Barclays sees 5-10% upside for U.S. defense on stronger European budgets

Investing.com -- Barclays analysts anticipate that "US Defense could see [a] 5-10% benefit from higher European budgets," as Europe is now "targeting higher defense budget growth of approximately 70% to >$800B." 

The bank’s note comes as European defense stocks have outperformed U.S. counterparts. “They trade at double the valuation of the US on average,” wrote Barclays.

With the upcoming NATO summit, Barclays expects member countries to target defense spending at "5% of GDP," including 3.5% on core defense and 1.5% on defense-related infrastructure. 

Barclays estimates that "all Europe members meeting 3.5% of GDP on core defense would represent an additional cumulative $335B in spending with total spending increasing to >$800B annually." 

This substantial increase follows a decade where European defense spending has already risen from approximately $260 billion to around $490 billion annually.

U.S. defense companies are poised to benefit from this surge, as they are "approximately 7% exposed to Europe on average." 

Barclays notes that specific companies like Lockheed Martin (NYSE:LMT) have 11% exposure, while L3Harris Technologies (NYSE:LHX) and Northrop Grumman (NYSE:NOC) have 7%, and RTX has 6% of total revenue. 

Europe constitutes approximately "one-third of the U.S. companies’ total international exposure."

Barclays also highlights the "ReArm Europe plan" from March, which aims to increase EU defense spending by more than "$200B annually over four years." 

Additionally, the U.K. plans to increase spending to "2.5% of GDP by 2027 and 3% of GDP by 2035." 

Barclays estimates that "full participation in ReArm Europe + UK defense plans represents an additional $255B, or ~50% increase from current levels in total across Europe." 

However, constrained production capacity from past consolidation could limit how quickly these higher budgets translate into revenue growth for U.S. companies.