The outlook for the industry has been transformed by the significant changes in United States foreign and defence policy under the new Trump administration which have forced European nations to reassess their defence strategies, with the priority now on building up military capabilities independent of the US as Russia’s war in Ukraine continues, Scope says in its new report on the sector, available for download here.

EU member states are on course to spend more than EUR 100bn in defence procurement (purchases of new equipment) this year, a sharp rise from EUR 90bn spent in 2024. This increase reflects just one aspect of the growing government defence budgets – EU states spent an estimated EUR 326bn on defence (about 1.9% of EU GDP) in 2024 – as support for Ukraine continues and pressure grows for Europe to assume greater responsibilities for its own defence.

Amid discussions of an additional EUR 800bn in EU defence spending over the next few years under the ReArm Europe Plan/Readiness 2030, European defence contractors are anticipating a surge of new orders even though the region’s combined defence spending remains about half of the US’s despite recent increases triggered by Russia’s full-scale invasion of Ukraine.

Strong order intake points to robust free operating cashflow, increased financial headroom

“European defence contractors stand to benefit from rapid growth, but they face structural challenges related to the peculiarities of the European sector: the relatively modest size of individual firms, fragmented procurement processes across multiple different defence ministries, in addition to supply-chain, staffing and current funding constraints,” says Sebastian Zank, head of corporate credit production, commenting on Scope’s new study of Europe’s defence sector.

“However, a changing perception of the industry, new funding routes and robust free operating cashflow provides financial headroom for new investment, particularly among the larger contractors such as UK’s BAE Systems PLC, Italy’s Leonardo SpA, Germany’s Rheinmetall AG and aircraft-maker Airbus SE’s defence units.”

Pressure for more industry consolidation likely to grow

“One of the strongest indicators of sustained growth in Europe’s defence sector is the record-high multi-year order backlogs across leading firms, totalling EUR 330bn by YE2024,” says Zurab Zedelashvili, lead author of the report.

“However, unless there is further consolidation in the European industry, the region’s smaller and more specialised firms, with fewer economies of scale, are less well placed for ramping up output, leading to slower, costlier procurement,” Zedelashvili says.

It may take some time before the European industry more closely resembles that of the US, where large contractors such as Lockheed Martin Corp., RTX Corp. and Northrop Grumman Corp. have the advantage of serving a single Department of Defence.

“To compete with US firms, European companies must scale up joint R&D efforts under EU-funded projects. The Future Combat Air System – a trilateral programme between France, Germany, and Spain to develop a next-generation fighter jet – is one example of how Europe might collaborate more closely in the future,” he says.

“Even allowing for improved cashflow, the new phase of heavy capital expenditure and working capital requirements may strain the finances of smaller companies. We believe that lenders will increasingly change their view on the funding of European defence companies. This shift is driven by heightened geopolitical tensions, a re-evaluation of ESG investment criteria and growing confidence in issuers whose credit quality will benefit from more supportive and stable regulatory and fiscal frameworks,” says Zedelashvili.