European defence stocks dominated a historic quarter of outperformance for the region’s equities. And some investors are still trying to increase their positions.
Armoured-vehicle producer Rheinmetall AG and Thyssenkrupp AG — which has a submarine business — both saw their share prices double in the first quarter, the two members of the benchmark Stoxx 600 Index to do so. The next six best performers were all firms that stand to benefit from a surge in defences pending by European nations amid US threats to walk back its security commitment to the continent.
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“It’s a huge pocket of growth going forward, and where I can I’m fully invested,” said Vera Diehl, a portfolio manager at Union Investment Privatfonds GmbH, regarding defence. “That is the future in terms of earnings growth, that’s where we’ll see it.”
The rally played a major role in Europe’s outperformance. In dollar terms, the region’s Stoxx 600 Index had its best ever quarter versus the S&P 500. A Goldman Sachs Group Inc. basket of pure-play European defence shares rose by a record 70% in that period. Companies such as Thyssenkrupp and Iveco Group NV were also lifted by speculation around sales and listings of military units.
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Investor demand has sent valuations soaring. A number of defence stocks now trade on forward earnings multiples that exceed those of the luxury and tech sectors. Rheinmetall, Saab AB and Kongsberg Gruppen ASA trade at around 40 times. Leonardo SpA is on the cheaper side, trading at around 24 times.
Morgan Stanley strategists led by Marina Zavolock polled over a hundred European defence investors in March. They said the results supported their overweight stance overall, though positioning remained light with ESG restrictions easing only gradually and the sector still being “discovered” by a broader set of generalist investors.
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Amid the frenzy, some investors have been more indiscriminate in their approach. “People are buying small caps that say they have an exposure to the defence business that we need to pick up with a magnifying glass,” said Alec Cutler, a Bermuda-based portfolio manager at Orbis Investments.
Charlotte Ryland, head of investments at CCLA Investment Management, is holding off on European defence shares until “rhetoric becomes reality” in terms of profitability. “Given valuations, given the historic returns these businesses have made, we’re not at a point where we’re rushing in and saying we should be buying everything,” Ryland said.
European Defence Stocks Hit a Record High in March | A Goldman Sachs basket is up around 70% this year
Still, bullish investors remain undeterred. “Our system loves all European defence,” said Patrick Armstrong, chief investment officer at Plurimi Wealth LLP, which uses artificial intelligence and machine learning to pick stocks. Valuations might be getting stretched, he added, but “Germany and EU policy will drive revenue growth that leads to estimates being beaten.”
