Russia’s invasion of Ukraine last February has not been good for global stock markets for a number of reasons. A major war on European territory that is still ongoing and has the potential to escalate is a serious geopolitical risk that investors have factored into valuations, dragging markets down.

Another result was spiralling commodity prices, especially oil and gas, entrenching decades-high levels of inflation and squeezing consumer spending. Central banks have responded with aggressive interest rate rises, a move which threatens recession in many of the world’s major economies.

The net result of market nerves over geopolitics, inflation weighing on consumer and business budgets and the value of future revenues, plus a sharp increase in the cost of debt and borrowing, has been a tough year for most sectors.

There have been, however, exceptions and some sectors have benefitted from the same conditions that have afflicted the majority. Energy companies, especially oil and gas producers, have recorded record revenues and profits thanks to elevated sales prices.

The defence sector, which had languished for years as countries around the world cut back on military spending under pressure from electorates to divert funds elsewhere, is back with a bang. Tens of billions of dollars of ammunition and weapons systems have already been expended by Ukraine’s army in the defence of its territory and many more are expected to be in the months ahead.

In late November, the New York Times reported that NATO countries had  “so far provided some $40 billion in weaponry to Ukraine, roughly the size of France’s annual defense budget”.

The same article also wrote:

“The Ukrainians want at least four systems that the West has not provided and is unlikely to: long-range surface-to-surface missiles known as ATACMS that could hit Russia and Crimea; Western fighter jets; Western tanks; and a lot more advanced air defense systems.”

The reason it was presumed tanks were unlikely to be delivered to Ukraine’s armed forces was that, like fighter jets, they “are just too complicated, requiring a year or more to train in how to use and maintain.”

Allies have committed to giving Ukraine tanks and the vast majority will be Rheinmetall’s Leopard 2

Things have changed since November and last week it was confirmed that Ukraine’s allies will provide it with modern tanks. The UK has pledged 14 Challenger 2 tanks and the USA 31 M1 Abrams tanks. But crucially, Germany, which had been reluctant to do so against the politically divisive backdrop of the prospect of its tanks being active on European soil for the first time since the end of WWII, agreed to send 14 Leopard 2 A6s.

Germany also, in a move which is much more important in the bigger picture than its own donation of Leopard 2s, said it would allow other countries which have purchased the model to send them to Ukraine. Doing so requires Germany’s sign-off and now that is forthcoming, many European countries are expected to donate tanks from their own armies.

Over the weekend, Ukraine’s ambassador to France Vadym Omelchenko told the French TV station BFM “as of today, numerous countries have officially confirmed their agreement to deliver 321 heavy tanks to Ukraine.”

The large majority of these tanks are expected to be Leopard 2s donated by other European armies.

Why the Leopard 2 will form the bulk of tank donations to Ukraine

Source: The Guardian

In an active war setting, the military capabilities of active tank battalions are only one part of the equation. Just as important to their effectiveness in influencing the direction of war are the supply lines of ammunition and spares as well as maintenance and repair logistics.

That’s why the Leopard 2 is likely to be far more influential in bolstering Ukraine’s resistance to Russia’s continued invasion of its territory, and potential counteroffensives reclaiming occupied territory, than more modern tanks with theoretically more advanced technology and weaponry like the Challenger 2s and Abrams.

The latter two tank models will be gratefully received but will require more training to both operate and maintain. The logistics around keeping them stocked with ammunition, which is more specific, will also be trickier. The USA has said that the Abrams it is providing will have to be commissioned because it doesn’t have any spare. And that even if it did, months of training and logistics set-up will be required for their deployment.

That means that alongside the Challengers from the UK, they are likely to be used sparingly and it will take at least several months, possibly well into next year, before they might see action.

The Leopard 2, in service since 1979, is not as advanced a piece of weaponry but it is considered far superior to the Soviet-era T-72 and T-80 tanks Russia is mainly relying on. More importantly, at least 16 nations, mostly European but including Canada, have Leopard 2s.

A consortium of European nations including neighbouring Poland donating Leopard 2s from their own stocks will mean they can be transported into Ukraine relatively quickly. That could see them potentially already deployable in counteracting the major spring offensive it is believed Russia is planning as the next stage of its invasion.

Their diesel engine that powers the Leopard 2 also means they are a lot easier to maintain and repair compared to the turbine engine-powered Abrams that will eventually come from the USA. And Ukrainian tank crews will also be able to be trained to operate simpler Leopard 2s more quickly than the other tanks being provided.

All of this means hundreds of the Leopard 2 tanks produced by Frankfurt Stock Exchange-listed Rheinmetall will almost certainly be in active service in Ukraine in the relatively near future. The European countries donating tanks to Ukraine from their own armouries will have to replace them. Many had anyway signed off on new orders to bolster their armed forces after years of military spending that presumed a significant land war on European territory was all but an impossibility in the modern era.

What the order of hundreds of new Leopard 2 tanks means for Rheinmetall and its investors

Rheinmetall already recorded a record year for booked revenue in 2022, largely as a result of a surge in new arms and ammunition orders from around Europe, including the Leopard.

The Frankfurt-listed company, which also makes parts and systems for the civilian automotive industry, is not entirely responsible for the Leopard 2. But it assembles it and manufactures its 120mm smoothbore gun, a range of ammunition for it and the tank’s fire control technology and C4I systems.

CEO Armin Papperger last week told Reuters:

“In 2022, we had a very good year, a record year. We are approaching an order backlog of 30 billion euros, and I expect to see an order backlog of 40 billion euros next year.”

He added he expects to see 15% to 20% growth in the company’s defence division over the next few years with the civilian automotive parts unit expected to contribute just 20% of sales by 2025. Currently, about a third of the company’s sales come from tanks and armoured vehicles and over a quarter from guns and ammunition.

Papperger said he expected to see at least 15% to 20% growth in Rheinmetall’s defence division over the coming years, with the civilian business likely to account for only 20% of sales in 2025. The company is ramping up capacity in expectation of sales doubling to around €12 billion within 3 years. 2022 is expected to see record revenues of €6.5 billion. 2000 new workers have been hired in preparation.

Does the Rheinmetall share price still have significant upside potential despite gains of almost 150% in a year?

Rheinmetall has seen its valuation surge by 148% over the past twelve months. Does that mean the recent uptick in the company’s prospects have already been factored into its share price or is there more to come?

The consensus among analysts is that Rheinmetall looks good value and has some significant upside potential at its current share price of €227.4. The average analyst 12-month stock price target is for €242.46, which is 7% higher than now. However, it should be noted that target may well not yet fully price in developments over the past week and the commitment of what will most likely turn out to be hundreds of Leopard 2 tanks to Ukraine from European allies who will need to then replace them.

The most optimistic analysts have €290 as a 12-month price target, which would represent 28% upside on the current share price.

The company’s automotive parts business is also doing well and is well positioned to benefit from the electrification transformation. In early January, Rheinmetall Automotive confirmed it has won an order worth €250 million to supply contactors, the electrically controlled switches that it safe to turn electric vehicles on and off, to a premium German automaker. Starting in 2025, Rheinmetall will supply tens of millions of these contactors for the automaker’s new vehicle platform, the company said.

Rheinmetall’s valuation may not have the upside it did some months ago after recent gains but if the war in Ukraine drags on beyond 2023 and it maintains a strong performance in its automotive parts unit, it still looks like a strong prospect. Defence stocks are generally expected to have a strong 2023 and Rheinmetall is a very well run company with a huge uptick in its booked revenues that could grow a lot more in coming months.

Most analysts rate the stock as a buy and it’s not hard to see why.