Europe defense stocks face rearmament test

After years of surging military budgets, emergency Ukraine spending and soaring defense stocks, Europe’s rearmament push must now prove it can turn hundreds of billions of euros into weapons, factories and usable military capability.

The question for investors no longer seems to be one of defense demand or political ambition, but whether valuations have run ahead of the industry’s ability to execute.

That test is becoming more critical ahead of next week’s NATO Summit in Ankara, Turkey, where leaders are due to review progress since last year’s summit and set out a roadmap for delivering on new spending goals to “turn allied commitments into concrete results.”

But the path from higher budgets to delivered weapons is proving uneven. Procurement delays, fragmented national programs, labor shortages, and strained supply chains are raising doubts over how quickly Europe can rebuild an industrial base that has been hollowed out from decades of lower defense spending.

The pressure is rising from both sides of the Atlantic. NATO allies agreed on a dramatic rise in defense spending at last year’s summit, reflecting growing concern that Europe can no longer live under the protection of the U.S.

Pressure intensified when U.S. War Secretary Pete Hegseth earlier this month announced a review of American forces in Europe and warned that allies failing to meet spending commitments could face consequences. The review, expected to last up to six months, added fresh urgency to a debate already transformed by Russia’s war in Ukraine and changing U.S. approach to NATO.

“There is no question that the evolving U.S. geopolitical stance has been a real moment of truth,” Hugues Lavandier, a senior partner at McKinsey, told CNBC. It has accelerated Europe’s recognition that “the period of the peace dividend was behind us” and that governments needed to reinvest in defense capabilities, he said.

The shift has already transformed investor expectations. European defense companies from Rheinmetall to BAE Systems, Leonardo, Thales, and Saab have benefited from a surging order book since Russia’s 2022 invasion of Ukraine, as governments ramp up military spending. 

McKinsey calculates that European NATO core defense spending has doubled since 2019 and could reach about 800 billion euros ($912 billion) by the end of the decade. That would put it on the path toward NATO’s new core benchmark of each member spending 3.5% of its GDP on defense. Venture funding is also flowing into European defense technology, such as drones and autonomous systems.

Lavandier said the market was in a “price discovery moment.” Backlogs were initially the clearest proxy for growth, he said, but investors are now getting a better read on which companies can convert those order books into production, revenue and margins.

Last week, Germany canceled a multi-billion euro F126 frigate program after delays and expected cost increases, and said it would buy eight smaller Meko A-200 frigates…