[Weekend Money] Defense Stocks Slump... But Growth Drivers Remain Intact

"Global Military Spending Growth Trend Remains Intact
Order Drought Weighs on South Korean Defense Stocks
'Companies That Can Hold Out' Are Attractive Ahead of New Orders"

Although defense stocks have entered a downturn, industry experts say the sector's structural growth drivers remain intact. Even if defense budgets are uncertain in the short term, the trend toward increased military spending over the medium to long term is expected to continue. Against this backdrop, they say that a backlog advantage is needed for South Korea's defense sector to rebound.

Chae Unsaem, an analyst at Hanwha Investment & Securities, said, "The scale of defense budget increases next year may be reduced due to changes in the balance of power in the U.S. Congress and worsening fiscal soundness in France, but the outlook for expanded military spending over the medium to long term remains unchanged. Three structural growth drivers are expected to persist: increased military spending by the United States and China, stronger self-defense capabilities among U.S. allies, and demand to replace aging weapons systems."

On next year's defense budgets in major countries, Chae said, "The scale of the increases, rather than their direction, is the variable." A review of national budgets shows that double-digit increases from the previous year are being pursued, particularly in the United States and major European countries. However, budgets in major countries in North America and Europe have yet to be approved by their legislatures, while many countries in the Asia-Pacific and Middle East have not disclosed detailed defense budget information. Chae said, "The scale of the increases could change during upcoming legislative reviews, but based on the budget plans available so far, it is difficult to identify any structural shift in the trend toward increased military spending."

Chae analyzed that the downturn in global defense stocks reflects a combination of factors, including concerns that budget increases may fall short of expectations, weak production capacity, and order backlogs. The reasons for share price corrections also varied by region. In Europe, companies secured large orders, but production capacity failed to keep pace, and revenue and operating profit growth fell short of market expectations. In South Korea, stable production capacity supported strong earnings growth, but a recent slowdown in earnings growth and disappointment over a lack of new orders weighed on share prices. In the United States, companies generated high revenues, but limited production capacity, relatively small order backlogs, and uncertainty over the scale of defense budget increases in 2027 and 2028 put pressure on share prices.

Chae said, "Securing new orders will be the most important catalyst for a sustained rebound in South Korean defense stocks. Using Hanwha Aerospace, the sector's largest company by market capitalization, as a benchmark, narrowing the order backlog gap with global competitor Rheinmetall could mark an important turning point."

Because it is difficult to predict when new order contracts will be signed, investors should focus in the short term on companies that can wait for new order wins to become visible. As the first criterion, Chae named Hanwha Aerospace, which is expected to increase earnings in 2027 and whose valuation is nearing the lower end of its historical range. As a second criterion, Chae pointed to companies that can sustain strong earnings growth on the back of sufficient order backlogs, naming Korea Aerospace Industries and LIG Defense & Aerospace.

This content was produced with the assistance of AI translation services.