US defence stocks rise on Iran strikes but pitfalls loom

US-Iran conflict raises production needs

The US-Israel military campaign enters its second week and markets grapple with prospects of prolonged operations. President Trump has demanded unconditional surrender ^[1], while seemingly vague objectives make a clear exit strategy harder. Meanwhile, the country's new Supreme Leader is seen as a status quo figure and a hardliner, while the Foreign Minister told CNBC last week that Tehran is not looking to negotiate. ^[2]

According to US Central Command (CENTCOM), more than 3,000 targets have been struck during the first seven days of Operation Epic Fury, while multiple assets have been deployed including B-2 bombers, F-35 stealth fighters and THAAD antiballistic missiles ^[3]. At the latest Department of Defense press conference, Admiral Cooper said that US bombers dropped dozens of 2,000-pound penetrator bombs during the first 72 hours. ^[4]

The operations are depleting stockpiles, so the defence industry will need to pick up production to replenish supplies. After meeting with the largest defence manufacturers on Friday, President Trump announced an agreement to quadruple production of "Exquisite Class Weaponry" ^[5]. Although this is not an official classification, the term likely refers to advanced, high-precision systems and in any case underscores the need for rapid production.

Heightened geopolitical uncertainty drives military spending

The current military campaign comes at a period of heightened geopolitical uncertainty, following the operation in Venezuela and an ongoing war in Ukraine, and not long after President Trump's push to acquire Greenland. Trade antagonism through tariffs, advanced tech export curbs and critical minerals supply weaponisation shapes a fluid geopolitical landscape that is powering ballooning defence budgets.

The United States is raising its security budget to new records and President Trump has called for a further increase to $1.5 trillion for the next fiscal year ^[6], as he pursues his Golden Dome initiative during these "very troubled and dangerous times". The European Commission aims to mobilise nearly €800 billion over the next years ^[7] and NATO has committed to raising investment levels to 5% of GDP by 2035 ^[8]. Meanwhile, China may have lowered the pace of growth but still targets a 7% increase in defence spending. ^[9]

Lockheed and Northrop benefit from the defence supercycle

Military contractors benefit from rising defence budgets, which boost demand, financials and stock prices. Shares of Lockheed Martin and Northrop Grumman hit new all-time highs after the start of Operation Epic Fury.

Lockheed Martin's sales rose 6% last year and its order backlog ballooned to a record $194 billion. Management expects solid revenue growth this year, while targeting higher earnings and capital expenditure ^[10]. Northrop, meanwhile, returned to sales growth of 2% and its backlog hit a record $95.7 billion. For the current year, the firm projects faster revenue growth and higher operating income. ^[11]

The defence sector benefits, but challenges loom

Heightened geopolitical uncertainty and ballooning military spending can continue to drive growth across the defence industry and for key players like Lockheed and Northrop. However, the sector continues to face significant pitfalls.

Despite raising the defence budget, President Trump has also been critical of military contractors and ordered them to curtail buybacks and excessive dividends ^[12]. Furthermore, tariffs create friction with traditional allies, which may prompt them to limit purchases of US weaponry in favour of national contractors. The levies also create an uncertain macroeconomic backdrop, just as supply chain risks linger, particularly around critical minerals. At the same time, military operations against Iran push oil prices to nearly four-year highs, while silver remains close to its record peak. As a result, military contractors are exposed to input cost inflation and execution risks that could eat into profits.