Small defence stocks: the backbone of the sector

The global defence sector is a behemoth, often overshadowed by industry giants like Lockheed Martin, BAE Systems, and Northrop Grumman. These "primes" dominate the landscape, managing massive multi-billion contracts and intricate supply chains. However, beneath the surface lies a wealth of smaller, publicly traded companies that are quietly reshaping the industry. This article delves into the world of small defence stocks, examining their recent successes and the opportunities they present for investors willing to look beyond the well-trodden paths of large institutional players.

The Rise of Small Defence Stocks

A Case Study: Filtronic

One prime example of a small defence stock making waves is Filtronic, a micro-cap company that designs and produces components for communication systems. Back in January 2024, Filtronic was struggling to stay afloat, barely breaking even and relying on shareholder cash infusions. Fast forward to April 2024, when a strategic partnership with SpaceX transformed its fortunes. Following this collaboration, Filtronic secured multiple contracts that nearly quadrupled its revenue, resulting in an astonishing share price increase of nearly 1,800% since the beginning of 2024.

Filtronic’s transformation is a microcosm of the broader changes occurring in the global defence market. With increasing demand for innovative technologies, small players are finally getting their due, offering unique solutions that meet the evolving needs of modern warfare.

The Landscape of the Global Defence Market

The global defence industry is traditionally dominated by a handful of major players. These primes are not only responsible for executing multi-year contracts but also play a crucial role in financing the extensive supply chains that support them. This means that smaller companies often operate in the shadow of these giants, even as they contribute significantly to the overall supply chain.

In Europe, a recent study by the Bruegel think tank highlighted that the ten largest military contractors capture between 67% and 90% of total public military procurement spending in key countries like Germany, Poland, and the UK. In the UK specifically, 39% of procurement expenditure in the 2024-2025 financial year was awarded to just ten strategic suppliers, with BAE Systems alone accounting for 16.3% of core Ministry of Defence expenditure, marking the highest recorded share for a single supplier since records began in 2008.

The Importance of SMEs in the Supply Chain

While it may seem that the primes hold all the power, a closer examination reveals a structural dependence on smaller companies. For instance, BAE's contracts to produce eight Type 26 Global Combat Ships for the Royal Navy, initially valued at £3.6 billion, are expected to see 40% of the total cost flow to the 3,000 small and medium-sized enterprises (SMEs) in its supply chain. This relationship highlights the critical role that SMEs play in supporting larger defence contracts.

BAE Systems estimates that it has a total of 5,800 suppliers in the UK and spent approximately £5.8 billion with these SMEs in 2024, supporting around 61,000 jobs—nearly 20% more than its direct employee base. A similar trend is evident in Germany, where the Mittelstand—SMEs that form the backbone of the economy—supports major global primes like Rheinmetall.

U.S. Leadership in Supporting Small Defence Stocks

Federal Initiatives

The United States has taken a proactive approach to support small defence companies, consistently raising contract awards to small businesses. In federal fiscal year 2024, the Department of Defense increased prime contract awards to small businesses by $4.9 billion, showcasing its commitment to integrating these companies into the supply chain.

Additionally, programs like the Accelerate the Procurement and Fielding of Innovative Technologies (APFIT) initiative have provided direct funding to small and non-traditional defence contractors, enhancing their capacity to deliver innovative solutions. For example, Gremlin Low-Cost Munition recently received $35 million to develop affordable precision-strike capabilities for the US Marine Corps, underscoring the government's focus on integrating small players into its defence strategy.

The UK and European Context

While the U.S. leads in support, the UK and its European allies are working to develop similar programs. However, progress has been slow due to funding constraints and the existing concentration within the sector. In the UK, the Ministry of Defence's spending directly with SMEs accounted for just 4% of its total budget last year, a figure that remained flat year-on-year. Plans are in place to increase this spending from £2.5 billion annually to £7.5 billion by May 2028, contingent on government approval.

Moreover, the UK government has pledged to raise defence spending from 2.7% to 5% of GDP by 2035, although reports indicate a funding gap of around £28 billion in existing plans. In an effort to streamline engagement with SMEs, the government established the Defence Office for Small Business Growth in January 2026, acting as a “single front door” for small companies to interact with the ministry.

Mining for Diamonds in the Rough

The Challenge of Identifying Opportunities

Despite the inflow of capital into the defence primes, finding promising small defence stocks can be challenging. The market is largely dominated by exchange-traded funds (ETFs), which typically track the largest, most liquid companies in the sector. Furthermore, active investment funds that specialize in defence are few and far between, often lacking the in-depth technical knowledge needed to navigate the rapidly evolving landscape of defence technologies.

One notable exception is the Finserve Global Security Fund, a Swedish actively managed equity fund that focuses on defence, cybersecurity, and the burgeoning space industry. Though not available to UK investors, the fund's strategy emphasizes capturing long-term mega-trends with potential for above-market growth.

Spotlight on Promising Small Defence Stocks

Nordrest: A Growing Player in Military Supply

Among the intriguing companies highlighted by Finserve is Nordrest (Stockholm: NREST), which has capitalized on increased defence spending through its meals-ready-to-eat (MRE) division. As an essential supplier to NATO, Nordrest provides the meal kits issued to soldiers on the front lines. The company has seen its shares rise by approximately 180% since early 2025, driven by its involvement in NATO contracts.

Nordrest’s MRE division, while only accounting for 24% of revenue, represents about 60% of its profitability. With plans to double its MRE capacity in response to growing demand, Nordrest is poised for continued growth, especially given its market capitalization of $410 million—still a small player in the larger context of defence.

Hanwha Ocean: Competing with the Giants

Another company capturing attention is Hanwha Ocean (Seoul: 042660), formerly known as Daewoo Shipbuilding & Marine Engineering. This South Korean shipbuilder has jumped over 230% since the end of 2024, following its strategic acquisition of Philadelphia Shipyard in a joint venture with Hanwha Systems.

This bold move positions Hanwha to tap into the nearly $1 trillion U.S. Navy procurement system. Although the shipyard is currently incurring losses, Hanwha has earmarked $5 billion to turn it around, aligning its strategy with the U.S. government's Make American Shipbuilding Great Again initiative.

Exail Technologies: Innovating in Drone Warfare

Lastly, Exail Technologies (Paris: EXA) has emerged as a leader in drone warfare technology. The ongoing conflict in Ukraine has highlighted the significance of unmanned systems in modern defence strategies. Exail specializes in unmanned mine countermeasures, boasting a 95% win rate on naval and mine-hunting tenders since 2019.

As nations increasingly recognize the effectiveness of drone warfare, Exail's innovative solutions position it well for future growth, particularly as military budgets expand in response to evolving threats.

Conclusion: The Future of Small Defence Stocks

Investing in small defence stocks presents a unique opportunity for those willing to look beyond the established giants of the industry. While the likes of Lockheed Martin and BAE Systems will continue to dominate, the growth potential of smaller, innovative firms cannot be overlooked. As the global defence market evolves, these companies are set to play an increasingly vital role in shaping the future of warfare and security.

For investors, the landscape is ripe with potential, but careful consideration and due diligence are paramount. By identifying the diamonds in the rough, savvy investors can capitalize on the growing demand for innovative defence solutions, all while supporting the smaller firms that form the backbone of this critical industry. As the world faces new security challenges, the small players may very well become the key to unlocking exceptional growth in the defence sector.