European defense stocks are not cheap, but budgets still support selective stock opportunities

Overview

This Bernstein report centers on “European defense budgets under war or peace,” with the core question being whether European defense stocks have become attractive after the recent pullback in global aerospace and defense stocks. The conclusion is cautious but selectively positive: sector valuations are still not cheap, and if Ukraine achieves a sustainable ceasefire, the European defense sector could see significant de-rating; however, budget data still show visibility for military spending expansion in the U.S., Germany, and France, and the rearmament cycle is likely to continue through the end of this decade. Therefore, the report does not recommend buying the sector broadly, but instead favors Leonardo, Thales, and Rheinmetall, which have self-help improvement potential or high budget sensitivity.

Core views

First, ceasefire expectations are the main negative sentiment variable for European defense stocks, because active conflict in Europe is an important catalyst for the sector. Second, valuations are still not cheap after the pullback, and 12.9x EV/EBITDA is not a blind buy point. Third, the real fundamental support comes from budgets: the U.S. 2027 base budget, German rearmament, and the French LPM all provide medium- to long-term growth. Fourth, stock differentiation matters more: Leonardo has the greatest room for earnings upgrades, Thales benefits from strong core businesses and lowered Cyber expectations, and Rheinmetall has growth far above peers; BAE Systems and Dassault Aviation are steadier but lack near-term upgrade catalysts, while TKMS may benefit from a large Canadian order but is fairly valued.

Analysis framework

Using defense budgets as the main thread, the report breaks down the long-term performance of European defense companies into four dimensions: geographic exposure, business segment exposure, valuation levels, and company-specific self-help improvement. The budget analysis covers the U.S., Germany, France, the U.K., and the EU SAFE fund; the company analysis combines ratings, target prices, EV/EBITDA multiples, sales CAGR, order opportunities, and risk events to assess which companies can achieve higher-quality growth from the rearmament cycle.

Methodology notes

• Valuation methodEV/EBITDA target price method

  Derives 12-month target prices based on forward EBITDA or enterprise value, assumed valuation multiples, net debt adjustments, and discounted cash distributions.

  Rheinmetall, Thales, Dassault Aviation, BAE Systems, TKMS, and Leonardo all use EV/EBITDA-related frameworks; some companies include additional adjustments based on competitive positioning, stake value, or net cash.

• Fundamental frameworkBudget-driven geographic exposure analysis

  Breaks defense company growth into key budget pools such as the U.S., Germany, France, and the U.K., as well as the corresponding serviceable markets of related business segments.

  The report believes long-term share price performance mainly depends on military spending growth and company exposure to key regions and key categories, rather than relying purely on short-term market sentiment.

• Rating methodologyBernstein equity rating definitions

  Outperform means expected outperformance of more than 15 percentage points versus the benchmark index over the next 12 months; Market-Perform means relative performance within plus or minus 15 percentage points.

  This report assigns Outperform to Leonardo, Thales, and Rheinmetall, and Market-Perform to TKMS, Dassault Aviation, and BAE Systems.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Leonardo

  Outperform; a selected European defense stock; about 25% of sales come from U.S. exposure.

  Strengths

  The report believes it has the greatest room for earnings upgrades, and the recent share price pullback triggered by the CEO change can be viewed as an entry point; DRS exposure provides benefit from the U.S. budget.

  Weaknesses

  It needs to deliver on financial targets and business transformation, while still facing project execution pressure.

  Comparison

  Compared with most European defense companies, Leonardo is more sensitive to the U.S. budget and also has greater room for upward earnings revisions.

  Risks

  Declines in defense funding, weaker-than-expected project execution, failure to achieve 2028 financial targets, and large, expensive transformational M&A.

• Thales

  Outperform; benefits from the French budget, strong core businesses, and a tactical upgrade after lower Cyber expectations.

  Strengths

  Growth in the French defense budget and increased investment in aircraft, space, ammunition, and air defense support Thales in maintaining a high share of opportunities.

  Weaknesses

  Weak Cyber business and a slower recovery in commercial telecom satellites may weigh on expectations.

  Comparison

  Compared with Dassault Aviation, Thales benefits more directly from its core defense and electronic systems mix, while also having room for expectation repair.

  Risks

  Uncertainty in the French defense budget, a slow recovery in commercial telecom satellites, and persistent Cyber weakness.

• Rheinmetall

  Outperform; the core beneficiary of Germany’s rearmament cycle.

  Strengths

  Germany’s serviceable market is expected to grow at about +21% CAGR, and Rheinmetall is in the sweet spot in ammunition, land vehicles, and domestic industrial capability, with sales CAGR expected at about +29% through 2030.

  Weaknesses

  The stock has been punished by the market due to near-term volatility, and the company is shifting toward a longer-cycle portfolio.

  Comparison

  Its growth rate is clearly above peers, and the report says it stands in a class of its own in terms of growth.

  Risks

  Potential ceasefire in Ukraine, demand shifting to longer-cycle products as new ammunition and ground vehicle capacity comes online, and execution risk during the shift to a longer-cycle portfolio.

• BAE Systems

  Market-Perform; one of the companies with the highest U.S. budget exposure in European coverage.

  Strengths

  About 45% of sales come from the U.S., it has a strong domestic position in the U.K., and defense fundamentals are solid with relatively resilient operations.

  Weaknesses

  Although it benefits from budget growth, the report struggles to see a near-term earnings upgrade catalyst; it is also not best positioned in the most critical categories such as space, missiles, and air defense.

  Comparison

  Compared with Leonardo, BAE Systems is more stable but lacks near-term upside elasticity.

  Risks

  U.S., U.K., or international defense funding cuts due to political and fiscal challenges; easing of the Ukraine conflict weakening European defense sentiment; and project execution issues affecting growth, margins, and cash flow.

• Dassault Aviation

  Market-Perform; a French defense and aviation asset that the report sees as more resilient but lacking near-term catalysts.

  Strengths

  Rafale orders, gradual improvement in Falcon, and margin enhancement from the maturing Falcon 6X are potential positives.

  Weaknesses

  Near-term upgrade catalysts are lacking, and the business is also affected by business jet demand and supply chain constraints.

  Comparison

  Compared with Thales, Dassault Aviation is more resilient, but the report finds it harder to see near-term upgrade momentum.

  Risks

  Uncertainty around the FCAS project, weakening business jet demand, supply chain challenges hindering the Falcon delivery ramp-up, and self-funded R&D investment coming in above expectations.

• TKMS

  Market-Perform; a pure-play long-cycle naval defense asset that may benefit from a large Canadian order.

  Strengths

  The long-cycle nature of the naval business, significant order backlog, and positioning as a scarce pure-play long-cycle defense asset in Europe provide resilience.

  Weaknesses

  The report believes the stock is already fairly valued, and the transformation still needs to prove earnings improvement.

  Comparison

  Compared with Rheinmetall, TKMS is more long-cycle and defensive, but has limited growth elasticity and rerating potential.

  Risks

  Legacy contracts continuing to incur costs, F127 and F126 contracts not being awarded to TKMS, and poor operating execution slowing the transformation.

• U.S. prime defense contractors

  Industry observation; fundamentals are solid but lacking near-term upside catalysts.

  Strengths

  Both the 2027 U.S. budget proposal and the base budget indicate strong demand, with space, missiles, air defense, autonomous systems, and counter-drone as key directions.

  Weaknesses

  Valuations were previously near historical highs, and market rotation has led investors to prefer opportunities with higher revenue growth.

  Comparison

  Compared with selected European stocks, U.S. prime contractors have more stable fundamentals, but the report does not see significant near-term upside catalysts.

  Risks

  Congressional budget cuts, intensifying competition from new entrants in autonomous systems and counter-drone, and insufficient valuation appeal.

Key data

• European defense valuation12.9x EV/EBITDABelow the 13.6x at the start of 2026, but the report believes it is still not obviously cheap.
• U.S. 2027 base budget scenario$1.1tn vs. $0.9tn in 2026, about +22%The report does not expect the full $1.45tn to $1.5tn budget package to pass Congress in full, but the base budget could still deliver strong growth.
• German defense budgetAbout €100bn rising to €180bn by 2030Budget CAGR is about +12%, while the serviceable market CAGR is about +21% due to higher equipment spending.
• German special fund€100bn; €73bn spent as of 2026Used to accelerate equipment projects for the German armed forces.
• French defense budgetBudget CAGR about +7%; serviceable opportunity CAGR about +8% through 2030The 2024-30 LPM adds €36bn of spending in 2026-30, focusing on ammunition, space, fighter aircraft, transport aircraft, drones, land systems, and air defense.
• U.K. defense budgetExpected CAGR of about +3% through 2030The U.K. has committed to raising defense spending to 2.5% of GDP by 2027 and aims to move toward 3% in the next parliament, but this is constrained by fiscal capacity.
• EU SAFE fund€150bnUsed to accelerate member-state defense preparedness through long-term loans, requiring at least 65% of equipment component costs to come from the EU, EEA-EFTA, or Ukraine.
• U.S. sales exposureBAE Systems about 45%; Leonardo about 25%These two companies are the biggest beneficiaries of U.S. budget growth within Bernstein’s European coverage.
• Rheinmetall growthSales CAGR about +29% through 2030; peers about +10%The report believes Rheinmetall is clearly ahead on growth, but near-term volatility has put the stock in the penalty box.
• Main target pricesRheinmetall €1,900; Thales €260; Dassault Aviation €330; BAE Systems £20.50; TKMS €76; Leonardo €65All are the 12-month target price-related valuation outcomes disclosed in the report.

Impact & implications

The investment implication is that the risk-reward in the European defense sector is not suitable for being treated simply as industry beta. If a ceasefire in Ukraine becomes a sustainable reality, sector valuations may come under pressure; however, long-term support from budgets still gives some stocks a path upward. At the portfolio level, investors should focus more on budget exposure, sub-segments, earnings upgrades, and self-help improvement, rather than allocating solely based on conflict escalation or sector pullbacks.

Risks

• If Ukraine achieves a sustainable ceasefire, European defense stocks could see significant de-rating, as the market would question the sustainability of the rearmament cycle.
• European defense valuations are still not cheap, and 12.9x EV/EBITDA is insufficient to constitute an obviously undervalued buying point.
• U.S., U.K., French, and international defense budgets may come in below expectations due to political and fiscal constraints.
• As new ammunition and ground vehicle capacity comes online, demand may shift toward longer-cycle products, weakening some short-cycle growth elasticity.
• There are execution risks in Rheinmetall’s shift toward a longer-cycle portfolio, BAE Systems’ project execution, TKMS’ transformation, and Leonardo’s delivery on financial targets.
• Thales faces risks from weak Cyber performance and a slower-than-expected recovery in commercial telecom satellites.
• Dassault Aviation faces risks from uncertainty in the FCAS project, weaker business jet demand, supply chain constraints, and rising self-funded R&D investment.

What to watch

• Whether Ukraine ceasefire negotiations result in a sustainable agreement, and whether the market reassesses the European rearmament cycle as a result.
• The final size of the U.S. 2027 defense budget, especially the difference between the base budget and reconciliation funding.
• Whether German defense spending advances toward €180bn by 2030 as planned, and whether the share of equipment spending continues to rise.
• The pace of execution of the additional €36bn in French LPM spending, especially across ammunition, space, aircraft, drones, land systems, and air defense.
• The rollout speed of the EU SAFE fund, country allocation, and the impact of the 65% European local content requirement on the supply chain.
• Leonardo’s earnings upgrade path after the CEO change, whether Thales’ tactical upgrade in Q2’26 materializes, and whether Rheinmetall’s risk-reward improves after near-term volatility.
• TKMS’s large Canadian order and progress on the F127 and F126 contracts.
• The impact of new entrants in autonomous systems and counter-drone on the competitive landscape for traditional prime contractors.