Jefferies Names Leonardo New Top Pick in European Defense, Upgrades to Buy

Jefferies has upgraded Italian aerospace and defense company Leonardo to a 'Buy' rating, naming it the firm's new top pick in the European sector. The move, which displaces Germany's Rheinmetall, signals a strategic pivot by the investment bank toward defense electronics and air defense systems over land-based platforms.

A Shift in Valuation

The upgrade is underpinned by a significant change in Jefferies' valuation methodology for the defense sector. The bank has extended its valuation horizon for most covered companies to a 2028 sum-of-the-parts (SOTP) model. According to the firm's analysts, this change reflects that "near-term execution remains key" and inherently favors companies with strong positions in defense electronics.

This new approach has elevated both Leonardo and Thales in Jefferies' order of preference. Conversely, it resulted in price target reductions for CSG and RENK, despite largely unchanged full-year estimates for those companies. Jefferies sees 30% potential upside to its new price target for Leonardo.

The Case for Leonardo

Jefferies analysts, including Chloe Lemarie, highlighted several key factors driving the positive outlook for Leonardo. The company is currently the cheapest air defense stock in the bank's coverage, trading at 14 times its 12-month forward EV/EBIT.

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Key drivers for the upgrade include:

• MBDA Exposure: Leonardo's stake in European missile systems manufacturer MBDA is considered "a major driver... for upside on the 2029 outlook."
• Export Potential: The firm noted potential for increased exports of the SAMP/T NG air defense system and the Eurofighter aircraft.
• Above-Consensus Forecasts: Jefferies' 2028 EBIT estimate for Leonardo is 8% above the market consensus, driven by stronger expected performance from its Defense Electronics & Advanced Technologies (DE&E) division.
• Subsidiary Premium: Leonardo's majority-owned U.S. subsidiary, DRS, trades at a higher multiple than the one Jefferies applies to the parent's DE&E division in its SOTP model, which could create "further multiples tailwinds."

Sector-Wide Implications

Jefferies expects Leonardo's stock to re-rate to valuation multiples closer to those of peers like BAE Systems. The valuation shift has also impacted other names in the sector, though the bank maintained some of its existing calls.

Despite a price target cut, CSG remains one of Jefferies' top picks due to what it called a "highly de-rated profile." In the civil aerospace segment, the firm named Rolls-Royce as its top selection, anticipating guidance upgrades driven by its Power Systems unit and aftermarket margins.