News stories this past week have been accompanied by footage of rockets fired by Hamas militants into Israel getting intercepted by the Tamir missile, the business end of the Iron Dome air defence system. Each successful intercept probably means some lives on the ground have been saved; each successful intercept also means a US$40,000 ($54,993) piece of military hardware has been expended. And with thousands of missiles being lobbed over, the dollar figure adds up quickly.
When Hamas militants attacked Israel last weekend, some described it as Israel’s 9/11. Just like how the US 9/11 spurred two decades of spending on weapons, global spending on arms and security — already rising because of the Russian invasion of Ukraine last February — are likely to reach new levels. “The dramatic situation in Israel after this weekend’s attacks could prove a geopolitical game changer,” says Steen Jakobsen, Saxo’s chief investment officer.
“While the fog of war makes any predictions on what might happen next impossible, the situation should be at the centre of our attention as we hope for peace, while also considering the possible impact on financial markets and our portfolios.”
In light of the latest developments, Saxo maintains its view that equities investors ought to stay overweight on cybersecurity, infrastructure and semiconductors energy and “defence stocks (unfortunately)”, says Jakobsen.
According to the Stockholm International Peace Research Institute, global military spending rose by 3.7% in real terms last year to a record US$2.2 trillion, no thanks to Russia and Ukraine. The increase was at its biggest pace since the fall of the Berlin Wall and the end of the Cold War more than three decades ago. Europe, unsurprisingly, picked up the most pace with an increase of 13%.
As the table of 10 defence-related stocks (see below) indicates, some investors have made gains from this business of selling weapons over the past few years, especially European contractors. France’s Safran and Thales, among the 10 stocks, made the most and thirdmost gains year to date. Germany’s ThyssenKrupp, which gained prominence nearly two centuries ago building cannons for the Prussian army (and remains doing so for the Bundeswehr), was the second-best performer, up 18.8% year to date.
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And, of course, American contractors figure prominently. RTX, better known by its former name Raytheon, is in a joint venture to build more Iron Domes with Israel; Lockheed Martin, on its part, is kept busy into the next decade building F-35s costing more than US$100 million apiece for both the US and friendly foreign parties (including Singapore).
Interestingly, Asian companies figure as well. South Korea’s Hanwha Corp, for example, has been actively promoting its artillery and ammunition that is Nato-compatible as replenishment in Ukraine. China’s AVIC Shenyang Aircraft Co, meanwhile, is the country’s leading maker of military aircraft.
Now, it needs to be emphasised that the 10 stocks maintain a rather broad product portfolio, selling to both commercial and defence customers. And given the lumpy nature of this market, year-by-year comparisons are not always fair because contract sizes fluctuate. Boeing and Airbus, of course, are better known for their civilian airliners and less so for their military products.
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Nonetheless, defence spending is seen to continue rising. According to Citibank’s US aerospace and defence analyst Jason Gurksy, defence-industry stocks have underperformed the broader market this year amid concerns that the legislative gridlock in DC would lead to spending cuts. Now, following the weekend violence, defence stocks have rallied this week. Even so, they are still “attractive”, notes Gursky in his Oct 9 report.
According to Gursky, the situation now is a reminder that the world remains a volatile place and the US will need to keep on playing a stabilising role. As such, the US is likely to speed up military modernisation as it acquires more “tools of deterrence”. He expects low-single-digit topline growth for Pentagon spending and mid-single-digit growth for defence contractors through 2030. “The events of this past weekend make this outcome more likely, in our view, as they demonstrate that the threat environment to the US and its allies remains high,” adds Gursky, who has “buy” calls on General Dynamics; Leidos; L3Harris Technologies; Lockheed Martin and SAIC.
However, because of the long lead times in foreign military sales — the US Congress’ approval has to be given, for one — defence contractors will not see an immediate jump in revenue from the fighting going on in Israel now. Capacity needs time to come on stream as well. Thus, growth will be seen only in 2025 in the mid-single digits, says Gurksy. “In addition to top-line growth, we expect industry margins to begin expanding in 2024 as pre-pandemic backlog rolls off, as new business is priced to better reflect today’s cost reality and as mix shifts to more production and international work versus lower-margin research, development, testing and evaluation,” adds the Citibank analyst.
The Singapore angle
Closer to home, engineering conglomerate ST Engineering is a direct play into this market. As observed by Peggy Mak of Phillip Securities, Singapore’s defence and public security spending increased by 12% y-o-y in FY2021 and a further 17% y-o-y in FY2022, exceeding the average of 4% in the decade prior. In 1HFY2023 ended June 30, ST Engineering won $5.2 billion in new orders for defence and security work, which is 20.9% higher than in FY2022. Besides supplying Singapore's military, ST Engineering exports some of its products too.
Among the Singapore-listed entities, there is also a clutch of smaller companies that provide security services, among others. IPS Securex, listed in 2014, provides both security products and security services. For its FY2023 ended June 30, IPS Securex reported revenue of $11.5 million, down 26.8% from FY2022, which the company attributes to a change in customers’ spending priority, plus higher costs of goods sold, no thanks to disruptions caused by the pandemic. It went into a loss of $2 million, from earnings of $295,124. IPS Securex continues to win new contracts though, such as one announced on May 24 worth $4.92 million.
There is also Secura Group 43B , which provides security guards and the secured printing of sensitive documents. For its 1HFY2023 ended June 30, Secura reported earnings of $542,000, up 18.2% y-o-y. Revenue in the same period was up 36.1% y-o-y to $29.5 million, thanks to new contracts. On Aug 1, Secura announced it is taking a 51% stake in cybersecurity firm Onesecure for $2 million to bring “positive revenue growth”. Meanwhile, it has won some contracts for security services too, such as a four-year contract with the Ministry of Education worth $64.7 million with effect from Sept 1, 2022.
Nordic Group, as part of its move to diversify its customer base, in early 2022 completed the acquisition of another listed company Starburst Holdings for $62 million. The latter specialises in building and maintaining shooting ranges for police and security agencies across the region. In its 1HFY2023, Nordic’s proportion of revenue from a segment that lumps law enforcement, security agencies and civil authorities was 16% of the total. This makes it the second largest revenue segment after 37% from the semiconductor industry.
