Bernstein Puts Timeline On When EU Rearmament Supercycle “Goes Boom”

Readers by now know how we’ve laid out the looming rearmament supercycle in the West colliding with the “own the bottlenecks” theme, as resource nationalism makes industrial metals and rare earths scarce because of Beijing’s export restrictions.

Adrien Rabier, Bernstein’s equity analyst covering European aerospace and defense, penned a note on Tuesday explaining why the European defense rearmament cycle remains a top investment theme and even outlined a timeline.

In a report titled “European Defense: Beyond the order boom,” Rabier said EU defense firms are set to enter a massive demand-driven cycle for new weapons.

Here’s the timeline in three phases:

Stage 1: New paradigm (2022-2026).

The first stage, following the invasion of Ukraine, was characterized by rapid order collection. It drove multiple expansion across the sector, in anticipation of faster growth. The stocks re-rated from 9x EV/EBIT (-30% discount vs. SX600) to 15x currently (+17%). Exposure to the best geographies (Germany) and the quickest growth segments (short-cycle) were the most important drivers of performance.

Stage 2: Re-Arming Europe (2026-2030). 

The second stage marked the transition from an order-driven performance to execution-driven, as backlogs became rich across the sector. Exposure to structurally attractive product categories will remain the most important factor, in our view. We expect the narrative against short cycles products, legacy weapons, and Ukraine-related demand to intensify. Our “new warfare” basket is up +14% YTD, vs. the “old warfare” basket down -34%. We expect this gap to keep widening. We see few positive catalysts for the sector, and therefore favor self-help stories. We expect investors to focus increasingly on the exit multiples, as we head toward Stage 3.

Stage 3: Normalization (2030+). 

After the re-arming phase, we believe European military budgets will normalize near 3% of GDP. European Defense should then return to a GDP+ growth and ~12% EBIT margins sector, close to the Index’s average.

Rabier’s key message is that investors will reward companies capable of converting backlogs into profitable deliveries: 

With all players now virtually benefiting from very large backlogs, the ability to convert backlog into profitable growth and scale capacity efficiently will matter more. We continue to view electronics exposure as the best, because these businesses grow through volume and content share, and are easier to scale (Thales, Leonardo, BAE Systems). Some companies will also benefit from turning around parts of their businesses (TKMS, Leonardo).

Top picks:

One major constraint on both Europe’s rearmament cycle and the looming US weapons buildup is access to reliable, conflict-free supplies of critical materials. Larger budgets and expanding order books can translate into weapons deliveries only if manufacturers secure the necessary copper, tungsten, and rare earths that are in scarce supply. 

 That makes “owning the bottlenecks” a complementary investment theme to the broader defense buildup.