European defence sector valuations, particularly UK names, remain below historical peaks, with potential upside as military budgets rise in the wake of Donald Trump cutting US support, according to Deutsche Bank.
The sector is currently trading at 15.5 times earnings a year ahead, on average, with UK defence stocks below this level.
If defence spending increases to 3% of GDP, sector multiples could rerate to 14.3x, and even to 14x at a 3.5% share of budgets.
Deutsche analysts highlighted that European defence stocks previously peaked at just below 16x EBIT though US peers have rarely traded above this level since 2009.
Germany is considering a €400 billion defence budget increase over five years, which could push its military spending to 3.5% of GDP from 2% in 2024. Companies like Rheinmetall, Hensoldt and Renk are seen as key beneficiaries, given their exposure to German defence contracts.
Meanwhile, today European Commission President Ursula von der Leyen proposed a plan to "mobilise" €800 billion of joint defence funding for common defence projects and arms procurement. Non-EU nations, such as the UK and Norway, could perhaps also take part.
Further developments on European defence funding are expected at the March 6 summit, where von der Leyen is set to outline a plan to strengthen military capabilities.