Defence contractor Babcock International PLC (LSE:BAB) was highlighted by JPMorgan as a beneficiary of significant growth potential within the European defence sector.
The FTSE 250-listed group's upcoming post-close update for the year to end-March could prove a catalyst for the shares, the investment bank said, as the estimated earnings per share for 2025 to 2028 are notably above consensus forecasts.
Taking a wider view, the investment bank expects the “European rearmament cycle” to last a decade, noting a "new political consensus ... emerging across Europe", with multiple recent comments from senior European politicians on the urgent need for higher defence spending.
This follows "up to 30 years of under-investment", based on a calculation by Germany's IFO institute that European countries had saved €1.8 trillion since 1991 by spending less on defence compared to meeting the NATO target of spending 2% of GDP on defence.
"Today, Europe’s military capability is much diminished; it has less equipment and some of this equipment is aging and in a poor state of repair. It will take many years of higher spending to improve Europe’s defence capabilities," JPMorgan said in a note to clients.
It highlighted strong earnings growth potential, upside risk to consensus and potential for further re-rating of stocks in the European defence sector.
Strong order books for defence companies justify higher valuations, the bank said. "Order backlogs across the industry have risen sharply in the last two years. These backlogs provide greater visibility, underpin stronger top-line growth prospects and, in our view, justify higher valuation multiples for the sector."
Other large European defence stocks include BAE Systems PLC (LSE:BA.), ThyssenKrupp, Thales, and Safran, while Avon Protection PLC (LSE:AVON) is a provider of helmets and breathing equipment, and Chemring Group (LSE:CHG) makes countermeasures to protect from missiles or radar detection.