We believe that Rheinmetall, which possesses a wide economic moat, presents compelling value, currently trading at approximately a 68% discount to our fair value estimate of EUR 2,220. The company generates 80% of its revenue from the defense sector, with a product portfolio that is closely aligned with NATO priorities, particularly in artillery, armored vehicles, and air defense. Rheinmetall is also recognized as the world's largest fully vertically integrated ammunition producer.
The rise in global security threats is driving growth in the defense market, especially in Europe, where military budgets have been stagnant since the Cold War. In light of increasing geopolitical tensions, potential U.S. disengagement, and pressure from Washington, we anticipate that European defense spending will increase from 2.2% of GDP to 3.1% by 2029 and reach 3.5% by 2032. NATO is expected to formalize a new defense spending target in June, with indications suggesting a target of 3% to 3.5% of GDP by 2030. Additionally, EU proposals to relax fiscal rules and unlock up to EUR 800 billion in funding could enable participating countries to elevate defense spending to 3.5% of GDP by 2029.
This environment presents a significant opportunity for Rheinmetall to leverage its well-diversified geographical presence and extensive product portfolio. As Germany's leading defense contractor, Rheinmetall is poised to benefit from a substantial shift in Germany's defense spending, following Parliament's approval of a proposal to exempt defense spending above 1% of GDP from debt limits, effectively eliminating any cap on future military budgets. We project that Germany’s defense spending will reach 3.5% by 2029-2030, averaging around 3% in the midterm.
The sales of Rheinmetall's weapons and ammunition division are expected to continue to surge due to the ongoing Russia-Ukraine conflict and the necessity to build stockpiles for Ukraine and NATO countries in anticipation of a ceasefire. The company aims to ramp up production from 100,000 rounds in 2022 to 1,100,000 by 2027, with the potential to double this target if necessary. Furthermore, Rheinmetall's electronics division is anticipated to grow, driven by its involvement in German military digitization and NATO's European Sky Shield Initiative.
Beyond Europe, Rheinmetall is strengthening its presence in Australia and expanding its operations in the United States. The Lynx infantry fighting vehicle is a contender in the U.S. XM30 combat vehicle program, which aims to replace approximately 3,800 M-2 Bradley vehicles.
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