European defence stocks have fallen out of favour in recent months despite a strengthening backdrop for military spending, prompting Morgan Stanley to flag that "the buy case for the sector is as strong as ever”.
The bank reiterated its positive stance (arguing the recent weakness presents an attractive entry point), noting that shares are on average about 20% below recent highs and valuation multiples have slipped to around 20 times earnings.
That weakness is visible at the stock level. Over the past month, Babcock International PLC (LSE:BAB) has fallen 8.8%, QinetiQ Group PLC (LSE:QQ.) is down 7.7% and Avon Technologies PLC (LSE:AVON) has dropped 10%, though BAE Systems PLC (LSE:BA.) has edged 2% higher.
Morgan Stanley said much of the weakness reflects positioning rather than fundamentals, describing recent trading as “sell first, ask questions later” as investors cut exposure during market volatility.
At the same time, growth expectations elsewhere, particularly in the US and Asia, have improved, drawing capital away from Europe.
Yet the underlying case remains intact. Analysts point to rising defence budgets, weaker US commitment to European security and ongoing geopolitical tensions as drivers of sustained demand.
They said the recent pullback does not reflect these improving fundamentals, leaving the sector looking undervalued relative to its growth outlook.
The Middle East conflict is seen by the analysts as reigniting the “old vs new” defence debate, driving flows into larger names such as BAE Systems and Leonardo with US exposure.
They argue the distinction is misplaced in Europe, where countries will need a mix of conventional and modern capabilities rather than choosing between them.
Rising geopolitical tensions, Donald Trump's abandonment of the US commitment to Europe and potentially NATO, as well as the risk of diverted support from Ukraine as drivers of higher regional defence spending.