Expanded NATO Will Shoot Billions To US Defense Contractors

Two more Nordic countries are joining the North Atlantic Treaty Organization. The real winners are American defense companies.

Finland and Sweden officially applied last week to join NATO. If admitted they would join their Nordic neighbors in the alliance, and open up a big new market for American defense contractors.

It would be a big win for Raytheon (RTN), Lockheed Martin
LMT
(LMT) and Northrop Grumman
NOC
(NOC).

The Russian invasion of Ukraine was a shockwave for Europe. For much of the last eight decades democracies on the continent have benefitted from a peace dividend. Elected leaders spent lavishly on social safety nets while largely ignoring that the world remains a dangerous place. The creation of the European Union expedited pacifism. Images of the destruction of Ukraine changed everything.

Before the Feb. 24 war in Ukraine support for NATO membership in Finland remained in the 20%-30% range. According to a report from the Associated Press, 70% of Finnish now want to join.

Sauli Niinistö, President of Finland summed up the shift succinctly.

Prior to the war Finland was in control of its political allegiances, he says. While the country contributed to NATO’s air policing initiatives in the North Sea, Finland also shared an 830-mile border with Russia, resulting in many economic benefits. The invasion removed nonalignment as an option. Finland was either with Russia and defenseless, or aligned with NATO.

Treaty obligations will a mean significant increase in defense spending. Finland has already ordered 64 new F-35 warplanes, the elite joint strike fighter developed by Lockheed Martin, Northrop Grumman and BAE Systems (BAESY). The JSFs cost between $110 million and $135.8 million.

More importantly, aligning with NATO is a commitment to interoperability with the American defense ecosystem. This directly benefits the big U.S. contractors. The market for their goods is expanding and they will face no competition for the foreseeable future.

In the short term, the revenue increase is going to me minimal. Defense contractors recognize sales when systems are delivered, and that can take several years. In the interim the sector will benefit from supplementary bills passed to aid the war effort in Ukraine.

President Biden signed last week a $40 billion Ukrainian war package. The United States is sending existing equipment to the war-torn country. Those systems will later be replenished at an additional cost to U.S. taxpayers.

The Raytheon-made Javelin missile system has become a vital part of the Ukrainian defense effort. The heat-seeking, shoulder mounted anti-tank missiles are mostly responsible for destroying 664 Russia tanks, according to data published at Radio Free Europe.

In early April the U.S. Department of Defense said that 7,000 Javelins had been deployed to Ukraine. For perspective, another DoD procurement document notes that Raytheon has never been able to produce more than 6,480 units during any 12 month span.

The F-35-ification of European armies might be a bigger deal, though. In addition to the cost of the units, corresponding ground support, spare parts and maintenance, there is lock-in factor. Europe is now committed to America-made gear for decades to come.

The benefit to Europe is peace of mind.

If Finland and Sweden are accepted into NATO the countries would join their Nordic neighbors, Denmark, Norway and Iceland. The five countries currently work together under the Nordic Defense Cooperation pact. Bringing NORDEFCO inside NATO would facilitate joint planning, cut off Russian maritime access to St. Petersburg, and strengthen defense of the North Atlantic and Artic sea routes.

American defense contractors are reliable technology partners. The companies are also backed-up by the largess of the U.S defense budget, a record $810 billion in 2021. There is no appetite politically to decrease military spending. And that sentiment is spreading globally, thanks to the carnage in Ukraine.

Raytheon, Lockheed Martin and Northrop Grumman are currently the best way to play this bigger trend. At share prices of $90, $424, and $443, the stocks trade at 15.5x, 14.9x, and 16.3x forward earnings respectively.

Given the prospect of new markets in Europe for the foreseeable future, these multiples seem inexpensive. Longer-term investors should consider buying shares into further weakness.

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