Capital Restrictions And Order Decline Will Undermine European Defense

Key Takeaways

• Heightened ESG scrutiny, reduced investor appetite, and legacy governance issues threaten funding access, net margin expansion, and international contract opportunities.
  
• Emerging tech competition and defense industry transformation expose Leonardo to innovation shortfalls and structural vulnerabilities in its traditional business lines.
  
• Strategic focus on operational efficiency, international expansion, and high-value partnerships positions Leonardo for sustained growth, margin improvement, and greater resilience amid robust defense demand.

Catalysts

An industrial and technological company, engages in the helicopters, defense electronics and security, cyber security and solutions, aircraft, aerostructures, and space sectors in Italy, the United Kingdom, rest of Europe, the United States of America, and internationally.

• As the global investment community places greater weight on ESG principles, Leonardo is likely to see restricted access to capital and a shrinking pool of institutional investors, which may translate into higher funding costs and downward pressure on valuation multiples, ultimately constraining net margin expansion and future earnings growth.
  
• Despite management's optimism for continued strong demand driven by geopolitics, any shift towards lower Western European defense spending due to political cycles or changing public attitudes could erode Leonardo's order book growth and reduce revenue visibility, putting long-term top-line expectations at risk.
  
• The accelerating digitalization of warfare also attracts competition from large technology firms and non-traditional defense players, which could outpace Leonardo's innovation despite recent bolt-on acquisitions, resulting in market share loss and a declining long-term revenue pipeline.
  
• Leonardo's historical exposure to litigation and governance scandals, combined with a persistent gap in R&D investment compared to global peers, raises the risk of being technologically outpaced and could limit access to high-margin international contracts, compressing group operating margins and capping earnings scalability.
  
• The anticipated transformation in defense procurement towards autonomous, unmanned, and AI-driven systems may disrupt Leonardo's core conventional aerospace and hardware divisions, leaving legacy operations structurally vulnerable to demand erosion, which would weigh on both revenue trajectories and group free cash flow.

Leonardo Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Leonardo compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Leonardo's revenue will grow by 5.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 5.6% today to 5.7% in 3 years time.
• The bearish analysts expect earnings to reach €1.2 billion (and earnings per share of €2.12) by about August 2028, up from €1.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 25.2x on those 2028 earnings, up from 25.0x today. This future PE is lower than the current PE for the GB Aerospace & Defense industry at 39.8x.
• Analysts expect the number of shares outstanding to grow by 0.2% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.73%, as per the Simply Wall St company report.

Leonardo Future Earnings Per Share Growth

Risks

• Strong secular tailwinds such as increasing NATO and EU defense budgets, ongoing geopolitical tensions, and multi-year order visibility are expected to sustain elevated demand for Leonardo's solutions, supporting long-term revenue growth and resilience.
  
• The company is executing comprehensive operational efficiency and capacity boost initiatives, focusing on digitalization, portfolio rationalization, and supply chain empowerment, which are already resulting in superlinear growth in KPIs such as EBITA and free cash flow, and are likely to drive margin expansion and earnings growth in coming years.
  
• Strategic expansion into high-margin electronic, cyber, and space segments, including successful bolt-on acquisitions in cybersecurity and formation of joint ventures in next-generation defense programs like GCAP, positions Leonardo for structurally higher profitability and long-term free cash flow improvement.
  
• Leonardo's increasing international footprint-particularly in the US and Middle East-along with an accelerating shift towards export-driven revenues, reduces exposure to the domestic Italian market and enhances revenue diversification, underpinning more stable and robust top-line and bottom-line performance.
  
• Pipeline of high-value joint ventures and partnerships (Baykar for drones, Rheinmetall for armored vehicles, GCAP for sixth-gen fighters), as well as a potential game-changing aerostructures partnership, collectively position the company to capture long-term industry trends of modernization, autonomy, and multi-domain operations, driving significant cash flow and bottom-line upside over the next decade.

Valuation

• The assumed bearish price target for Leonardo is €39.35, which represents two standard deviations below the consensus price target of €53.45. This valuation is based on what can be assumed as the expectations of Leonardo's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €64.0, and the most bearish reporting a price target of just €35.3.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be €21.6 billion, earnings will come to €1.2 billion, and it would be trading on a PE ratio of 25.2x, assuming you use a discount rate of 10.7%.
  
• Given the current share price of €45.43, the bearish analyst price target of €39.35 is 15.5% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.