Europe Is Stepping Up Its Defense Spending. This Company Stands to Profit.
Russia’s war in Ukraine has led several European countries such as France, Germany, and Sweden to reassess their defense budgets. War on their doorstep has proved to be a wake-up call for public spending in areas that have fallen down the priority list.
While the geopolitical outlook remains uncertain, defense and aerospace companies like Thales (ticker: HO.France) could see a revenue boost. Shares have risen about 65% this year to a recent price of 123.30 euros ($132.40), but there’s room for more gains, according to several analysts who recently reaffirmed or launched bullish ratings on the French company.
“The stars continue to be well aligned for Thales, with all divisions showing upside from the current levels” and defense stocks set to outperform for years, says Christophe Menard, a Deutsche Bank analyst. Menard on April 12 raised his price target on Thales to €137 from €110 while maintaining a Buy rating.
The acceleration of the French defense budget will be the main short-term catalyst for Thales, according to Jefferies analyst Chloe Lemarie, who has a Buy rating on the stock with a €133 price target. Emmanuel Macron, who on April 24 defeated far-right rival Marine Le Pen to be re-elected president of France, has pledged to increase military spending to €50 billion from €41 billion by 2025.
On top of military spending, Lemarie sees an array of potential upside for Thales. These include exports of its Dassault Rafale jet fighter to the United Arab Emirates and an additional six for Greece. Thales should also benefit from an announced contract with Canadian satellite operator Telesat to manufacture 298 satellites for a broadband network in low-Earth orbit.
Thales, which is 25% owned by the French state and 24% by defense group Dassault, is Europe’s largest defense electronics company, valued at €26 billion. Its systems range from radar to rail, and biometric sensors to satellites.
Thales came under pressure at the start of the pandemic in April 2020, cutting its dividend and suspending profit guidance. At the time, the group predicted a progressive recovery in most businesses, and that appears to have happened. Operating profit for 2021 rose to €1.649 billion on sales of €16.2 billion, up 5.3%. New orders rose 18% in 2021 to €19.9 billion, outpacing sales. Thales expects this to be repeated in 2022.
Thales stock has risen 44.67% over the past year. The company fetches 17.5 times this year’s expected earnings, compared with rival Raytheon Technologies (RTX), which trades at 20.98 times, and Boeing (BA), at 62.66 times.
Investors have stayed away from defense companies in recent years, instead choosing stocks with stronger environmental, social, and governance, or ESG, profiles. But the threat of war in Europe has made some investors reconsider the social value of defense companies, giving them surprising ESG credentials.
Sweden’s SEB Investment Management recently reversed its year-old policy of banning defense stocks, saying that beginning in April, it would allow six of its more than 100 funds to invest in companies that generate more than 5% of their revenue from defense.
Still, some analysts see risks. Thales’ organic growth plans might disappoint, and Citi analysts say the group could get distracted by plans to hunt for acquisitions. CEO Patrice Caine last month said Thales is interested in making bolt-on acquisitions of companies with an enterprise value of up to €500 million across its three core areas of aerospace, defense and security, and digital identity and security.
If Thales sticks to these parameters to find profitable growth opportunities, investors could be in for further gains.