Morgan Stanley on Thursday reconfigured its European defence preferences, taking Rheinmetall AG off the Top Pick list and naming BAE Systems PLC its new Top Pick - while keeping both stocks at an "overweight" recommendation.
The broker cut its price target for Rheinmetall to €1,750 from €2,500, a reduction of 30%, a change it attributes to Germany's cancellation of the €12.8 billion F126 frigate programme. That programme had been planned to deliver six large multipurpose warships. In its note, Morgan Stanley said the move was "completely unexpected by us, the market, and the company" and pointed to "major delays, cost overruns and the risks/costs linked to changing the main contractor."
The bank highlighted that a hypothetical change of main contractor to NVL would have raised the estimated bill for the six F126 frigates to in excess of €18 billion.
Germany now plans to procure eight MEKO A-200 DEU frigates instead, according to Morgan Stanley's summary of the decision. The first four ships carry a contract value of €6.3 billion, with an option for the remaining four at €5.3 billion, implying an aggregate value of €11.6 billion for the eight vessels, subject to approval by the German Budget Committee.
Despite the headline impact, Morgan Stanley judged the financial hit to Rheinmetall as relatively contained. The bank wrote that "F126 has damaged confidence in visibility and German procurement execution, but the direct impact is limited, with only ~2% 2030 EPS cut." On a sales basis, the firm estimated a hit to 2030 Naval sales of €1.4 billion, which it said equates to roughly a 30% reduction for the naval division but amounts to only a 3% effect at group level.
Restoring momentum at Rheinmetall, the broker said, hinges on the Boxer land vehicle contract. The firm described that contract as "the key catalyst" and assessed there was a "low probability that the Boxer contract does not happen, as it is part of a key NATO requirement that Germany needs to fulfil."
On BAE Systems, Morgan Stanley elevated the company to its new Top Pick for European defence, while trimming its price target to 2,420 pence from 2,662 pence. The cut reflected "a mark-to-market of our SOTP multiples and a modestly higher WACC (by 25bp to 7.75%)" that the broker says is intended to capture heightened UK political uncertainty.
Still, Morgan Stanley framed BAE as an opportunity. The note said: "We continue to see upside to forecasts, expect current overhangs to subside, and think the recent derating offers an attractive entry point," and added that the revised target presents "more than 30% upside." The bank reported that BAE shares closed at 1,825 pence on June 23, 2026, and observed that the shares have derated from a 2028 price-to-earnings ratio of 22 to 23 times down to 17 times.
The broker also set out BAE's geographic revenue split for fiscal year 2025, noting the company's exposure across major defence markets: 43% of revenue from the United States, 27% from the United Kingdom, 12% from Europe excluding the UK, 10% from the Middle East and 4% from Australia.
While Morgan Stanley's repositioning signals a tactical preference within its European defence coverage, the bank's overall stance remains cautious but constructive. It retained "overweight" ratings on both Rheinmetall and BAE - even as it adjusted targets and elevated BAE into the Top Pick role.
The immediate financial ramifications of the F126 cancellation, per the broker's analysis, are concentrated on Rheinmetall's naval division and on investor confidence in German procurement processes. For BAE, the valuation reset and purported derating create what the bank characterises as a potentially attractive entry point for investors leaning into anticipated upside once current overhangs ease.
Investors and market participants will likely focus on two near-term elements flagged by Morgan Stanley: the outcome and timing of the Boxer contract process for Rheinmetall, and whether political uncertainty in the UK further affects BAE's cost of capital or valuation multiples.