Increase in military spending in Europe. These actions should benefit from it.

Russia’s attack on Ukraine leads Europe to increase its defense spending.

Courtesy of Rheinmetall

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Russia’s attack on Ukraine means that Europe’s military capabilities are in the spotlight and, following President Vladimir Putin’s aggression, some defense stocks could benefit.

Germany said last month that it create a 100 billion euro ($110 billion) fund to increase military spending, exceeding the North Atlantic Treaty Organization’s commitment to a minimum of 2% of gross domestic product for defense spending. Christophe Ménard, an analyst at Deutsche Bank, calculated that NATO members would spend an additional 75 billion euros.

“European budgets could see a bigger uptick compared to the United States given their closer proximity to Russia and Ukraine and the relative underinvestment of European nations” in defense in recent years, says Ross Law, analyst at Berenberg.

Two companies that derive the largest share of their income from arms and ammunition – areas that traditionally benefit from increased demand during conflicts – are German arms manufacturers


Rheinmetall

(ticker: RHM: Germany), at 22%, and the British defense giant


BAE systems

(BA: UK), 20%. The law also cites a British defense company


Chemring Group

(CHG), a manufacturer of flares that act as decoys for heat-seeking missiles, as having indirect exposure to the conflict since it supplies parts for the weapons but not the weapons themselves.

Rheinmetall, based in Düsseldorf, employs 23,268 people and has a market value of 7.1 billion euros. In addition to weapons, it manufactures defense equipment such as tanks, infantry equipment and automotive parts such as pistons and ball bearings.

Rheinmetall is recouping 14.4 times expected earnings this year and is valued at 30% off its peers. While the stock has gained 83% so far this year to €151.95, Metzler analyst Alexander Neuberger predicts it could rise to €210.

A key indicator is the geographical distribution of its turnover. Berenberg’s law states that Rheinmetall derives 64% of its revenue from Europe, which puts it well positioned to benefit from any increase in military spending in the region.

But modern wars are also fought far from the front lines. The law looked at defense stocks that earned revenue in 2021 from weapons and ammunition as well as cybersecurity divisions that fight the spread of disinformation and electronic warfare. The top three were BAE, with 34% of combined revenue, Chemring, at 31%, and Rheinmetall, at 23%.

Rheinmetall says preliminary figures for 2021 show operating profit of 595 million euros, up 149 million euros on the previous year, on sales of 5.65 billion euros, in increase of 253 million euros compared to the previous year.

London-listed Chemring employs 2,300 people and has a market value of £1.2 ($1.6 billion). Shares in the maker of missile components and sensors capable of detecting explosive, biological, chemical, radio or cyber threats rose 20.6% on the year to £3.35. Investec is pricing the stock long with a price target of £4.30. Chemring is recouping 18 times expected earnings this year and is valued at a 10% premium to its peers.

CEO Michael Ord said in a statement that “Chemring’s outlook remains strong.” A BAE spokesperson says Barrons that “we have seen an increase in spending in Europe over the past few years and we expect this to continue”. Rheinmetall did not respond to requests for comment.

BAE, which is involved in manufacturing the F-35 fighter jet, is one of Europe’s largest defense companies. It employs 81,000 people and has a market value of £29billion. The company claws back 13.7 times this year’s expected earnings and is valued at 20% off its peers. Shares up 39% this year at £7.34.

Mary I. Bruner