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In the UK – and across Europe more generally – governments are looking to increase their military spending. And this could be a big boost for one UK stock in particular.
Names like BAE Systems and Rolls-Royce are obvious beneficiaries. But neither of these is the company that I think stands to be the big winner from increased military spending.
National security
The US has been putting pressure on NATO countries to start meeting their spending commitments. This involves investing at least 2% of GDP on defence each year.
On top of this, US foreign policy is somewhat volatile at the moment. So other countries aiming for a more self-sufficient military operation is potentially desirable regardless.
Britain currently does meet its spending commitment, spending 2.3% per year. But, its plan is to increase this to 2.5% and then 3%, which would be the largest increase since the Cold War.
That doesn’t sound like much, but it would amount to a 30% increase in the defence budget. So I think it’s only natural for investors to be interested in the implications of this.
UK defence
BAE Systems sells a broad range of products and services to the UK government. This includes warships, aircraft, and munitions, as well as cybersecurity systems.
The thing is, though, the UK only makes up just over a quarter of revenues at BAE Systems. So other things being equal, a 30% increase in defence spending only translates into 7% sales growth for the firm.
With Rolls-Royce, its entire defence division only accounts for 24% of total sales. And while I’m a big fan of diversification, I think this means the impact of the UK increasing its military spending is likely to be even more limited.
Furthermore, only 14% of total revenues (across all three of its major divisions) come from the UK. So again, I think the biggest impact on growth is going to come from elsewhere.
Cohort
The stock that stands out to me in this context is Cohort (LSE:CHRT). With a market cap of £589m, it’s much smaller than BAE Systems, but around 54% of its sales come from the UK.
Cohort is actually a collection of smaller businesses focused on military technology. And even without governments committing more GDP to defence, it has some strong growth prospects.
This comes from its ability to acquire other companies and add them to its existing operations. This can be a risky strategy and the possibility of making a bad investment can’t be ignored.
Despite this, the firm’s relatively small size means it has a lot of scope to keep expanding. And demand for its products has climbed sharply over the last few years.
Defence spending
The shares trade at a price-to-earnings (P/E) ratio of 26. That’s clearly high compared to other UK stocks and reflects a degree of optimism about the company’s growth prospects.
With almost 55% of sales coming from the UK though, a 30% increase in government spending could be significant. If the firm maintains its market share, revenues could rise around 16%. This makes the stock worth considering, I feel.
