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Europe’s Defense Stocks Just Got Hit Hard

The sell-off this week was sharp enough to grab attention. Whether it tells you anything useful about the next three years is a different question entirely.

European defense stocks have had a rough 2026. Shares have traded markedly down year-to-date amid souring sentiment as investors weigh the prospect of an end to the wars in Ukraine and the Middle East, and question how much of governments’ military spending commitments will actually materialize. That skepticism came to a head this week. European defense shares extended losses as investors reassessed the rearmament story after Germany scrapped a flagship naval program. Berlin’s reversal on the F126 program, which could have been worth more than 12 billion euros and for which Rheinmetall had been expected to become the lead contractor, exposed a key risk to the European defense trade.

Rheinmetall took the brunt of it. Shares fell 1.8% following an 18% drop the prior session. German peers Hensoldt and Renk dropped 6.7% and 2.5% respectively, also following losses from the previous session. That is a significant two-day drawdown for a sector that was already consolidating from early-year highs. Rheinmetall shares had already fallen about 30% from their January highs coming into Wednesday’s trading.

Here’s where it gets interesting. The F126 cancellation is a real event. The program had already accumulated approximately €2.3 billion in costs prior to cancellation, covering design work, software development, construction activities, and contractor payments. The ministry stated that continuing the program would have driven total expenses beyond €18 billion, compared to an initial program value of roughly €10 billion for six frigates. Berlin has pivoted to eight smaller MEKO A-200 frigates from TKMS instead. But this is one procurement decision in a spending cycle that spans the better part of a decade. The cancellation emphasized to markets that government procurement remains political, unpredictable, and subject to shifting military priorities. Analysts noted the major difference between the defense sector and other sectors: the customers are essentially always sovereign governments, whose financial priorities change. That has always been true. The structural tailwind beneath the sector does not require every single contract to close on schedule.

The Numbers Have Not Moved

Pull back from the week’s noise. At the 2025 NATO Summit in The Hague, Allies made a commitment to investing 5% of GDP annually on core defense requirements and defense- and security-related spending by 2035. That commitment is not canceled. In 2025, all Allies met or exceeded the pre-summit target of investing at least 2% of GDP in defense for the first time. European Allies and Canada achieved a 20% increase in defense spending compared to 2024.

The revenue proof is in the books. Rheinmetall grew revenue by 42% and EBITDA by 42% in the last fiscal year. For 2026, Rheinmetall has guided for consolidated sales of between €14.0 billion and €14.5 billion, up from €9.935 billion in 2025. That is revenue guidance backed by an order book that was already in place before this week’s news.

EU Member States collectively spent approximately €240 billion on defense in 2022, rising to €279 billion in 2023, €326 billion in 2024, and are estimated to have exceeded €360 billion in 2025. Germany alone allocated €90.6 billion in 2024, then activated a €500 billion multi-year package covering defense, infrastructure, and industrial capacity in 2025. In 2026, Germany has shifted from one-off emergency funding toward permanent increases in baseline defense budgets, with procurement timelines extending well into the 2030s.

Slight tangent, but it matters: the F126 replacement order is not zero. Subject to approval by the Bundestag’s budget committee, the first four MEKO frigates would cost approximately €6.3 billion, with an option for four additional ships exercisable through end-2026 for roughly €5.3 billion. Germany is not walking away from naval procurement. It is redirecting it. TKMS shares rose as much as 12% on the news, suggesting investors are not pricing in lower German defense spending overall, but rather a shift in which companies are likely to benefit from future contracts.

Where the Opportunity Has Shifted

The large-cap European names that got hit hardest were already priced for a meaningful amount of execution. Rheinmetall’s TTM P/E of approximately 74x sits 263% above its 10-year median of 20.46 and 92.6% above the Aerospace and Defense industry median of 38.56. The risk was always that the biggest names had priced the cycle before it fully delivered. After last week’s roughly 22% share price decline, Rheinmetall now trades at a forward P/E of approximately 28x – still elevated relative to the sector, but a very different conversation than where it was entering 2026.

The more interesting opportunity is one layer down. Hensoldt delivered its strongest Q1 ever, with order intake more than doubling year-on-year to nearly €1.5 billion and revenue up 25% to almost €500 million. Adjusted EBITDA rose 47% to €44 million, and management reaffirmed full-year 2026 guidance, highlighting robust order backlog and high revenue visibility into the next decade. Full-year 2026 guidance stands at revenue of approximately €2.75 billion, adjusted EBITDA margin of 18.5-19.0%, and a book-to-bill ratio of 1.5x to 2.0x.

The order backlog increased 41%, reaching a new record level of approximately €10 billion. A substantial portion of the orders currently booked extend well into the 2030s, underpinning long-term growth and strong positioning in key European defense programs. After this week’s additional drawdown, the MarketScreener consensus from 15 analysts sits at a mean Outperform rating with an average 12-month price target of approximately €90.70 – well above where shares have been trading. Targets from the most constructive analysts reach as high as €101.

Hensoldt has been particularly successful in the electronic warfare and sensor systems segment, a product area that has received elevated funding given the modern combat environment’s emphasis on electromagnetic spectrum capability. That is a product mix that does not depend on any single naval contract or land systems program. It is embedded in the operational requirements of every NATO air force that has watched electronic warfare reshape the battlefield in Ukraine.

The Thales angle is worth noting separately. In 2025, Thales revenue reached €22.14 billion, an increase of 7.6% compared to the prior year, while earnings rose 18%. The TTM P/E ratio sits around 20x – among the lowest of the major European defense names. Thales guided 2026 for organic sales growth of 6-7%, an adjusted EBIT margin of 12.6-12.8%, and free operating cash flow conversion of 95-100%. For investors who want defense exposure without paying elevated multiples for the headline names, Thales screens differently.

The Risk That Is Actually Real

Procurement risk is real. This week proved it. The decline reflects weakening sentiment as investors increasingly question how much of the announced military spending will ultimately translate into contractor revenues. That question will not go away. JPMorgan analysts noted they cannot rule out that governments may buy fewer vehicles and ammunition than currently expected because they decide to reallocate money to other areas, such as drones, space, or advanced air defense systems.

What investors are conflating is procurement timing risk with spending commitment risk. Governments can delay or redirect individual programs. They cannot easily unwind decade-long treaty-level commitments that are publicly linked to collective security obligations. The F126 cancellation is procurement timing risk. The Hague Summit commitment to invest 5% of GDP annually on core defense requirements and defense- and security-related spending by 2035 is something structurally different.

Morningstar’s Chief Market Strategist Michael Field noted that in a decade, countries like Germany will still likely be restocking weapons sent to Ukraine, and that “the market is missing” that defense spending does not depend on one war ending or starting. The sell-off this week compressed entry points across the sector. Whether those entry points are fleeting or the start of a longer re-rating lower depends on one question: do you believe spending commitments survive political friction, or collapse under it. Over the past decade, European Allies and Canada have increased their collective investment in defense from 1.4% of their combined GDP in 2014 to 2.3% in 2025. The evidence so far runs in one direction.

For informational and educational purposes only. Not investment advice. Trading involves risk, including loss of principal.