Citi has moved to a more constructive stance on three European defence contractors - Babcock, Leonardo and TKMS - upgrading each to Buy after recent declines in their stock prices reduced the growth investors must assume to justify current market valuations.
The bank applied its "What’s priced in?" framework, a reverse discounted cash flow model designed to back out the profit growth embedded in today’s share prices. For the trio that were upgraded, Citi’s analysis shows implied profit growth targets between 2030 and 2035 that the bank judges achievable given expected procurement spending in their domestic markets.
Implied profit hurdles and unchanged targets
- Babcock - implied profit CAGR of 5% between 2030 and 2035; target price unchanged at 1,554p.
- Leonardo - implied profit CAGR of 5% between 2030 and 2035; target price unchanged at 8.
- TKMS - implied profit path equates to a negative 5% CAGR between 2030 and 2035; target price unchanged at 00.
Citi considers those implied growth rates manageable in light of anticipated procurement budgets across the companies' home markets. The bank therefore upgraded the three names to Buy while leaving the published price targets intact.
Saab and Rheinmetall: cautionary reads
Not all names received an upgrade. Saab remains a Sell in Citi’s view. The bank calculates that Saab’s current share price implies investors must assume profit growth of 2.1 times local procurement budgets and an 18% CAGR between 2030 and 2035 - a profile Citi views as unrealistic and therefore not supportive of a Buy rating.
Citi also initiated coverage of Rheinmetall with a Neutral rating and a 1,480 target price. On headline measures the analysis looks undemanding, with only a 2% growth requirement between 2030 and 2035. However, Citi’s analyst Charles Armitage flagged the company’s Weapons and Ammunition division as a particular concern.
Armitage said demand for that division is currently "unsustainably high and will materially decline to 5-6% of capacity once the stockpiles have been replenished." The bank models that replenishment point could occur around 2028 when the Ukraine war ends, with European stockpile replenishment taking a further five to ten years.
Citi notes that removing the Weapons and Ammunition division from Rheinmetall’s forecasts materially increases the growth burden placed on the remainder of the business, underpinning the more cautious Neutral stance.
Conclusion
Citi’s reverse DCF approach has prompted upgrades where implied profit trajectories now look attainable, and maintained or initiated more guarded ratings where growth assumptions appear stretched or concentrated in potentially temporary demand spikes. Target prices for Babcock, Leonardo and TKMS remain at 1,554p, 9 and 00 respectively, while Rheinmetall is set at 1,480 and Saab remains a Sell based on the bank’s calculations.