Subscribe
Share
Share
Embed
In this audio segment from our recent Insight Matters publication, our experts examine recent shifts in European defence spending, considering the macroeconomic and market implications of this evolving landscape and what it could mean for the future of the sector.
Read the full report here: Insight Matters report, Autumn 2025 | TrinityBridge
This podcast is brought to you by TrinityBridge – trinitybridge.com – and features James Tulloch, Senior Investment Specialist, in conversation with Ben Butcher, Equity Analyst.
Read the full report here: Insight Matters report, Autumn 2025 | TrinityBridge
This podcast is brought to you by TrinityBridge – trinitybridge.com – and features James Tulloch, Senior Investment Specialist, in conversation with Ben Butcher, Equity Analyst.
We’ve created this podcast to set out possible approaches. Please do not view it as financial advice, or its content as investment recommendations. Just because an investment or an investment strategy has performed well in the past, does not mean it will continue to do so. Our predictions are based on information that is currently available, however events and markets can and do change rapidly.
Creators and Guests
What is Insight Talks?
Our in-house experts share our views on the current market conditions facing investors. Brought to you by TrinityBridge.
Ben, great to see you. Thanks very much indeed for for joining me today.
Speaker 2:Great. Thanks for having me.
Speaker 1:Now today's topic is that of UK and European defense spending, is clearly very topical at the moment given that the geopolitical landscape in recent years has shifted significantly, particularly post the Russian invasion of of Ukraine. And then also because of a an apparent reluctance on the part of The United States to to backstop Europe and the West militarily, at least to the extent that it was post or has been post the Second World War. And that's meant that defence spending considerations have been front and centre of sovereign investment and foreign policy considerations, and led to an inevitable market interest on the sector and companies which might stand to benefit. So let's begin if we can by just providing a little bit of context here. What historically has Europe spent on EU defence?
Speaker 1:And what other factors are driving the apparent urgent need to upgrade capacity and capabilities here?
Speaker 2:Sure. So European defence spending as a percentage of GDP has been falling for decades, really reaching a trough in the early twenty tens. This was after fiscal consolidation post the great financial crisis and the euro's Eurozone debt crisis. But after Russian Russia's invasion of Ukraine in 2022, that really exposed collective underinvestment in European defense. And so more recently, we have seen a increase in European defence spending getting to around 2.1 of GDP in 2024.
Speaker 2:Now, the quite remarkable fallout between President Trump and President Zelenskyy at the Oval Office in February Yeah. Further increased the urgency to spend on European defense, as it became apparent that potentially The US wouldn't be quite supportive as it once was when it came to European security. If we look at countries more specifically, Poland is leading the way when it comes to defense spend, around 4.1% of GDP. The Baltic countries are also very strong. Greece is over 3% as well.
Speaker 2:Right. And then further west, UK is over 2%. Germany got to 2% for the first time last year. France is around 2% as well. But some larger Eurozone countries still aren't reaching that previous NATO targets.
Speaker 2:So Spain and Italy are still further behind. I think what's quite clear, though, is that there is a fairly strong correlation between proximity to Russia and defense spending with those countries further away from Russia have see see defense spending as a lower priority than those on the eastern flanks
Speaker 1:of of Europe. And what's the latest in terms of the the pledges and commitments which have which have been made recently? And and where is that spending likely to go? Because there's there's a distinction to be made between core defense spending and then a broader definition which includes related spending as as well, isn't there?
Speaker 2:Yeah. That's absolutely right. So the key headline figure that's out there is 5% of GDP on on defence, which is a big uplift from that 2% that we achieved in 2024. Now, as you said, that's been broken down into three and a half percent on core defence related activities, with an additional 1.5% for infrastructure related defence. So these are things like railways, like roads that you could consider would be taking defence equipment to the front lines or wherever they may need to be, as well as enhancing cybersecurity capabilities.
Speaker 2:Yeah. Now that's to be achieved towards 02/1935, so they've got a ten year timeline, countries will have to provide updates on an annual basis to provide some credence to it, to provide some forward planning. But I think where it actually gets more interesting is related to how defence is spent within equipment versus personnel. So about ten years ago, 60% of defence spend was on personnel, and that's reduced now to around 40%.
Speaker 1:Okay.
Speaker 2:And at the same time, equipment has risen from around 15% to 33% today. And so we could even double down even further and say, okay, within that equipment spend, only a third of that is on Europe. So if we think about a rise from two to just 3% of GDP, that's
Speaker 1:a 50% headline rise, but doubling down into equipment and then potentially European equipment even further, the growth should be much more substantial. Okay. Okay, then purely from a sort of deliverability point of view, we hear an awful lot about the fiscal challenges which are facing Western governments at the moment, with high debt to GDP ratios and significant budget deficits actually suggesting a need to rein in spending. So are are the pledges that have been made by by countries affordable?
Speaker 2:You know, are are they realistic? Yeah. So if if we think about what will drive a country to how we think that they're going to be spending going forwards, there are really four key factors. Firstly, are these NATO targets, which are clearly very much out there? Secondly, is that fiscal headroom and and whether that's available?
Speaker 2:Thirdly, is the whether what we believe GDP growth for these countries will be. And then finally is that proximity to Russia point that I alluded to earlier. On the fiscal side of things, I think in the near term, the next, say, three to four years, there does look to be some headroom available. And that's due to something called the National Escape Clause or the NEC Yeah. That 16 countries have signed up to.
Speaker 2:That effectively loosens some of the fiscal restraints on on these countries and allows them to spend an additional 1.5% of GDP on defence. And that is going to be a key driver of defence spending going forwards from here. There's also something called the Security Action for Europe, or SAFE, is a additional €150,000,000,000 debt fund or debt facility that European countries can tap into and spend on European equipment. So I think on a country by country basis, it's going to be very different. Certainly that point around proximity to Russia, whether it's on the Eastern flank of Europe or even the Nordics as well, they are going to be prioritizing higher spending.
Speaker 2:Germany is going to be certainly the strongest. We've seen them release their debt break with regards to defense spending as well. So overall, I think the picture's a little bit murky, but certainly the direction of travel is one that is gonna be more positive Okay. Defense
Speaker 1:That's good to know. And and aside from the fiscal challenges then, what are the other significant challenges that both governments and and the defense industry itself face to ensure that they deliver a military capability and capacity that's fit for the future. But it sort of strikes me that there's a need to both collaborate with allies and partners to deliver that, but then also a need for the manufacturing capacity, the actual industrial base, to deliver as well.
Speaker 2:Yeah. So, I mean, there's definitely further challenges here. The first one, as you said, it's that capability gap in particular to The US. The second one is this fragmented industrial base. And then the final point is on just collaboration between European partners.
Speaker 2:So on that first point, the capability gap is quite significant. And that's in part because of this lack of spending that Europe has just done over the past two or three decades. And even with the rise in increased spending in the last few years, research and development is still only around 4% of spend, US is around 16%, so there's still continued differences. Then it come and then it comes on to the fragmented industrial base. So this is really being being driven by the fact that there are a lot of enterprises across Europe that create defence capabilities, often aligned across national borders.
Speaker 2:And that compares greatly to The US, which post the Cold War went from around 50 enterprises right down to about five. And, and obviously, that's just one jurisdiction, one government. So certainly that's that creates a lack of standardization and lack of efficiencies. And I think, I mean, President Junker of the EU said it himself quite earlier this year, when it came to supplying goods to Ukraine, we had we were supplying Ukraine with 10 different types of howitzer, which is effectively the piece of machinery that fires 155 millimeter artillery. We have more than more different types of helicopters than European countries able to buy them.
Speaker 2:We've got 17 different types of battle tanks. So it's a very inefficient way of procuring defence. The final point is just on the lack of collaboration between European countries. You can imagine that the UK government would favour and procuring goods from BAE,
Speaker 1:or
Speaker 2:Thales with France, Germany and Rheinmetall, Leonardo with Italy. And so that is causing a kind of lack of exposure to the competitive landscape and and the benefits that come through that, whether it's value generation or just from just from general efficiencies. So we really want to see European countries investing together, possibly both in the startups and into the kind of main defensive players. And I think that will help kind of defend Europe as a whole much more efficiently going forward.
Speaker 1:Yeah. Sure. Okay. And then from an environmental, social and governance perspective, or ESG perspective, it was always historically the case that any ethical mandate would completely eschew the defence sector and any company involved in the manufacture of weapons of any kind. But recent years have seen a quite significant recalibration there, haven't they?
Speaker 2:Yeah. That's absolutely right. So defence exclusions are very common. But that doesn't mean to say that they don't have a place or the investors can't be exposed to to the sector. The most common exclusion is controversial weapons.
Speaker 2:So these are weapons that effectively cause indiscriminate harm. We're talking nuclear weapons, chemical weapons, biological weapons, anti personnel mines, cluster munitions. Yeah. More recently, obviously post the Russia's invasion of Ukraine, geopolitics has changed the stance, I think, quite materially, along with, dare I say, just the the the performance of the sector, which is which has garnered a lot of investor attention. So I think, really, the the key argument here that is being made is that defence is a right, if not an obligation, for countries, and that will drive further sustainability and national sovereignty going forwards from here.
Speaker 1:Okay. Okay. And then finally, Ben, how are we thinking about the sector at the moment? How's it all feeding into your thinking as an analyst here? UK and European defence companies, as you allude to, have seen share prices rally quite significantly.
Speaker 1:So there's clearly been some momentum there, but are valuations still sufficiently attractive? How how do you view the sector at the moment?
Speaker 2:If you look at the defense spending at in 2024, it's about €400,000,000,000, 2% of GDP. If that rises to three to three and a half percent by 2035, that would imply budgets are increasing by about 5% per year. But to my point earlier, that the spend on defense equipment, particularly in Europe, is going to rise much faster, potentially 9%, 1011%, 12%. And so that is a really strong structural growth driver for these long cycle names in particular, and gives real confidence in the visibility into future revenue and earnings growth over the next decade or so. And so we like long cycle names, they provide a better risk profile for client portfolios.
Speaker 2:And so the likes of BAE take that name as an example. This is a company that's highly diversified across both geographies and and products, making the likes of submarines, battleships. It is currently a key partner on the Typhoon fighter jet. It will be a key partner on something called the G CAP or Global Combat Aircraft programme, which is a partnership with Mitsubishi Heavy Systems, which is a Japanese contractor and Leonardo out of Italy. So it does also have some short cycle exposures as well through its JV ownership of MBDA, which is Europe's leading missile manufacturer, has exposure to to space defense as well.
Speaker 2:So all sorts of things, and it gives real confidence that this will be a winner in the and a beneficiary of the structural uplift in defence spending.
Speaker 1:Okay. Brilliant. Ben, a it's fascinating topic. Wonderful to be able to get your your insights. I'm sure we'll revisit it again in the future.
Speaker 1:But for now, thanks very much indeed.
Speaker 2:Thank you.