Andy Burnham’s Defence Sector Pledge Puts UK Defence Stocks in Focus

The message from Britain’s new government is unmistakable: defence spending is expected to move higher.

Investors, of course, should treat political pledges with care, particularly when ministers have yet to spell out exactly how a costly policy will be funded. 

Even so, Prime Minister Andy Burnham’s choice of Cabinet ministers has strengthened expectations that the defence budget will receive additional support. 

John Healey, now Chancellor, has already shown how seriously he takes the issue, having previously stepped down as defence secretary over a shortage of funding. That history makes it likely he will push military spending up the agenda, according to Matt Dorset, defence analyst at wealth manager Quilter Cheviot. 

‘Healey has called for a clear pathway to spending 3 per cent of GDP on defence by 2030, compared to Sir Keir Starmer’s government’s 2.68 per cent, as a staging post towards the Nato target of 3.5 per cent by 2035,’ he adds. 

‘Healey will face many competing fiscal priorities. But it would be difficult for him to leave defence expenditure unchanged. 

‘Also, Wes Streeting – the new Defence Secretary – is saying that he has a “firm friend” in the Treasury, which seems to confirm that a policy shift is on the way.’

Whatever the final shape of this policy, ‘it is clear that defence spending as a percentage of UK GDP is on a steadily increasing trajectory over the next decade’, says Laura Foll, joint manager of the Law Debenture investment trust. 

Moreover, an uplift in the UK defence budget could be accompanied by similar strategies elsewhere, according to Joakim Agerback, manager of the Finserve Global Defence & Security Fund. 

‘The UK’s increased defence spending is part of a broader global re-rating,’ he says. ‘National security and defence capability are increasingly seen as pre-conditions for stable and resilient societies.’ 

For the moment, Streeting may not be guaranteeing that military spending will be 3 per cent by 2030. 

But he also says that he will not ‘do defence on the cheap’. This stance, combined with the choice of Healey as Chancellor, has this week boosted shares in British defence companies. 

Among the names moving upwards were aerospace giant BAE Systems and Babcock – which builds warships and maintains the Royal Navy’s submarine fleet. 

Also rising were Rolls-Royce, which makes combat aircraft and nuclear reactors for submarines; Chemring, which specialises in explosive and cyber defence; and QinetiQ, the technology group. Indeed, such is the excitement that shares in the Aim-listed mini-conglomerate Cohort are nearly 42 per cent higher than at the start of the year. 

Cohort’s output includes sonar systems. Adding to the enthusiasm is the hope that Healey could issue ‘war bonds’ to raise extra cash on top of the £15billion earmarked in the Defence Investment Plan (DIP). 

When Burnham’s predecessor Sir Keir unveiled the DIP earlier this month, he acknowledged that defence was ‘underfunded and unsuited to the threats we face’.

Burnham seems to agree. So if you want to back the rebuilding of the defence of the realm, here are the stocks and funds that could be the bulwark of your portfolio.

Back the Britons

Additional investment in the nation’s defence readiness would be good news for the British contractors with the highest UK exposure, such as BAE Systems, Babcock, Chemring, Cohort, QinetiQ and Rolls-Royce. 

BAE’s shares closed yesterday at 1971p. The average target price is 2100p, based on optimism over the outlook for the UK, but also the assessment that US military stockpiles – which have been run down in the Middle East and Ukraine conflicts – will need to be replenished. 

Babcock’s price is 1121p. But the average target price is 1439p, with one broker believing that the shares could reach 1675p. Chemring is also considered a ‘buy’ at 596.5p. The average target price is 623p. 

Chemring is one of the businesses heavily involved in the key ‘digital targeting web’ initiative, which will link drones and radars to commanders and weapons, enabling battlefield ‘decisions to be made and executed faster’. But this innovation is not the only reason why Chemring is in the spotlight. 

The US private equity player Albion River Management has amassed a 9 per cent stake, sparking bid speculation. QinetiQ – at 489.8p – is another ‘buy’. 

The average target price is 547p, although brokers Peel Hunt predict a jump to 615p. Over the past five years, Rolls-Royce shares have soared by 1380 per cent to 1415.6p. But Chloe Lemarie, of Jefferies, is one of the analysts who see this £116.5billion contractor as a buy, with a target price of 1870p. 

Rolls-Royce chief executive Tufan Erginbilgic is demanding Burnham provides support for its return to the £1.6 trillion shorthaul plane engine market. 

If Burnham declines, the Rolls boss has threatened to shift jobs to the US or Germany. The ferocity with which Erginbilgic pursued the turnaround of the firm from ‘burning platform’ to FTSE 100 star is well known. 

Shareholders await to see if Burnham buckles under the pressure. There will also be considerable interest in the direction of Cohort’s high-flying shares. The price is 1290p, but brokers Berenberg are targeting 1630p. 

Take a bet on Europe 

Shares in some European armaments and aerospace groups have had an unhappy year to date. For example, the German titan Rheinmetall has tumbled by 34 per cent to €1038. 

This is thanks to uncertainty over the viability of traditional artillery equipment. These weapons, as Bank of America analysts explain, are being displaced by the drones and precision strikes systems which have come to the fore in the Middle East and Ukraine hostilities. 

Drones are a market in which the US titans Boeing, whose shares are a ‘buy’, and Northrop Grumman, rated a ‘hold’, dominate. 

Yet, despite this drawback, Rheinmetall shares are seen as a ‘buy’ at their current level, given its other fields of expertise. By contrast, RTX, the US group formerly known as Raytheon, is reporting more demand for its Tomahawk missiles and other munitions the stocks of which have been depleted in current conflicts. Analysts are targeting a rise from $213 to as high as $242. 

Agerback says that one of the US contractors likely to benefit from improved UK defence spending is shipbuilder Huntington Ingalls. Its output includes amphibious vessels and nuclear powered aircraft carriers.

 Huntington operates a hub for its Remus autonomous underwater vehicles near Portsmouth. 

The varied nature of Huntington Ingalls’ operations underlines the complexity of modern warfare in which drones have displaced traditional weaponry and AI will play a crucial role. Calculating the potential payback from these technologies is tricky, which suggests that a fund or trust may be the best bet. 

Finserve Global Defence & Security has holdings in RTX, Rolls-Royce and Howmet – the US group that describes itself as a ‘mission-critical supplier for virtually all commercial and military aircraft’. 

The other options are specialist exchange traded funds such as Van Eck Defence, Han Future of Defence and iShares Europe Defence. Law Debenture may be a general UK trust but it owns shares in Babcock and BAE Systems, which also feature in the portfolio of City of London, where I am an investor. 

At a troubled time, I am going to seek out other opportunities in defence, relieved that the Government seems to be acknowledging that – as Streeting put it this week – ‘freedom is hard won and even harder preserved’.