Integrated Review: defence sector still waiting for clarity

Benefitting from the stability of long-term government contracts and robust demand, defence companies’ earnings have proved relatively resilient in the face of Covid-19 – at least for those with limited exposure to commercial aerospace.

Yet investors have been wary of buying into defence stocks over the past year amid concerns that government spending across the world will be curtailed post-pandemic. In the UK, there has been additional uncertainty as we awaited the outcome of the integrated review of security, defence, development and foreign policy.

The review began early last year, promising “the most radical assessment of our place in the world since the end of the Cold War.” Having been delayed by Covid-19, its findings have finally been published. Under the title of ‘Global Britain in a Competitive Age’, the 114-page document lays out a vision of the UK’s role in a post-Brexit world over the next decade.

In the face of a more fragmented international order, key objectives include:

• Remain committed to European collective security via NATO to counter the “most acute threat to our security” from Russia.
• Pursue deeper engagement with the Indo-Pacific in response to the “systemic challenge” posed by China.
• Invest in research and development to become a “science and tech superpower” by 2030.
• Make tackling climate change and biodiversity loss the UK’s number one international priority.

Going nuclear

The biggest news on the defence front centred around the nuclear deterrent, reversing the course of non-proliferation since the end of the Cold War. The UK had been aiming to reduce the cap of its stockpile of Trident nuclear warheads from 225 to 180 by the middle of the decade, but this target has now been abandoned, with the ceiling being lifted to 260 warheads.

The review says that the controversial decision was taken “in recognition of the evolving security environment, including the developing range of technological and doctrinal threats”. The UK could now consider a nuclear response to a non-nuclear threat, such as a chemical, biological or even cyber attack.  

Any increase in the UK’s nuclear arsenal will benefit US defence giant Lockheed Martin (US:LMT) which manufactures the Trident II D5 ballistic missiles. At present, they are carried on Vanguard Class submarines, although, as previously announced, these are being replaced by four Dreadnought Class vessels that are being constructed by BAE Systems (BA.), with nuclear propulsion systems from Rolls-Royce (RR.) and other key components from Babcock (BAB).  

Difficult trade-offs ahead

With more money being spent on nuclear weapons, that likely means that savings will have to be found elsewhere. While the government did unveil a £16.5bn boost to the defence budget back in November, there will undoubtedly be trade-offs as efforts to modernise the military and introduce “cutting-edge technology” will require scaling back some traditional capabilities.

That’s before accounting for a potential £17.4bn black hole in the Ministry of Defence’s (MoD) 10-year equipment plan through to 2030, which the House of Commons Public Accounts Committee has warned could wipe out the benefit of additional funding. In a report released last week, the committee also pointed to an extra £20bn of cost pressures to develop future capabilities and accused the MoD of being “over-optimistic” about potential efficiency savings.

The Commons Defence Committee has been similarly scathing in its assessment of the MoD, with a report published just a day before the Integrated Review decrying “bureaucratic procrastination, military indecision, financial mismanagement and general ineptitude” over the past two decades. It concluded that the army’s fleet of armoured fighting vehicles is facing “mass obsolescence” and requires significant funding to be upgraded.

But, as the Integrated Review has reiterated, defence spending will pivot towards domains associated with the digital age, such as space and cyber warfare. Indeed, £6.6bn will be invested in next-generation research and development to deliver “an enduring military edge in areas including space, directed energy weapons, and advanced high-speed missiles”.

Professor Peter Roberts, director of military science at the Royal United Services Institute (RUSI), has cautioned that these modernisation efforts shouldn’t be overstated. “Allies and competitors made such big bets 5 years ago,” says Roberts. “This review would have therefore been excellent if delivered in 2016. Today? Worryingly behind the times.”

A waiting game

The review largely rehashed earlier promises on defence, as details on specific cuts and investments are set to be revealed when the Defence Command Paper is published on 22 March. 

BAE is the most exposed to cutbacks on expensive platforms and there are reports that the UK will scale back its planned purchases of the F-35 fighter jet. But the group is integral to the Tempest programme and will benefit from Boris Johnson’s promised “renaissance of British shipbuilding”, in particular the commitment to add eight Type 26 frigates to the UK’s naval fleet.

Meanwhile, preparing for the battlefields of the future should bode well for Cohort (CHRT) and Ultra Electronics (ULE) given their expertise in electronic warfare and cybersecurity solutions, and QinetiQ’s (QQ.) testing, training and evaluation services should remain important as the MoD adopts new technology.

Still, all British defence companies should gain from the shift towards self-sufficiency, focusing on domestic industrial capability to fulfil the UK’s technology requirements. The championing of national expertise is part of the government’s wider agenda of levelling up the country and reinforcing the union.