Other European defence stocks including Thales SA and Leonardo SpA have also soared. The test now is whether the companies can live up to the earnings growth expectations investors have placed on them, to match the headspinning advance in their share prices. That intensifies the focus on Rheinmetall’s results, due Wednesday.
Bulls base their confidence on Germany’s newly announced pledge to unlock hundreds of billions of euros for military spending and its push for European Union leaders to follow suit. Defence shares rose on Tuesday after Germany’s Green party said it was prepared to reach an agreement as soon as this week and pave the way for a deal. It’s a shift that turns an historically low-growth corner of the stock market into one that has the potential to rapidly expand.
Valuations for defence stocks have raced ahead as investors snap up the shares much faster than analysts have managed to rework their price targets to account for an anticipated rush of government orders.
“The growth outlook for these companies is very different today than it was six months ago,” Graeme Bencke, a fund manager at Amati Global Investors, said in an interview. “We need to expect that they look expensive right now because the market and the Street haven’t really had a chance to upgrade earnings.”
There’s clear evidence that analysts haven’t kept up with the breakneck rally. While Rheinmetall’s average price-target has shot up by more than 60% since the start of the year, it suggests little upside over the next 12 months. The company’s earnings will shine a spotlight on its prospects for the year to come, possibly prompting analysts to lift their expectations.
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For some, valuations have already become stretched, particularly given Rheinmetall’s shares have surged around 1,100% since Russia invaded Ukraine in February 2022.
Warburg Research analyst Christian Cohrs downgraded his recommendation on Rheinmetall to hold from buy last week, saying the shares already reflect government budgets pushing defence spending toward 3% of gross domestic product. “Against this backdrop we encourage investors to lock in some profits,” he said in a note.
On Friday, Kepler Cheuvreux’s Aymeric Poulain gave Hensoldt AG, another German defence name, its second downgrade of the week. “The speed at which the share is discounting the future is dangerous as it underplays execution risks,” he wrote in a note.
And then there is the question of transparency around state defence spending. Revenue visibility is “far from perfect,” said Jens-Peter Rieck, an equity analyst at Mwb Research. “Many defence programs remain classified, and long-term planning depends heavily on political decisions and evolving security needs.”
But as a few lose their nerve, others are steadfastly bullish.
Goldman Sachs Group Inc strategists said in a March 7 note that their basket of European defence stocks had surged 70% since the start of the year, without the sector becoming overvalued. “European defence companies are starting to be expensive, even compared to their US peers, but the growth expectations are so elevated they look fairly valued when look on the price/earnings growth ratio,” the team including Guillaume Jaisson wrote.
Over at JPMorgan Chase & Co, the view is that “there is more to go” for European defence stocks, according to strategists including Mislav Matejka.
“We remain bullish on defence names, irrespective of a potential Ukraine ceasefire,” Matejka and his colleagues wrote in a note Monday.
