Sean Kenney:
Hi, I'm Sean Kenney and welcome to the MFS All Angles podcast. In our 2026 market outlook, we highlighted a number of key themes that we believe will drive the markets over the coming year. One of those key themes is navigating growing geopolitical uncertainty, not just as a transient risk, but as a structural force that's reshaping policy and impacting capital allocation. In a world that's becoming more fragmented, less predictable and increasingly security focused, the defense sector is fertile ground for disruption, and that creates opportunities and risks for investors. So to discuss this and more, I'm really excited to be joined by equity research analyst Elizabeth McGuire. So Elizabeth, thank you for joining us.
Elizabeth McGuire:
Happy to be here.
Sean Kenney:
So I always like to start with a little bit of context and some background. So if you don't mind telling us a little bit about your journey as an investor and what brought you to MFS and what you're doing today for MFS.
Elizabeth McGuire:
Sure. Got started investing when I was in business school about 10 years ago and spent the first eight years of my career at Putnam Investments and then joined MFS about three years ago. I joined the capital goods team. I cover aerospace and defense, started small and mid-cap, but now I cover the large cap as well. And then more recently, I joined the energy team here at MFS where I cover nuclear and renewable energy, and I'm the sector team leader for energy as well.
Sean Kenney:
Great. Well, certainly a great background for this discussion, so I'm looking forward to the conversation. I do want to start with a bit of an overview of the landscape and kind of where we are now. I will say there's a lot going on in the world today. The conflict in Iran is certainly a topic of conversation. This conversation was really started before that conflict and really the defense sector is interesting in a ripe stock picking opportunity even before the Iranian conflict started. So we'll touch on a bit of that, but that won't be the context of our discussion, it'll be a broader conversation. So when you think about the defense sector, where are we today and sort of what's the landscape that we're operating in across the defense sector?
Elizabeth McGuire:
Yeah, it's definitely a lot of change happening, I would agree with that. We're starting about a year ago to see just huge increase in global spending. So 2025, we spent about 2.6 trillion dollars globally on defense and that's up 6% over 24 with kind of the biggest acceleration happening in Europe and the UK. And obviously we have primes that we own there in our global and international strategies, but for the US as well, these US primes have 10 to 25% of sales from international countries and those can be higher margin as well. So that's sort of the rearmament of Europe and it has been a big theme over the last year. And I would say if 25 was kind of the year of Europe accelerating, 26, we're seeing more of Middle East accelerating. And there, that's countries like Saudi Arabia, Israel, the UAE, buying radar, missiles, helicopters and more. And we've seen almost 30 billion of foreign military sales notifications already this year with a lot of that happening kind of before the current conflict. So we're seeing a lot more spend. And then in the US, we're seeing some brand new programs. So Golden Dome for America, I think most people have heard of. It's $185 billion program introduced last year in May. And then we also had the Trump administration awarded the Next Generation Air Dominance Program, which is also called F-47. It's the sixth generation fighter jet. So that's kind of some big things that have happened in the last year.
Sean Kenney:
Yeah. Well, you just went a bit around the world. So if we spend a minute on Europe, because one of the big conversations going into, well, in 2025, coming into 2026 is Europe and the increased spend, the rearmament as you framed it. Tell us what's happening there. What's going on in Europe and is this sort of a short term thing or do you think there's a longterm structural opportunity in the defense sector?
Elizabeth McGuire:
Yeah, no, I mean, we definitely think we're in the early innings of a long term. So defense cycles tend to be very long and slow. And so we see in Europe a desire to kind of have local content increasing and there's certainly great companies there and they're also looking to US primes to buy as well. So it's broad based. It's not just one country. Germany, UK, France, and others are increasing their spend.
Sean Kenney:
And when you think about Europe, what comes to mind for me is some of the policy changes that are happening in Europe. And how is policy changes impacting growth? When you look at a region like Europe, for example, where does the growth come from are the policy changes driving that? Is there more to it?
Elizabeth McGuire:
Yeah, so there's definitely a desire to spend more on defense globally, but everywhere there's going to be budgetary constraints and fiscal pressures they have to work through, politics. And so while I think there's been a broad consensus, the direction of travel is up, maybe there's more debate around kind of how quickly. So yeah, I think politics is always a part of defense budgets.
Sean Kenney:
Yeah. Yeah. So outside of Europe, you mentioned the Middle East. It may seem obvious at this point, given where we are with some of the conflicts in the Middle East, but is there anything that you look at as a long-term structural opportunity that companies are taking advantage of in the Middle East from a policy perspective and access to that market?
Elizabeth McGuire:
Yeah, one of the things that has changed under the Trump administration is sort of more openness to selling our US, many of our weapons to parts of the Middle East. So that's been part of the acceleration and there's a lot of money there and less ... In Europe, there's a lot of primes, but maybe less domestic companies producing there. So that's kind of part of the driver there too.
Sean Kenney:
And is this growth ... I mean, how do you think about the growth? I mean, when you look at Europe, this is a long investment cycle. There's huge investments and big projects and missiles that take time to not only build, but then to implement. What does the growth cycle look like in not only the US, but around the world here?
Elizabeth McGuire:
Oh, yeah. I'd articulate it as we're in the first or second inning of the upcycle. To your point, a lot of these weapons take many years to build in and of themselves, that many of the primes have backlogs that extend out for years. There's efforts in the US to increase capacity, particularly around missiles to be able to make them kind of faster, but there's just practical limits in an industry that hasn't been a growth industry historically to how quickly we can scale up production. So that will in and of itself be kind of an arbiter on ... We won't double overnight, it'll take some time and that'll extend the duration, but that is connecting to one of the other themes which is neoprimes. One of the big things this administration is trying to do is to kind of move faster and have defense companies be able to produce more quickly. And that's what kind of bringing in some new entrants is about.
Sean Kenney:
Yeah. I want to get to the neoprimes in a minute. One of the things that I, before we turn into some of the things that excite us about the sector is talk a little bit about the structure of these contracts. My understanding is these contracts are uniquely long and that's different than historical contracts and some of the standards we've seen. What's changing there?
Elizabeth McGuire:
Yeah, so in addition to just kind of more dollars being spent on defense globally, we're seeing big changes into how the contracting is done. And so we're seeing longer term, the government kind of committing to longer term contracts. And this has happened first in missiles in the US with up to seven year commitments. And there's kind of talk of extending that beyond missiles. And we've seen this in Germany as well, some longer term commitments, which obviously we love as investors, better visibility of the growth, but then we also have seen if there's a big investment required for this capacity expansion, the governments being willing to share in some of that upfront capital investment, which is new as well.
Sean Kenney:
Yeah. So you mentioned the neoprimes and what's interesting about this sector is I would historically associate this sector with more of a value, not a sleepy sector, but not one that you would consider a high growth sector. And like the energy sector, we were talking with Jude Jason a few episodes ago about how the energy sector was historically, again, a pretty sleepy, slow growth type of a sector that's now very much a growth sector. The same can be said for defense. Is that fair?
Elizabeth McGuire:
Yep.
Sean Kenney:
And so neoprimes and some of the technology innovation and some of the emerging companies coming into the space, what excites you as an investor about the defense sector?
Elizabeth McGuire:
Yep. Well, it's sort of improving fundamentals and we've talked about accelerating growth and sort of potentially longer visibility. We're seeing some potential for improving profitability as well as we roll off contracts that were negotiated before inflation, which has been kind of a challenge for the sector over the last few years, but really it's just the innovation. We're seeing innovation. This new class of defense tech companies are called neoprimes. And innovation comes in a couple forms. Some of it is just kind of producing similar weapons faster and cheaper, right? So I guess the two examples that come to mind are in space where SpaceX has dramatically lowered the cost to launch. And then we had an IPO in January. There was a company called York Space Systems that came public and they make satellites 50% cheaper than the primes. So there's kind of innovation on can we make things faster and cheaper, but then there's also just new capabilities. And here, autonomy and uncrewed systems is a big area of innovation. You read about the role drones they're playing in modern warfare, but there's autonomy not just in the air and in the ocean and a lot of private companies. So, we had a handful of defense tech IPOs last year and we're expecting even more this year.
Sean Kenney:
Yeah. You mentioned some of the unmanned innovation happening. And if you look at what's happening, for example, in the Ukraine, where part of the narrative around some of the success they've had is effectively deploying unmanned drones to a lot of success and maybe potentially reshaping that conflict. It seems to me the defense sector has always been technology oriented, very engineer focused and product development focused, but is it fair to say technology is even more of a factor today? And if so, where are those opportunities and what are you seeing?
Elizabeth McGuire:
Yeah. I mean, we're definitely seeing an acceleration in kind of innovation and ... So yeah, a lot of it is private. A lot of these sort of new defense tech companies are ... We have some public neoprimes, and I think in a year we'll have a lot more, but many of them, and many of them are large in the private markets, and we meet with those companies and they're important to learning about the landscape. But yeah, I agree. A lot of the kind of innovation that has ultimately worked its way into other sectors has come from the defense sector historically.
Sean Kenney:
Yeah. You mentioned the private element and one of the biggest private companies that is arguably defense oriented is SpaceX. They're planning an IPO, seemingly planning an IPO, which would be a pretty big one. What else are you seeing in terms of IPOs? Are there expectations of new IPOs coming into market?
Elizabeth McGuire:
Yes, in the drone space specifically, there's a number that I can think of. Space as well is a big area. Beyond SpaceX, there's a lot of smaller space companies doing launch or satellites or kind of managing some of the data that we're gathering from space. So yeah, I would say drones and space are kind of the big areas within defense tech.
Sean Kenney:
Okay. When you think about this sector, we've talked a lot about growth. There's also risks, right? So while we can be excited about the growth potential and these stocks are likely being considered in more growth oriented portfolios, what are some of the risks that you see that you're considering, that you're watching closely as you look at these companies?
Elizabeth McGuire:
Yeah. I mean, I think the first we touched on a bit is just budgetary and fiscal pressures and that this is government spending, governments don't have unlimited budgets. So this spend comes at the expense of other non-defense needs. And as a part of that, politics is always involved. So there's wide expectations in the US, the current budget we're talking about, the fiscal 27 budget will be up over fiscal 26, but then we have midterm elections and who knows what happens beyond that. And I think there's kind of elections occurring in countries in Europe as well. So that's always there, how do we pay for this? And then just on the kind of execution or manufacturing side, we are talking about accelerating rates of production in an industry that hasn't typically grown that fast. And some of this can be capital intensive and take years to build more capacity. So I think just on that point, just can we ... So the dollars are there, the demand is there, can we ramp up production?
Sean Kenney:
Yeah. And I would imagine just like other sectors and industries, when you look at growth opportunities, there's a difference between growth potential and valuation, good stock versus an exciting growing business. How do you think about valuation relative to growth potential? Some of this stuff is predictable through longer term contracts, but some of it is sort of projecting out potential sales into the future. How do you think about valuation as you assess companies?
Elizabeth McGuire:
Yeah. And I'd say the answer's pretty different based on if I'm looking at a traditional defense prime or like one of these defense tech companies. So traditional defense primes, they do trade valuations that are elevated relative to historic averages. That said, the fundamental picture is better than it's been historically. They've always been good free cash flow generators. So when you look at valuation on a free cash flow based metric, the defense sector is still cheaper than the S&P 500. So we're kind of comfortable there given the improving fundamentals. And the other thing these bring to the portfolio is an element of construction that is unrelated to AI. So right now, the market at times can singularly feel focused on AI, either the CapEx required to build out the infrastructure or what businesses are at risk as a result of AI. And this defense sector is relatively insulated from both of those trades. So that also has implications on valuation.
In the defense tech arena, these are smaller companies, many of them are not profitable. Most of them don't generate free cash. So there, we will look at forward sales multiples. We will look farther out into the future, think about the total addressable market, maybe not just products they have today, but products that might launch in the future. That is much more of an early stage company valuation exercise.
And do the primes ever buy those companies or they generally exit their IPO or is there both?
We have not seen them buying much. There's some degree of partnership happening, but generally it's been an exit through IPO.
Sean Kenney:
Okay. You mentioned partnership. One of the things that comes to mind is as Europe and other parts of the world want to build more defense, and candidly, from a geopolitical and just a security perspective locally, investing in local defense capabilities, contractors, there is increased partnership happening between countries and contractors in different countries. Can you expand on that a little bit?
Elizabeth McGuire:
So my colleague in the London office, Lyran Lee covers aerospace and defense in Europe and she brought up the point to me the other day that increasing partnerships between European primes and US prime. So she covers the company, Rheinmetall, they make tanks and they have a partnership with the company I cover Curtiss-Wright and one of many partnerships for them and that's a way to access technology, but produce it locally. And so we're seeing more of that.
Sean Kenney:
Okay. You mentioned your colleague in Europe and one of the benefits I would imagine for you is sitting on a globally integrated platform that isn't only global in nature, but is a cross sector and collaborative in nature. Can you share a little bit about how you tap into other areas of expertise within the investment platform as you sort of work through some of these interdependencies for the companies?
Elizabeth McGuire:
Yep. So it's a global industry, so I work closely with Lyran. We also, many of these defense tech companies are software companies and maybe one of the biggest is Palantir covered by our software analysis Matthew Doherty. So understanding software is increasingly becoming part of the defense analyst job. And we have a number of portfolio managers who used to cover aerospace and defense. I'd say we have a wealth of kind of institutional knowledge in defense.
And then what's been kind of cool as this has become more of a growth sector is kind of seeing that kind of shared across growth and value sectors. So an example I'd give is we went to meet with the private company, Anduril, one of the large leading players in autonomy and both the growth portfolio managers and then some of the value portfolio managers attended that meeting with me. The growth portfolio managers kind of interested in what they're doing and the disruption and then the value of portfolio managers trying to understand like, is this a threat? How soon to what parts of the business? And we kind of work together to figure that out.
Sean Kenney:
And so you mentioned the private sector space and the collaboration that happens there. Is there a philosophy in terms of when we make investments in privates versus do they need to IPO? And how do we think about that with the small cap team and as that company grows and matures?
Elizabeth McGuire:
Yep. We wait until they're public, but I would say to invest, but we will meet with them for years before. And that's very valuable to understanding current public stocks and valuations in current public stocks. And we're seeing a lot of companies outside of defense too stay private longer and these huge private companies that are big players in the industry, so we can't be blind to that. We have to meet with them and understand what they're doing in order to understand our public companies and get them right.
Sean Kenney:
Yeah. And do you find that research to be materially different or is it very similar or the same?
Elizabeth McGuire:
It's similar. Yeah, I'd say pretty similar.
Sean Kenney:
Okay. Well, we've gone around the world. We've talked about a lot of different factors within the defense space. Clearly there's a lot to not only understand, but find both risks and opportunities for clients. So I just want to summarize in a couple of key bullets to keep me honest, make sure that they're on track. The first is you mentioned that we're pretty early in this structural cycle. You mentioned first or second inning. Is that fair?
Elizabeth McGuire:
Yep.
Sean Kenney:
The second is there's a lot of money being spent and that's exciting on the one hand, but it's not just about the money being spent, it's how it's being spent and the duration of those investments, anything to add to that?
Elizabeth McGuire:
Yeah, I'd say visibility of growth is important as we think about valuation. So having that multi-year visibility, especially as being as long-term as we are here at MFS, I think that's a big deal.
Sean Kenney:
Yeah, what we hear consistently is with our growth teams, rate and duration matter. So obviously the growth rate is a big deal, but having confidence in the duration is a big part of how we think about investing, so clearly opportunity there for long-term investors. And maybe the third bullet is just, this is an incredibly interconnected, not only global, but cross industry sector type of a investment thesis. So working across the platform with colleagues and sharing information, traveling together, researching companies together is pretty valuable. Yeah?
Elizabeth McGuire:
Absolutely.
Sean Kenney:
Yeah. Well, thank you for the time and for giving us insights about this space. And I'm sure we'll be calling you back to give us more information as we go forward, but really appreciate the time and the conversation.
Elizabeth McGuire:
Absolutely.
Sean Kenney:
All right. Well, thanks. And thank you for listening to All Angles. If you enjoyed this episode, hit subscribe so you don't miss any future episodes. And until next time, be sure to consider your investment decisions from all angles. The views expressed are to those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.
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