Defense Stocks Face Correction After Surge, Analysts See Investment Opportunities

Following a significant surge driven by global conflicts like the war in Ukraine and Israel's "Swords of Iron" war, defense stocks have experienced a notable downturn in recent months. The Tel Aviv Stock Exchange's specialized defense index, launched in late 2023, initially soared by approximately 62% but has since fallen by about 20% in the last three months. This decline contrasts sharply with the broader TA-35 index, which saw a slight increase of 0.2% over the same period. Overall, the defense index shows a negative return of 11% since its inception, while the TA-35 has gained about 22%.

Analysts attribute this shift to profit-taking after years of strong gains, potential underperformance relative to investor expectations, and a reevaluation of company valuations. "Investors are starting to examine the quality of companies' growth and their ability to sustain it over time," explained Elad Salomon, a senior analyst at IBI Portfolio Management. The market is moving from general pricing to a more granular assessment of individual company performance.

Several major defense companies have seen significant drops from their peaks. The four largest defense firms on the stock exchange, Elbit Systems, Next Vision, IAI (Israel Aerospace Industries), and Ashot Ashkelon, collectively lost 75 billion shekels from their peak valuations earlier this year. For instance, Ashot Ashkelon, a munition manufacturer, dropped nearly 80%, losing 6 billion shekels. Next Vision, a manufacturer of stabilized cameras, lost over half its value, approximately 19 billion shekels, partly due to a surprising divestment by the US fund Fidelity. Elbit Systems, the largest defense company, fell about 34%, losing 48 billion shekels, while engines manufacturer IAI lost 22%, shedding 2 billion shekels.

Despite the recent downturn, analysts see potential investment opportunities. Ilya Peiner, an analyst at Leader Capital Markets, suggests that the current market conditions make entry points more attractive for certain companies, especially those with strong long-term demand trends and a competitive advantage. He specifically highlighted Elbit Systems for its significant order backlog and growth potential. Salomon also views Next Vision as a potentially interesting risk-reward opportunity, given its strong competitive advantage and product in a high-growth sector, though he cautions about potential competition impacting profitability.

Analysts advise investors to focus on companies with a clear competitive edge and strong management. While some companies like Ashot Ashkelon benefited from temporary demand surges, others like Elbit Systems are seen as having more sustainable growth prospects. RP Optical, a manufacturer of electro-optical products, is noted for operating in an attractive field but faces challenges with its current valuation, which relies heavily on future expectations.