Investing.com — UK defense stocks face a material hit to their fair values if the government fails to meet its NATO commitment of spending 3.5% of gross domestic product on defense, Citi Research said, after UK Defence Secretary John Healey resigned in protest over what he described as insufficient funding.
Healey, in his resignation letter, flagged that the government had proposed increasing defense spending to only 2.68% of GDP by 2029, well below the 3.5% target the UK committed to at the NATO summit in July 2025.
The UK government had aimed in its 2025 autumn statement to reach 3% of GDP by 2034.
Citi said it continues to assume the UK will reach 3.5% of GDP by 2035 in its base-case target prices, but modeled the potential downside to fair values for , , and under both a 3% and 2.68% GDP spending scenario.
Of the three companies, Babcock carries the heaviest exposure, with 62% of its business tied to UK defense. Citi’s target price for Babcock stands at 1,554 pence, implying 51% upside from its current share price of 1,031 pence under the 3.5% scenario.
Should spending settle at 3% of GDP, Babcock’s fair value falls to 1,416 pence, a 37% upside, while a 2.68% outcome reduces that further to 1,328 pence, representing 29% upside.
BAE Systems, with 20% UK defense exposure, carries a Citi target price of 2,438 pence against a current share price of 1,963 pence, representing 25% upside under the 3.5% scenario.
Under a 3% spending outcome, fair value is estimated at 2,368 pence, or 21% upside, narrowing to 2,324 pence and 19% upside if spending holds at 2.68% of GDP.
QinetiQ, which has 60% UK defense exposure, shows the most limited upside across all scenarios. Citi’s target price of 569 pence implies 18% upside from the current 483 pence share price under the 3.5% base case.
At 3% of GDP, fair value drops to 520 pence, an 8% upside, while the 2.68% scenario yields only 489 pence, or 1% upside.
Citi said the methodology adjusts fair value in proportion to each company’s UK defense exposure, and assumes limited operational leverage on either side, meaning margins are held constant across scenarios.
“We continue to believe this will happen, even though it is not clear where the funding will come from,” Citi analyst Charles Armitage said of the 3.5% by 2035 assumption, while stressing the analysis was intended to quantify the impact if ultimate spending came in lower.