3 European Defense Stocks Raising Guidance While the Sector Lags

Key Points

• Rheinmetall's Q1 2026 revenue miss and Germany's frigate order cancellation triggered a sell-off across European defense stocks despite growing industry backlogs.
• Leonardo, Thales, and Saab each show stronger order growth, cash conversion, or backlog trends than Rheinmetall, suggesting the sector sell-off is not a broad demand problem.
• Analysts at firms including Jefferies, DZ Bank, Royal Bank of Canada, Barclays, and Pareto Securities have issued upgrades on Leonardo, Thales, and Saab throughout 2026.

European defense stocks were a banner trade in 2025, and that trend was expected to continue into 2026. But markets laugh while we make grand plans, and the industry has lagged despite growing backlogs. The Stoxx Europe Aerospace and Defense Index was down more than 1% year-to-date (YTD) despite a nearly 5% advance by the broader Stoxx 600 index.

An alarming earnings report from German giant Rheinmetall AG OTCMKTS: RNMBY added teeth to the sell-off, but it is not a verdict on demand. And some European defense contractors have been unfairly dragged down in the process.

Rheinmetall: Q1 Miss Resets Valuations

The European defense trade was expected to continue to reap benefits as EU nations increased their budgets. Germany removed the debt brake that limits defense spending, and backlogs have grown to record levels at firms across the bloc. German-based Rheinmetall was one of 2025’s biggest defense trade winners, but its Q1 2026 earnings report (and subsequent news drops) created some concerns about the durability of its revenue.

Rheinmetall released its fiscal Q1 2026 results on May 7 and reported revenue growth of 7.7% year-over-year (YOY), but missed consensus analyst expectations by more than 15%. Operating margin was in line with expectations (but operating free cash flow was negative €285 million), and management chose to reaffirm full-year 2026 revenue guidance rather than raise it despite 31% backlog growth. And then a month later, Germany canceled its order for six F126 frigates.

The F126 cancellation raised just as many eyebrows as the Q1 revenue miss. A backlog only matters if the orders actually convert, and a €300 million (approx. $350 million U.S.) order cancellation is a serious hit to future revenue. Investors looking at this sector need to screen for both order and revenue growth and pay close attention to book-to-bill and backlog years. Here are three companies in a stronger position than Rheinmetall.

Leonardo: Flat Revenue Guidance Not a Sign of Wavering Demand

Leonardo S.p.A. OTCMKTS: FINMY is an Italy-based aerospace and defense firm that serves clients worldwide and even has a subsidiary trading on U.S. exchanges, Leonardo DRS Inc. NASDAQ: DRS.

In its H1 2026 report on July 30, Leonardo reaffirmed its full-year 2026 revenue guidance at €22.1 billion (~$25.6 billion), despite new orders rising from €26.2 billion (~$30.4 billion) to €28.2 billion (~$32.7 billion). EBITA and free operating cash flow guidance were also raised, and net debt was guided down from €2.3 billion (~$2.7 billion) to €2.2 billion (~$2.6 billion).

This is the exact opposite of the scenario investors are seeing with Rheinmetall. Orders are still growing, but the operating cash flow has increased, and book-to-bill has grown to 1.6. Leonardo is choosing high-value orders, and its operational constraints are capacity-based instead of demand-based. Analysts seem to agree with this assessment, as Jefferies and DZ Bank both upgraded the stock to Buy from Hold and Strong Buy from Buy in July.

Thales: Guiding a Full Cash Conversion

If backlog conversion is a key concern, Thales S.A. OTCMKTS: THLLY is the slow and steady winner of the race.

The France-based aerospace firm doesn’t have the revenue growth metrics of Leonardo or Saab, and it projects only 6%-7% organic growth in fiscal 2026.

But its defense order intake is up 22% YOY on an organic basis, and operating cash flow has soared. And perhaps most importantly, it upped its guidance on conversion rate into free operating cash flow to 100% to 110%.

The total order book is now worth €52 billion (~$60 billion) as of June 30, and the Royal Bank of Canada initiated the stock as a Moderate Buy on Aug. 11.

Saab: Flat Guidance Hides 60% Cash Conversion and Sales Target Beats

Saab AB OTCMKTS: SAABY didn’t actually increase any of its guidance projections in 2026, instead choosing to play it safe to ensure supply chain disruptions are resolved by the end of the year. But the conservative guidance belies the company’s performance; it's crushing its own estimates, and revisions are likely to come later this year.

New bookings grew 141% YOY in fiscal Q2 2026, including a SEK 47 billion (~$4.8 billion) submarine order from Poland, and the H1 2026 backlog grew 61% from the same period last year. Sales grew 25% vs. a 22% company target, and organic sales growth has nearly surpassed 30%.

Analysts have upgraded Saab shares throughout the year, suggesting this re-rating isn’t complete. The two most recent upgrades came from Royal Bank of Canada and Barclays, which upgraded the stock to Hold and Strong Buy, respectively.

This was the second Strong Buy rating the stock received this year, after Pareto Securities upgraded the company on June 25.