Three defence stocks set to flourish in an era of instability

Each week, a professional investor tells MoneyWeek where he’d put his money. Tom Bailey, the head of ETF research at HANetf, highlights three defence stocks that look promising.

The world has entered a new period of geopolitical instability. There is a growing list of either active or potential conflicts: Russian aggression in Europe, China and Taiwan, the US and Iran and Israel’s current war with Hamas. 

Across the globe, countries are rearming for this more perilous world. In particular, European NATO members are ramping up military spending, reversing the post-Cold War decline in defence budgets.

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1. HANetf’s Future of Defence UCITS ETF

HANetf’s Future of Defence UCITS ETF (LSE: NATO) provides exposure to the companies generating revenue from defence and cyber-defence spending by NATO and its allies. 

One example of the NATO ETF’s holdings is BAE Systems (LSE: BA), the largest British defence manufacturer and supplier. This company has played a crucial role in supplying weapons to Ukraine, with a record order intake of £37.1bn in 2022. BAE Systems has also entered agreements with the Ukrainian government to establish a local presence and increase support for Ukraine’s armed forces.

The company is also a key participant in Aukus, a security partnership between Australia, the UK, and the US aimed at countering China’s ambitions in the Indo-Pacific. In October, it received a £3.95bn contract from the UK Ministry of Defence to build a new generation of attack submarines as part of Aukus.

2. Leonardo

Then there is Leonardo (Milan: LDO), an Italian company specialising in aerospace, defence and security. It stands to benefit from European Nato countries’ commitments to increase military spending in line with the Nato target of 2% of GDP. 

Given Italy’s preference for domestic products, Leonardo is well-positioned to gain from the government’s increased spending. But Leonardo is a global company, with contracts across Europe, including the UK. At the same time, it has exposure to the growing demand seen by German defence firms, thanks to its 25% stake in German company HENSOLDT. This will also allow Leonardo to benefit from the growing demand for German-manufactured weapons. Germany, after all, is the industrial heartland of Europe, with its manufacturing base playing a key role in the revival of European NATO defence capabilities.

3. Palantir Technologies

Palantir Technologies (NYSE: PLTR) builds digital infrastructure and artificial intelligence (AI) to help clients manage data related to security or financial threats. 

It counts among its customers IBM, Amazon, and Airbus. But its technology also has a military application, increasingly demonstrated on the battlefield in Ukraine. In modern warfare, binoculars or physical maps are becoming less important. Instead, armies are using sensors, satellites, and fleets of drones to map out the battlefield. 

The reams of data collected need to be filtered to provide intelligence serving as a basis for action. Palantir uses satellites and social media to visualise enemy positions and then employs its algorithms to sift through this data, allowing an army to decide as quickly as possible where to deploy resources.

Ukraine’s military has been a big user of Palantir. The company’s CEO, Alex Karp, was the first global business leader to meet Ukrainian president Volodymyr Zelensky following the February 2022 invasion.

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