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What Do NATO Budget Plans Mean for Defence Companies?

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US President Joe Biden reaffirmed America’s “ironclad commitment” and support for the NATO alliance during his visit to Europe last month, in an attempt to undo the damage done by his predecessor.

Market Commentary

By Andrew Lane | August 17, 2021

During his presidency, Donald Trump had regularly criticised European NATO members of failing to spend the agreed target of 2% of GDP on defence. Trump had called out Germany in particular, for spending as little as 1.2% of its GDP. The former US President went as far as to urge other alliance members to increase their spend to 4% of GDP.

Despite a raging pandemic, the NATO countries raised their defence spend in 2020, representing the sixth consecutive year an increase. The meeting last month revealed that France and Norway had reached the targeted 2% for the first time, taking the total number of members meeting or exceeding the target to 10. The alliance members are on track to spending a whopping $1.03 trillion on defence in 2021.

Estimated Military Spend by NATO Countries in 2021

Country Amount in Millions USD Percentage of GDP
USA 811,140 3.52
UK 72,765 2.29
Germany 64,775 1.53
France 58,729 2.01
Italy 29,763 1.41
Canada 26,523 1.39
Spain 14,875 1.02
Netherlands 14,378 1.45
Poland 13,369 2.10
Turkey 13,057 1.57
Norway 8,292 1.85
Greece 8,014 3.82
Belgium 6,503 1.12
Romania 5,785 2.02
Denmark 5,522 1.41
Czech Republic 4,013 1.42
Portugal 3,975 1.54
Hungary 2,907 1.60
Slovak Republic 2,043 1.73
Croatia 1,846 2.79
Lithuania 1,278 2.03
Bulgaria 1,253 1.56
Latvia 851 2.27
Estonia 787 2.28
Slovenia 760 1.28
Luxembourg 474 0.57
Albania 239 1.44

 

While the 4% suggested by the US seems like a stretch, the spend is poised to continue growing. Although Biden has been more diplomatic than Trump, the European members and Canada are feeling the pressure. The heat from the US is understandable. After all, America spent more than 3.7% of its GDP on defence in 2020, versus the less than 1.8% average for the European members and Canada.

Defence Stocks are the Most Defensive Plays

Defensive plays are stocks that perform broadly the same irrespective of the economic conditions and these companies generate relatively stable earnings and offer fairly consistent dividends. Defence stocks fit the bill perfectly.

It doesn’t take a genius to guess that the growing NATO budget will benefit defence companies. What investors need to bear in mind is that the defence industry is not limited to companies that manufacture weaponry, like fighter jets, combat vehicles, and bombers. It also encompasses companies that offer cybersecurity, robotics, IT, and intelligence systems. Moreover, although the US is a key player in the defence industry, European defence companies are also poised to benefit.

So, which of the defence stocks should investors closely monitor? Here’s a look at some of the biggest names.

US defence contractors are in a strong position. After all, the bulk of their business is generated by a customer with the deepest pockets in the world. Yes, that’s the US government. This also makes their revenues largely predictable. The four leaders in this space, Northrop Grumman, Lockheed Martin, Raytheon Technologies, and General Dynamics, have had a great year so far in 2021. However, their shares have gained around 23%, 11%, 25%, and 31%, respectively, year to date, which is high for defensive stocks. Due to this, market sentiment is mixed ahead of the rollout of NATO related orders, as can be seen on Acuity’s Trading Dashboard.

These Defence Stocks Could Steer Ahead

The deployment of the NATO budget is likely to lend further upside to these names. This may be particularly true for:

  • Lockheed Martin – The world’s largest defence pureplay and the manufacturer of the world’s most expensive aircraft, the F-35 Joint Strike Fighter
  • Raytheon Technologies – A company that was born out of the merger between missile specialist, Raytheon, and the manufacturer of aircraft engines and other parts, United Technologies, in 2020.

Both these companies are worth a mention not because they will earn from the US government, but also because they are likely to be big winners as Europe expands its budget. Moreover, Lockheed Martin and Boeing are the leading candidates for Canada’s plans of purchasing new fighter jets next year, for which the Canadian government has allocated a budget of $19 billion. Boeing also has its eyes set on the Asia-Pacific region for its fighter jets and antisubmarine warfare aircrafts.

We will also monitor contracts inked by Northrop Grumman, for its stealth bombers and nuclear missiles, and General Dynamics, for its tanks and land vehicles.

Among the European stocks, we’re keeping a close eye on:

  • Airbus – The company already has a NATO-related order from Europe for its MRTT (multirole tanker transport) and has sold six Eurofighters as part of the NATO’s enhanced air policing missions. Moreover, Airbus is among the top three contenders for NATO’s plans to replace the current AWACS (airborne warning and control system) due to be retired in 2035.
  • BAE Systems – The company is poised to benefit as countries grow their defence spending to move closer to their NATO targets, especially the UK and Germany.

While these opportunities are immense, investors must know the threats too. For one, 20 of the 30 NATO members will still not make the cut to spending 2% of their GDPs on defence. In fact, Germany has said it’s unlikely to reach the 2% target till 2031. Most governments are also struggling with their fiscal budgets after injecting funds to revive their economies following the pandemic-led downturn. Moreover, while Washington has been vocal about singling out China as a threat, the EU is keen to maintain good relations, especially after signing a landmark economic treaty with the country in 2020.

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