Value Vantage Point: A call to more arms—sparking a European industrials revival

After decades of relying on the US defense umbrella, Europe now must take a more active lead in its own security. Not only will the region need to replenish the stocks of munitions it sent to Ukraine, but it must spend on new military hardware and plan its own nuclear deterrence strategy. At the same time, Germany is realizing the roads and rails to move equipment and people around—as well as key energy, education and digital infrastructure—need major upgrades.  

As more money is spent on both defense and infrastructure, we believe European industrials should benefit. Earnings growth should pick up for the large European defense names and more unified spending may force consolidation among smaller players. If this spending remains in place, corresponding infrastructure investment can further boost many old-economy, value industries and lead to faster regional economic growth. This structural tailwind could persist for years, in our view.   

Offensive posture 

European defense spending has climbed the past few years as Europe has had to replenish the equipment and munitions it sent to Ukraine. European NATO members spent about a fifth more in 2024 than 2023, according to preliminary NATO defense spending data. Despite this increase, Europe has underinvested for decades, and we believe the Continent is in the early stages of a multi-year expansion. Recent rhetoric from the United States about potentially cutting support has focused European leaders on the need to better plan for their own security.  

Europe has much to do, in our view. Several European NATO members still do not spend the minimum 2% of their gross domestic product (GDP) on defense (See Exhibit 1), and Europe overall makes up only a third of total NATO defense spending (See Exhibit 2). 

A recent report from research institute Bruegel and the Kiel Institute for the World Economy estimates Europe will need €250 billion more in defense spending and another 300,000 troops just to deter Russian aggression in the short term. And several European leaders have called for countries to spend as much as 3% of GDP to modernize and expand their defense capabilities.  

We also believe Europe must determine what regional nuclear deterrence should look like, with France recently proposing to open its limited nuclear umbrella over the Continent. Unlike the United States, which has the Nuclear Triad, encompassing nuclear ground, sea and air capabilities, Europe has no clear nuclear strategy, and only France and the United Kingdom are nuclear powers.  

To fund all this spending, the EU is looking at extending €150 billion in loans and allowing members to spend an additional €800 billion over the next four years without triggering the bloc’s budgetary rules. The incoming German chancellor also won legislative approval for a €500 billion defense spending facility in mid-March.  

Freeing up more funds is only a first step, in our view. EU defense spending tends to be uncoordinated, and the European defense industry is highly fragmented. For instance, Europe has 19 different battle tank systems in place compared to just one for the United States, and 27 different destroyers and frigates versus the United States’s four. Aggregating spending and harmonizing equipment specifications, as the European Commission recently proposed, could better boost economies of scale and capacity use.  

Combat-ready 

Despite the recent enthusiasm for defense stocks, the European defense industry may not currently have the full range of capabilities to meet all the region’s security needs. Nearly two-thirds of EU funds are used to purchase gear from the United States and to lesser extent South Korea, not European defense contractors. While some of this spending is on gear and systems only the United States currently produces, we believe European alternatives may exist.  

Additionally, as warfare increasingly relies on drones and digital technologies, there are opportunities for domestic sectors to develop. Meanwhile, beyond the big regional defense companies, the mid-cap defense groups may need to merge to improve operations and better meet Europe’s defense needs, another potential catalyst.   

We think South Korean defense companies have done an impressive job of supplying gear like tanks, rocket launch systems and armored vehicles to Eastern European and Scandinavian markets. They too may have the opportunity for additional growth as Europe spends more overall.  

Infrastructure support  

Regional governments have announced plans to increase investment in the region’s creaking infrastructure to go alongside more defense spending. Sweden, which recently joined NATO, is putting money into improving roads and railway lines to support the transport of troops and military hardware.  

To go with the €500 billion in defense spending, Even though the incoming German Chancellor’s term is only four years, he also won backing for €500 billion over the next 12 years to fund infrastructure investments. Other countries may find it necessary to follow suit, despite already high debt levels, as Germany loosens its fiscal constraints to spend more across the economy. As a result, this European defense investment cycle may also turn into a broader European infrastructure investment cycle over time.  

The construction sector, for one, has been particularly weak in major European countries like Germany and France in recent years (see Exhibit 3). A greater focus on improving public transportation, schooling, housing and energy supply can drive greater economic activity over time and lead to better long-term economic growth.  

Value industries, from cement and asphalt firms to rail and rail equipment companies, as well as power equipment, construction and commercial vehicle companies, could all benefit, and we could see a positive spillover to the broader economy which may help ignite regional economic growth after years of sluggishness (see Exhibit 4).