- Geopolitical tension and unilateral actions are driving an increase in global defence spending
- Defence capex carries strong upside potential, creating sustained growth opportunities in the sector
- Traditional prime defence contractors will continue to dominate
- Non-traditional high-tech disruptors are gaining traction and relevance thanks to their innovation
- Modern warfare’s swiftly shifting dynamics favours high-tech non-traditional contractors
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A prominent surge in defence spending. In an era where geopolitical fault lines crackle with unprecedented intensity – from Russia’s grinding assault on Ukraine to simmering American rivalries in the Western Hemisphere – the world’s governments are reaching deeper into their coffers. Global defence spending swelled to USD2.7tn in 2024 and is on track to reach >USD3.3tn by the end of the decade. This surge, propelled by NATO’s ambitious pledge to hoist expenditures to 5% of GDP by 2035 (up from a paltry 2% today), Japan’s plan to double spending by 2027, and the US’s target to raise defence spending by 50% over the same period, reflects not just paranoia but a grim calculus: the cost of deterrence in a multipolar world fraught with economic warfare, territorial spats and the spectre of great-power conflict.
The need for defence “self-sufficiency”. As the Trump administration flexes its muscles with military intervention in Venezuela, ostensibly to stabilise a region roiled by migration and oil disputes, and through eyebrow-raising overtures towards annexing Greenland for its strategic Arctic resources and rare-earth materials, the global order appears increasingly precarious. These moves, echoing 19th century gunboat diplomacy in a 21st century guise, heighten tensions by underscoring Washington’s willingness to project power unilaterally, jolting allies and adversaries alike into a scramble for defensive self-sufficiency. EU nations, wary of over-reliance on American largesse, are accelerating their push for “strategic autonomy”, while emerging powers in Asia and Latin America eye indigenous arms production to hedge against superpower whims.
The result is a stark reminder that in an age of unpredictable alliances, no country can afford to outsource its security entirely, fuelling a broader imperative for diversified supply chains and homegrown capabilities. Against this backdrop, the defence industry finds itself in a veritable golden age, albeit one laced with irony, as humanitarian appeals languish at a fraction of these sums. The beneficiaries emerge as a motley crew of incumbents and upstarts, from lumbering traditional prime contractors/enablers to nimble high-tech disruptors. Long criticised for its insularity, the industry now stands to reap rewards as global defence budgets balloon by the end of the decade, funnelling capital into everything from hypersonic missiles, defence dome, new generation fighter-jets, to AI-driven drones. With such escalations – exemplified by US’s Venezuelan foray and Greenland gambit – defence capex tilts decisively towards upside risks rather than downside revisions.
Dominance of traditional prime defence contractors. Traditional prime contractors – behemoths like Lockheed Martin, RTX, and Boeing – remain the undisputed titans, hoovering up the lion’s share of this torrent. Between 2020-24, the US “big five” alone pocketed USD771bn in Pentagon contracts, accounting nearly one-third of awarded private sector defence contracts during the period. Their edge lies in scale and incumbency: vast backlogs, proven hardware (e.g. F-35 & next-gen F-47 jets, and nuclear-powered ballistic missiles Columbia- & Virginia-class submarines), and a cosy relationship with governments prize reliability over revolution. In a spending spree, these firms thrive on “cost-plus” models where overruns are cushioned while profits, though arguably modest in margins, accrue steadily with burgeoning cashflows. As tensions escalate, for example Arctic NATO manoeuvres amid US-Danish frictions or persistent Ukraine quagmires, these traditional contractors are primed for absolute gains through continued ramp up in production for munitions and platforms. Non-US giants like the UK’s BAE Systems or Germany’s Rheinmetall mirror this trend, set to capitalise on EU’s rearmament and Asia’s export boom.
Rise of non-traditional tech disruptors. Meanwhile, a new source of intrigue is emerging in the form of non-traditional defence contractors: the agile high-tech interlopers from Silicon Valley and beyond, exemplified by Palantir’s AI analytics or Anduril’s autonomous systems. Powered by commercial tech capabilities and unburdened by legacy bureaucracies, these firms inject disruption into the sector, deploying venture-backed R&D at well over 10% of revenues (vs primes’ typical low-single digits), blistering growth rates alongside rich valuations. The Pentagon’s embrace of such “non-traditional” subcontractors open niches for innovators in drones, satellites, and robotics, where federally funded R&D boosts productivity while commercial agility yields faster and cheaper breakthroughs.
Modern warfare’s technological pivot. This evolution is accelerating with modern warfare’s inexorable march. Swarms of unmanned drones deployed with lethal efficiency in Ukraine’s trenches and Yemen’s skies herald a shift from brute-force hardware to precision, autonomy, and data dominance. AI-orchestrated systems, cyber intrusions, and hypersonic strikes demand adaptability over scale, upending dynamics: traditional primes’ grand platforms now require integrated software ecosystems, where a single drone can outperform a squadron at a fraction of the cost. This pivot favours high-tech non-traditional contractors, who leverage commercial and disruptive technology to iterate rapidly and secure more DoD (Department of Defence) contracts. That said, traditional prime contractors are also adapting through acquisitions and alliances, blending manufacturing might with startup ingenuity to expand their capabilities.
A multi-year secular growth trend. This bifurcation – stability for the old guard, velocity for the newcomers – heralds a hybrid future of partnerships and acquisitions. Risks persist: overcapacity, policy volatility, and ethical quandaries of profiting from peril. For investors, prudence dictates diversification – anchor with traditional primes for resilience, while allocating to non-traditional disruptors for tech-driven upside.
Valuation, currently at 25x and 60x average 2-year forward PE respectively for traditional and high-tech non-traditional defence contractors, is not excessively demanding when considering the industry’s prospects. As such, savvy investors should monitor and pounce on corrections, as the multi-year horizon promises enduring gains in a world where peace is increasingly a luxury. As the arms race quickens, the sector’s windfall may fortify nations while underscoring a sobering truth: in geopolitics, preparation for war often begets the very conflicts it seeks to avert.
Figure 1: Relentless global spending in defence readiness
Source: Bloomberg, DBS
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