European defence sector enters an earnings-driven phase as Q2 reports beat expectations
24 AUG, 2026
By Joanna Piwko from RankiaPro Europe
Second-quarter results from Europe's largest defence groups confirm that the sector has moved past its initial re-rating phase and into one defined by execution, according to a new report from Joakim Agerback and Shayan Heidari, Portfolio Managers at Finserve Global Defence & Security Fund. After two years in which higher budgets, record order backlogs and rising valuations drove share prices, investors are now watching a different set of metrics: deliveries, margins and cash conversion.
Rheinmetall's preliminary Q2 figures illustrate the shift. Revenue rose 69% year-on-year to €3.29bn, while operating profit of €562m came in roughly 20% above consensus. Saab reported organic sales growth of 29.8% and EBIT up 41%, and Kongsberg posted a record margin of 16.1% alongside revenue growth of 31%. Thales and Dassault Aviation also delivered double-digit gains, with Dassault's order backlog beginning to convert into deliveries after a total of 291 aircraft, including 208 Rafale jets, were logged.
We prioritise companies capable of converting funded demand into deliveries, margins and cash flows.
Joakim Agerback and Shayan Heidari, Portfolio Managers at Finserve Global Defence and Security Fund
The managers see the sector's demand profile as structurally sound but increasingly selective, adding that valuations have become more attractive after a first half marked by weak share-price performance and elevated volatility.
From Budgets to Deliveries
Research from BCG and McKinsey points to the same structural challenge: Europe needs to produce more defence equipment, faster, which requires less fragmentation and clearer government demand signals. McKinsey estimates that major European defence and defence-electronics companies now carry order backlogs equivalent to approximately 3.7 times annual revenue — strong visibility, but only 49% of major European platform contracts currently go to European or domestic suppliers, underlining both the capacity gap and the room for local growth.
Capacity Becomes the Competitive Differentiator
Expansion has moved from planning into implementation. RTX has more than doubled ammunition production, L3Harris lifted Aerojet deliveries by 60%, and GE Aerospace increased LEAP engine deliveries by 41%. New facilities are coming online at Saab, Northrop and L3Harris, while Kongsberg, Indra and others are localising production in the US, Poland and Australia — a trend increasingly tied to export-contract requirements. Subcontractors such as Kitron and NOTE are also gaining relevance as primes scale output.
Asia Adds a Second Growth Engine
The shift toward faster delivery is not confined to Europe. South Korean manufacturers — Hanwha Aerospace, Hyundai Rotem and Korea Aerospace Industries — have demonstrated an ability to combine rapid deliveries with local production and technology transfer, most visibly through Poland's K2 tank programme and Hanwha's K9 and Chunmoo contracts, including a new Finland order valued at roughly KRW 940bn.
Integration, Not Individual Innovation, Will Define the Next Phase
Primes are not being disintermediated by defence-tech start-ups; if anything, they are investing more heavily to absorb new capabilities. The Financial Times reported that primes took part in $4.1bn of venture-capital rounds in 2026, against a backdrop of over $40bn in global defence-related transactions. Internal R&D spend among 13 major defence companies is estimated to have grown more than 25% since 2021, reaching $11.6bn. Recent moves — including Thales's planned acquisition of Exail and Lockheed Martin's purchase of Ultra Maritime — reflect a consolidation of capabilities rather than a race for standalone innovation.
Valuations Still Leave Room to Run
European defence companies trade at a median forward P/E of approximately 23.35x, slightly below the Nasdaq and broadly in line with other quality-growth segments. In the US, RBC Capital data shows large-cap defence names trading at 107% of the S&P 500's NTM P/E but only 77% of its forward P/FCF multiple — suggesting cash-flow-based valuations are more attractive than headline earnings multiples imply. Given expanding backlogs, long-duration contracts and structural demand, the case for a valuation premium remains intact.
Outlook for H2 2026
Analysts expect annual earnings growth of 20–30% through at least 2028 and see, on average, roughly 25% upside to current price targets, even as the sector's valuation premium versus the STOXX Europe 600 has narrowed. That divergence between share-price performance and earnings expectations sets up what the report's authors describe as an attractive entry point heading into the second half.
The Bottom Line
The European defence sector has moved beyond the initial phase of budget-driven re-rating. The next leg is expected to be earnings- and cash-flow-led, as record order backlogs convert into deliveries. Fund selectors and institutional allocators should expect performance to diverge more sharply between companies — rewarding those that can scale production, manage supply chains and integrate new technologies into deliverable, cash-generative output.
More information:
Niclas Gutenbrink
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