While the war in Ukraine is raging on, arms manufacturers are having a field day. Or so it seems. “The war in Ukraine has boosted defence stocks,” reported Barron’s (February 24, 2023), a News Corporation publication.

They “have performed strongly over the past year... there are more gains to come. 2023 looks to be another strong year for the sector.”

And Responsible Statecraft, a right-wing publication crowed: “Ukraine war is great for the portfolio, as defence stocks enjoy a banner year.”

On the surface of it, such statements strengthen our beliefs that wars are a boon for the defence sector and perhaps even a reason for wars to be waged. So what does this mean for us retail investors? Is it ok, morally and financially, to invest now in defence? After all, our governments and we, the electorate, want Ukraine to prevail.

The Catholic Church, managing vast financial fortunes, would not allow its money handlers to invest in arms manufacturers. Neither does the Church of England. ESG-branded funds and ETFs too would give defence stock a wide berth.

A moral judgement whether to invest or not in arms manufacturers is neither simple nor clear-cut. If we want Ukraine’s self-defence to succeed, we have to supply her with vastly more arms than the $US 70 billion so far granted.

Someone has to produce them, deserving investment. Yet ordnance, even when stocked in peacetime, are meant to be used sooner or later. Peace campaigners therefore have a point when they call for universal disarmament. Without bombs, there’s no war.

Alas, like the environment, universal peace can only be preserved when everyone is on board. If a nation’s politicians believe that their security needs or territorial claims are better served by waging war, unarmed opposition is at a huge disadvantage.

The war in Ukraine is a prime example. Without continuing supply of military hardware, she would go under quickly. Or was she attacked because of her defence built-up?

It is impossible to tell if a war breaks out because we have added to tensions by judiciously preparing for it while perhaps largely neglecting diplomacy, or if neglecting preparedness is an open invitation to armed conflict.

Because we do not know, every nation maintains an army and spends for its armament – some aggressively, others with hesitation. The Ukraine war has shifted opinion in favour of much larger defence preparation, and hence the economic boon for arms producers.

If one believes in Ukraine’s right to self-determination, she deserves support. To refuse at the same time to provide capital to the defence industry and to profit from such investment is illogical. Yet the expected financial rewards for investors are not clear-cut.

On the one hand European governments, the US, Japan, Taiwan and many others are ramping up defence-spending for years to come. Too shocking was Russia’s assault and too menacing is China’s and America’s sabre-rattling.

Its customer is the taxpayer: purchases are almost exclusively governmental- Andreas Weitzer

But making arms is not a standard business. Its customer is the taxpayer: purchases are almost exclusively governmental. This is why profit margins can never be excessive and why production can only be based on existing government contracts, not demand expectations.

Governments are fickle customers. In peacetime, they will regret the money they have spent in war.

Arms are not consumer goods like iPhones or Gucci handbags. Demand is dependent as outlined above on a single buyer, the public, and private profits therefore hard to justify. Exhibit 1 is Lockheed Martin (LM), a major producer of the Javelins, Himars and GMLRS rockets so successfully employed by the Ukrainian army against Russia, their goliath aggressor.

When LM, usually a meagre dividend payer, promised shareholder returns of 11 billion US dollars for the year 2022, more than double its net earnings, it raised eyebrows.

Lockheed Martin is a US$125 billion, defence giant with a turnover of US$66 billion. Since February 24, 2022, when Russia invaded Ukraine, it has gained 19%. Within the last year, its shares have advanced 6.71%. Not spectacular, yet when compared to the S&P 500 Industrial Index, which has lost 6.09% in the same time, it is still comforting: LM fared 26.94% better than the 500 biggest US industries on average!

It is hardly fireworks, though. ExxonMobil, like other oil majors boosted by the Ukraine conflict, saw its shares gain 36.5% since last year, for instance.

Other American ordnance manufacturers have fared worse: Raytheon Technologies, a $US 148 billion behemoth, has gained only 3.4% since the invasion of Ukraine and its peer, Northrop Grumman, 0.9%.

Only General Dynamics, maker of the warheads of the GMLRS rockets, has gained 40% since the invasion of Ukraine, yet lost 3.80% since April last year. It would have been better to sell its shares in October last year.

Boeing, not a real defence player, since it tries without much financial success to produce passenger planes in its civilian life, advanced 5.39% since the invasion of Ukraine. Only rocket engine maker Aerojet Rocketdyne Holdings fared visibly better. Its shares rocketed, if the pun is allowed, 52.49% since February last year.

If anything, it was European defence contractors (tiny when compared with America’s big five and their 150,000 domestic suppliers) which would have made us retail investors rejoice. With the now incalculable risk of Putin’s Russia at the doorstep, all European countries are cranking up their

defence expenditure, even countries like Germany, which habitually considered defence-spending a waste of money. This is boosting not only the business prospects of Europe’s arms makers, but also their price-earnings-multiples, reflecting investor enthusiasm.

SAAB, the Swedish manufacturer of planes, missiles and control systems (approximately € 7.5 billion market cap) has gained more than 167% since the war began, Germany’s Rheinmetall, producer of tanks, artillery systems and air defence gained 145.7% and Hensoldt AG, which produces sensors for weapon programmes, 137.81%. Admittedly all of them made their biggest gains last year and have fared more modestly year to date, advancing in average 40% per annum.

Past success is never an indication of future performance as we know. Most of the initial enthusiasm for the defence industry seems to have been spent. All defence titles I looked at have retreated from earlier peaks and might justify investment.

Most of them are not overly expensive even, particularly US defence stocks, which have a P/E below the S&P 500 average. For the foreseeable future, order books will be full: inventories of ammunition and rockets have been depleted in Ukraine as we learned from the ‘Discord Leaks’ and are also running low in the US and within NATO.

Yet I doubt that weapon producers can profit from increased orders. To ramp up production, skilled workers are needed, who are in scarce supply, like in every industry post-COVID. Large capital investment, though urgent needed, may not come forward. Components will be hard to come by in sufficient quantities: a single anti-tank rocket like the Stinger contains more than 200 microchips.

But even if ‘banner years’ for the arms industry lay ahead: to financially prosper from a defence investment, one has to hope that the war in Ukraine will not end any time soon. For a retail investor like me, that seems too cynical for comfort.

Andreas Weitzer is an independent journalist based in Malta.

The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.

andreas.weitzer@timesofmalta.com