Defense Stocks Plummet on Tel Aviv Stock Exchange After Years of Surge
Defense stocks on the Tel Aviv Stock Exchange, which soared during recent conflicts, have seen a significant reversal, dropping about 20% over the past three months as valuations face correction.
The Swords of Iron war, following the conflict between Russia and Ukraine, has turned defense stocks into one of the biggest hits on the local capital market in recent years. Fueled by surging demand for defense products and a global arms race, defense stocks skyrocketed by tens, hundreds, and sometimes thousands of percent, transforming niche companies into investor favorites and even securing them spots in leading indices.
However, in recent months, the trend has reversed. This shift in sentiment is reflected in the performance of the Tel Aviv Defense Index. Towards the end of last year, amid the boom in defense stocks, the Tel Aviv Stock Exchange launched a dedicated index comprising all local defense shares. Initially, the index appeared highly successful, surging by approximately 62% by mid-March.
Since then, amid a cooling of military conflicts domestically and globally, and assessments that valuations had become overstretched, the trend has reversed. Over the past three months, the defense index has dropped by about 20%. By comparison, the benchmark Tel Aviv 35 index rose by a modest 0.2% over the same period. Overall, the defense index, launched in early November last year, presents a negative return of 11%, compared to a positive return of roughly 22% for the Tel Aviv 35 over the same timeframe.
"There are several explanations for the declines we have seen in defense stocks in recent months," says Ilya Feiner, an analyst at Leader Capital Markets. "First, profit-taking after several years of very strong gains, and second, company performance may not have met investor expectations.
"Secondly, we are seeing a shift in pricing, with lower multiples that investors are willing to pay, alongside the realization that expectations outpaced actual performance. In other words, some companies had already priced in all future growth, leading to stock price corrections and sell-offs."
Elad Salomon, a senior analyst in the research department at IBI Investment House, echoes this sentiment: "Over the past two years, all companies in the sector enjoyed significant tailwinds from expanding defense budgets and excess demand for military systems, resulting in sharp gains and multiple expansion. But now we are at a stage where the market is moving from general pricing to a phase where investors examine the quality of growth and the ability to sustain it over time."
Order Backlogs Matter
Amid the shifting sentiment, stocks that once topped the local exchange's return tables have lost ground, seeing significant portions of their peak valuations erased. Globes data shows that the four largest defense companies on the exchange—Elbit Systems, Next Vision, Beit Shemesh Engines, and Ashot Ashkelon—lost a combined 75 billion shekels from their peak valuations earlier this year.
For example, fuse manufacturer Arit Industries, one of the exchange's star performers over the past three years, lost nearly 80% from its early-year peak, wiping out 6 billion shekels in value. Stabilized camera maker Next Vision also suffered from the negative sentiment, plunging by about a quarter last week and shedding over half its peak value—roughly 19 billion shekels evaporated. The downturn was exacerbated by the US fund Fidelity liquidating most of its holding in Next Vision for 1.3 billion shekels (around $450 million).
Elbit Systems, by far the largest defense firm on the local market, fell about 34% from its peak, losing 48 billion shekels in value, while Beit Shemesh Engines dropped 22%, wiping out about 2 billion shekels.
"There are sectors and companies where high multiples relied on expectations of very high growth rates, and those saw sharper declines," Feiner explains regarding the stock divergence. "The more confident investors are in a company's order backlog and future growth, the milder the decline. For instance, Elbit Systems has a substantial backlog that provides a high level of future security."
Regarding Next Vision, Feiner notes that the declines began even before the sell-off. "I think investors fear that increased competition will hurt profitability. The company still posts insane profit margins, and I think it will continue to do so, but the market looks ahead. Fidelity's exit heightened investor anxiety, as a reputable fund pulling out can be a bad sign, even if the sale was merely technical, as the company claimed."
Despite the recent drops, IBI's Salomon spots an opportunity in Next Vision: "Here is a company with a very strong competitive advantage and a very good product in a structurally high-growth sector. Even at current valuations, the risk is not low, but it could be interesting from a risk-reward perspective, provided it maintains rapid growth and defends its competitive advantage."
"Choosing Companies with an Advantage"
Salomon is not alone in spotting opportunities: "We believe investment opportunities are emerging in certain companies, as recent drops make entry points more attractive," says Feiner. "Despite short-term volatility and negative sentiment, long-term demand trends remain positive, and we estimate that some companies will continue to deliver strong growth. Ultimately, one must select companies that possess an industrial moat and are well-managed."
Specifically, he highlights Elbit Systems favorably: "Although its multiple may still look high, it has many future growth drivers, giving us high confidence that it will continue to grow over time. We assess that it has not yet fully realized the advantages derived from Israel's military operations and the combat use of its products."
IBI's Salomon suggests "distinguishing between temporary growth and a competitive advantage." He notes that Arit "enjoyed very high demand for ammunition, but its competitive advantage is less pronounced." He also points to electro-optical product maker R.P. Optical, "which operates in an attractive field, but with problematic valuation, as it is not yet clearly profitable, with much of its pricing relying on future expectations."
