By Cristina Gallardo
Donald Trump's plans to create a Department of Government Efficiency is boosting uncertainty for European defense companies reliant on U.S. funding, according to analysts.
The U.S. president-elect has asked Elon Musk, chief executive officer of Tesla and SpaceX, and Vivek Ramaswamy, the biotech entrepreneur who ran for U.S. president, to run the new department with the aim of cutting government spending.
The move is weighing on valuations of European defense companies that rely heavily on U.S. contracts, such as the London-listed BAE Systems and QinetiQ, analysts from Bank of America Securities said.
On Friday, BofA Securities cut its rating of both companies to underperform from neutral, citing the "growing uncertainty" over the U.S. defense budget brought about by the DOGE plans.
European defense stocks are trading at high valuations since Russia's large-scale invasion of Ukraine in February 2022, leaving them vulnerable to a rating cut if defense budgets fall.
"We believe DOGE and the focus on budget efficiency adds uncertainty which could weigh on valuation," the analysts said. "DOGE could result in contract changes, but it also may not."
BAE Systems made 42% of sales in the U.S. last year, its biggest market ahead of the U.K. and Saudi Arabia. In the case of QinetiQ, the U.S. accounted for the 21% of revenue in fiscal 2024.
Mariana Perez, a U.S. aerospace and defense analyst at BofA Securities, said defense is usually at the spotlight when government spending is under pressure, because defense spending is more discretionary than civilian spending.
Last week, Goldman Sachs analyst Noah Poponak warned that U.S. defense spending runs in decades-long cycles and the country may be nearing the peak of the current cycle.
"The defense budget is at an all-time high, which creates difficult comparisons and challenging base effects," Poponak said. "It is difficult to embark on any large government spending reduction effort without touching defense, and there are potentially enough inefficiencies within the defense budget to reduce its total level without necessarily reducing military readiness or capability."
However, rising geopolitical tensions with Russia and China continue to support the rationale to modernize Western armies and invest in technological upgrades for defense purposes, Perez noted.
Overall, Trump's return to the White House is seen as positive for European defense companies, as the president-elect is expected to put pressure on the rest of NATO members to boost their national defense budgets above their current commitment to spend at least 2% of their gross domestic product annually.
But according to the BofA Securities analysts, in the midterm, the U.K. and the U.S. will likely increase their defense spending at a lower rate than European allies such as Germany, France, Italy or Eastern Europe.
This puts pressure on companies such as QinetiQ, which generates its revenue from Britain, the U.S. and Australia, and has less exposure to continental Europe, the analysts said.
"While we don't believe that this puts QinetiQ's midterm growth guidance at risk, we do believe that it highlights a less favourable ecosystem for defense," they added.
BAE shares were down 4.3% in early-afternoon trade in London, at 12.34 pounds, while QinetiQ's shares fell 3.8% to 4.14 pounds. The stocks are up 10.9% and 33.85% year-to-date, respectively.
BAE wasn't immediately available for comment, while QinetiQ declined to comment when approach by Dow Jones Newswires.
Write to Cristina Gallardo at cristina.gallardo@wsj.com
(END) Dow Jones Newswires
November 29, 2024 08:52 ET (13:52 GMT)
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