Key Takeaways

• Aerospace and defense stocks have soared in Europe this year
• Morningstar analysts say sector valuations still have plenty of road left to run
• Defense spending would continue to rise even if current conflicts abate

Aerospace and defense valuations in Europe have tripled since the beginning of the war in Ukraine, including a 54% gain this year, the Morningstar Developed Europe Aerospace & Defense Index shows.

Early talk of a peace deal in Ukraine is unlikely to halt European and UK defense stocks’ extraordinary rally. If anything, experts say, it could further bolster the sector as details of nations’ defense spending plans reach markets.

Political events in Europe mean Morningstar analysts are increasing their fair value estimates for key defense stocks like BAE Systems BA., in that case significantly so.

This week, US President Donald Trump warned that Vladimir Putin would seek revenge over a clandestine Ukrainian drone mission that reportedly destroyed billions of dollars worth of Russian aerospace assets. Just this week, UK Prime Minister Keir Starmer said defense spending needs to adjust to ”war-fighting readiness", citing the heightened threat from Russia. Peace in the near term looks unlikely.

Morningstar industrials and aerospace analyst Nicolas Owens maintains his forecast for a huge increase in European defense spending.

“We see $200 billion in increased funding for research and development and military procurement among NATO countries in the upcoming decade,” he says. “This will accrue to defense contracting firms’ backlogs, regardless of when and how the Ukraine conflict is resolved.”

Why Have Defense Stocks Risen So Sharply?

The importance of European defense stocks was thrown into focus by the full Russian invasion of Ukraine in 2022. Perspectives on defense changed quickly. Some commentators even argued arms companies should be included in ESG portfolios. An increase in ESG fund exposure to arms stocks followed. An escalation in the Middle East by Hamas in October 2023 also added to global fears of conflict.

By November 2024, when Donald Trump took the White House for a second time, there was already speculation about his country’s relationship with European allies and NATO. Subsequent political events have shown a very limited US tolerance for the status quo.

All that has contributed to a sparkling stock price rally as investors loaded up on stocks deemed to benefit from rearmament and national security fears.

Year to date, German defense giant Rheinmetall RHM is up by nearly 200% while its Italian peer Leonardo LDO has risen 103% in euro terms. UK defense manufacturer BAE Systems BA. is up more than 68%. Rolls-Royce RR., the commercial aviation manufacturer with global exposure to demand for submarine and air force engines, had a volatile April. Still, its stock price is up 50% year to date.

Could that momentum end if ongoing brutal conflicts in Ukraine and the Middle East abate, or even settle?

“The war in Ukraine brought three strong drivers of defense stocks to the fore, and all of them will remain salient if and when the war in Ukraine ends,” Owens says.

“First, prolonged ground combat highlighted that Western military planners underestimated the rate at which artillery shells could be expended, which resulted in increased orders to resupply and increase production capacity for these traditional armaments.

“Second, innovative military tactics and equipment highlighted the importance of low-cost, networked sensors and munitions, specifically drones, to modern warfare.

“And most importantly, the invasion of Ukraine forced European nations to reevaluate their level of investment and preparedness for armed conflict or its deterrence.”

Ceasefire: a Medium-Term Defense Opportunity?

At this stage, it is unclear whether a peace deal is even possible, let alone sustainable.

A shorter-term ceasefire, however, is possible. According to a defense consultant familiar with UK-Ukraine military cooperation, this could be good for defense companies large and small.

In their view, a prolonged ceasefire would pose two key opportunities for defense companies. The first would be logistical.

Since February 2022, the Ukrainian Army and Air Force has learned to its detriment just how difficult it is to maintain effective supply chains across a country that is 817 miles wide and fields such a vast array of combat vehicles of varying provenances—many from the former Soviet Union.

Maintaining this patchwork of equipment and matériel could be made easier with the breathing space provided by a ceasefire. The second opportunity is commercial.

Western product contracts now typically stipulate certain repairs must be carried out by the manufacturer rather than military mechanics—a change bedded in during the Global War on Terror that also requires time to embed in Ukraine. It could require the relative safety of a ceasefire for Western civilian defense sector professionals to work inside the country in greater numbers.

A New Era of Defense Co-Operation?

The possibility of a ceasefire isn’t the only tailwind for European defense companies. Europe is rearming anyway. Amid the economic disruption posed by tariffs, Morningstar’s analysts point to increased political cooperation in Europe as a boon for defense stocks.

“If tariffs are extended to defense-related goods, we expect the primary impact to fall on US defense firms—through higher production costs and increased procurement prices for the US Department of Defense and allied buyers in Europe,” Morningstar analyst Loredana Muharremi wrote in a note.

“Given current geopolitical dynamics and the need for Europe to close its defense capability gap, we see limited likelihood of retaliatory tariffs targeting US defense exports.

“However, a maintained protectionist stance from the US could diminish the competitiveness of its platforms over time and accelerate intra-European consolidation.”

The protection of supply chains via onshoring is also key. In April, BAE Systems BA., which in part produces artillery and small arms ammunition for the UK Ministry of Defence, announced a manufacturing overhaul.

It will now turn to running smaller facilities continuously in a bid to protect its supply chains for explosives and propellants from overseas price fluctuations.

Such moves come as the UK itself renegotiates its relationship with the European Union. In May, UK prime minister Keir Starmer announced a formal post-Brexit deal had been struck with the continent’s political bloc, which includes access for UK arms companies to access the Security Action for Europe (SAFE) scheme, a £150 billion EU defense fund providing loans for crucial defense projects.

In the wake of the deal, Muharremi significantly increased her fair value estimate for BAE stock from £15.50 per share to £22.50. Though she says the fund is too small to completely meet Europe’s defense ambitions, she says it is a very clear win for UK defense.

“Positively, the framework opens participation to non-EU contractors,” she says.

“UK companies such as BAE Systems and Rolls-Royce – previously excluded from the European Defence Fund – are expected to gain access to funding through a new bilateral UK–EU security pact, with details anticipated to be finalized [soon], provided sourcing thresholds are met.

“This is a clear win for UK industry and broader EU capability goals.”

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.