, the US have been very vocal about imposing tariffs on countries who do not pull their weight, and the pressure is on to remain contributing in the long-term. We see the sector as undervalued following the recent market correction, with over 20% potential upside. Our top pick is Rheinmetall.”
