(News Bulletin 247) – The sector experienced a surge last year, driven by this conflict. Increases in orders were anticipated by the market, even if certain obstacles still remain in the minds of investors.

It is certainly the sector that the conflict in Ukraine, which began a year ago, has (re) brought to the fore the most: defence. For several years, these stocks were little appreciated by the market, with the main reason for falling out of love with a theme deemed not very promising for ESG management (environment, social, governance, extra-financial criteria), investors being reluctant to place funds in businesses directly or indirectly related to weapons.

The conflict nevertheless reshuffled the cards. After the outbreak of war in Ukraine, “a re-rating (appreciation of stock market multiples, editor’s note) was observed in the Defense sector in Europe, which traded on average at 8 times the expected net profit against nearly 12 times today”, explains Yan Derocles, analyst at Oddo BHF.

This resulted in impressive stock market performance. Thales posted the biggest rise in the CAC 40 in 2022 with a jump of nearly 60%, Dassault Aviation, the manufacturer of the Rafale, for its part took the lead in the SBF 120, with an increase of 66.5%. Britain’s BAE Systems, for its part, recorded the strongest growth in the FTSE 100, the flagship index of the London Stock Exchange, with an increase of more than 50%. “The year 2022 was a year to play defense on the stock market,” summarizes Jefferies.

“The sector was at a significant discount to its fundamentals and the outbreak of the conflict was a wake-up call for the market by demonstrating the importance of national defense at a time when Western budgets were near historic lows,” emphasizes Yan Derocles.

“However, not all investors have reacted in the same way. While the Anglo-Saxons have strongly strengthened their positions in European defense groups, European managers have been slow to relax their exclusion policies and many are those who still do not position themselves on the values ​​of the sector due to persistent constraints”, nuances the analyst.

Increases in orders

Another market intermediary believes that “it is starting to relax in the minds of investors, especially German ones, with defense securities no longer being considered as ‘prohibited’ securities”, whereas the positions were previously clearly arc -boutées”.

“We slowly understand that defense is not a concept that is totally incompatible with ESG concepts because it contributes to maintaining security in the world”, he adds.

The market anticipated increases in orders which partly materialized. In the days following the outbreak of the conflict, Germany announced that it wanted to devote 2% of its GDP to military spending, against 1.49% in 2021, according to NATO, and released an exceptional envelope of 100 billion euros for the army. The Netherlands has recently announced that it wants to increase its spending on military supplies by 3.5 billion euros over the next few years, as reported by Reuters.

“The Russian invasion of Ukraine provided the political stimulus needed to accelerate defense budget increases that had been underway since Russia’s 2014 occupation of Crimea,” UBS said in a recent note. The Swiss establishment anticipates an annual increase in military spending outside the United States of 7% on average over the period 2022-2030 against 3.2% on average for 2014-2021, a growth according to it currently underestimated by the market.

A partially absorbed potential

“All defense groups will structurally benefit from the future order increases in the sector, initially with an acceleration in short-cycle activities such as ammunition, missiles or even land vehicles. But the extent will depend on geographical exposure: Germany has suffered a major booster shot, and is therefore increasing its military budgets, which will bring groups like Hensoldt or Rheinmetall”, adds Yan Derocles. Rheinmetall, which supplies armored vehicles to the German army, saw its price more than double on the Frankfurt Stock Exchange last year, as did Hensoldt, which specializes in particular in military sensors.

Obviously part of the long-term stock market potential has already been absorbed by the market. UBS now favors BAE Systems and Dassault Aviation compared to other titles to bet on Defense The Swiss bank considers that Thales is well positioned in the long term but considers that this asset is already reflected in the course of the company.

Lack of support from the European Commission

Last notable change caused by the conflict: the shedding of European pressures and initiatives to create a social taxonomy, i.e. a nomenclature to direct investors towards products considered to be socially “sustainable” or a European eco-label, which would damage the defence.

“The European Commission and the Member States have, on several occasions, declared in 2022 that it is necessary both to lead the economy towards the ecological transition, but also to finance the defense industry, without one of these two priorities is done to the detriment of the other”, explained in January Bertrand Delcaire, director of investor relations at Thales. “For this reason, the defense sector is optimistic that putting in place rules excluding defense from sustainable investments will not succeed,” he continued.

“However, the absence of clear and explicit support from the European Commission does not help the defense industry much, because in Europe, too many large institutional investors still prefer to stay away from this sector”, added Bertrand Delcaire. “Even if investors are gradually realizing that excluding defense from their ESG investments is inconsistent with the need to protect European nations,” he qualified.