Gun industry takes advantage of geopolitical chaos in stock market | Financial markets

The arms industry is enjoying good times in the stock market thanks to geopolitical tensions reflected in Russia’s February 24, 2022 invasion of Ukraine and the escalation of the war that began in the Middle East last October following the Hamas attacks. The Israeli response to Gaza, which continues without stopping. This is evidenced by the data: the global MSCI World & Defense index managed to rise by 13% over…

The arms industry is enjoying good times in the stock market thanks to geopolitical tensions reflected in Russia’s February 24, 2022 invasion of Ukraine and the escalation of the war that began in the Middle East last October following the Hamas attacks. The Israeli response to Gaza, which continues without stopping. The data reflects this, with the MSCI World & Defense Global Index managing to rise 13% in 2022, while its overall version MSCI World fell 18.14% that same year. Growth in the global defense sector slowed last year but was still 15.5%, compared with the overall market’s growth of 27%.

The cause-and-effect relationship between war and profits is not up for debate, as veteran analyst Pablo Gil of IG Markets points out: “In an environment of great geopolitical instability, many countries are looking to bolster their security or add to their weapons arsenals.” who use their army, which leads to a significant increase in the income of these companies, and with them the prices of their shares.” The most striking examples of the arms sector are Lockheed Martinthe world’s largest defense contractor, whose stock market has risen 22% since January 2022. Northrop Grumman, the fifth-largest arms manufacturer in the world, has risen in price by more than 13% during this time. When General dynamics, an American conglomerate in the aerospace and defense sector, revaluation exceeds 28%. Their prices overcame the general stock market decline in 2022 and consolidated throughout 2023.

Financial advisory firm Accuracy has just completed a study of twenty US and European defense companies that links good stock markets to business performance. “Since February 24, 2022, the average increase in the share price of the analyzed companies was 59.7%, while the dynamics of the S&P 500 and Stoxx Europe 600 indices during this period were 13.4% and 7.4%, respectively. ” And they add: “There has been a gradual increase in sales and operating profit (EBITDA) over the period, which contributes to the increase in market capitalization.” Of course, European arms companies fared better: the market value of shares in the United States rose by 25%, and on the Old Continent by 75%. The sad return of war to European territory was an important stimulus for its arms industry.

Bank of America’s (BofA) report on the European sector points to strong earnings growth next year, bolstered by increased defense spending focused on the Ukraine conflict. Of course, this organization also explains that the valuations of arms companies are high and are trading several times higher than those recorded before the war in Europe. “Over the last two quarters we have seen a change in the tone of companies, especially German ones (Rheinmetall and Hensoldt)who noticed an acceleration in orders. “Demand is likely to remain strong and we believe we are at the beginning of a multi-year defense industry growth cycle.” And they add: “This strong momentum and improved profitability allows us to expect earnings per share growth in the European sector of 23% until 2025,” they point out. Britain’s Babcock and Germany’s Rheinmetall are at the forefront of earnings expectations.

Goldman Sachs does not have a clear view of the US defense sector, which moves through ten-year investment cycles and is now approaching its ceiling, so only spending cuts can be expected. Also, consider that these stocks’ valuations already leave little room for upside. Finally, it notes that the Pentagon is maintaining stricter contracts with the weapons industry, which is affecting the profitability of its business. “As the current budget increase cycle approaches ten years, we believe there is greater risk of a decline in defense spending,” he concludes.

The vision for this framework is changing for the European defense sector, whose results for the third quarter of last year indicated strong growth in sales and orders. Thus, while American securities analyzed by Goldman have a sell signal, European ones continue to buy.

Values

European aircraft manufacturer Airbus This is an obvious bet for analysts. Bank of America gives it a price target of €208 (currently trading at €149), based on increased production, and expects net cash of €11 billion, allowing it to repurchase shares. For its part, Goldman highlights increased deliveries this year and expects earnings before interest and taxes (ebit) to be 6.3 billion euros in 2023. Another European stock that both investment banks like is a German company. Rheinmetall which BofA values ​​at 410 euros (currently 332 euros). “We believe Rheinmetall benefits from sustainable growth prospects and a valuation of 10 times operating profit, compared with the industry average of 12 times.”

There is unanimity in purchasing in Europe Safran, a French high-tech multinational specializing in defence, aeronautics and security, valued at €172, compared to Bank of America at €208. “Full-year results due in February 2024 will be the next major catalyst for these stocks due to expected improvement in margins,” Goldman explains, while Bank of America expects strong operating and earnings growth. .generation of cash when presenting its reports, and this situation will continue throughout 2024.

Bank of America gives less room for upside to also France’s Thales with a target price of €146 (currently €135): “We do not see significant headroom for a rating upgrade from our current neutral level before early this year, and we find positive catalysts limited in the near term perspective. We believe strong growth in the aerospace sector will continue, but with pressure on margins,” they explain.

Rolls-Royce, Melrose, BAE Systems or Saab This is another clear bet by Bank of America on the European arms sector. Goldman is neutral on Dassault, Leonardo or MTU shares.

For U.S. arms companies, a global power in defense spending, they face uncertainty about what levels of investment will be in the future. “US defense spending as a percentage of GDP has declined in recent years and currently stands at 3.1%. This percentage is expected to decline further to 2.8% by 2033, a situation that could pose future challenges for the DoD,” they noted at Deloitte. In an increasingly turbulent world, however, the policies adopted by the winner of November’s presidential election will be key.

Goldman is saving only a few stocks from sell recommendations. They’re getting rid of Teledyne (“well-managed business focused on high-growth end markets, strong margins and good cash flow”); Bozz Allen Hamilton (“consistently delivers industry-leading growth, earnings and cash flow. Shares continue to trade at a premium to peers, but operating earnings justify it”) and finally, Read (“It has recently signed important new contracts, leading to increased orders and greater visibility of medium-term growth”), they explain.

For sector giants such as Lockheed Martin or Northrop Grumman – which just announced order book levels at maximum levels but results below expectations – most analysts’ consensus advice is to keep the level above 60% with very little sales. recommendations.

The profit outlook for the sector is clear, although after the euphoria of consolidation in 2022 and 2023, as well as the unexpected conflict in the Middle East in the last quarter of last year, investments in the military industry now require greater caution. Without a doubt, this is a paradoxical business with strong capital gains, which is usually associated with the worst thing in people – war.

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