Don’t mistake the pullback: Why Asian defence’s growth thesis remains intact

• The recent pullback is nothing about weakening demand. The correction was triggered by the US-Iran ceasefire, Germany's F126 programme execution issue and earnings reflection delays in India, but none of these developments materially alters Asia's defence spending cycle.

• Asia's rearmament remains intact. Rising regional security risks continue to drive record defence budgets across Japan, South Korea and Taiwan, providing long-term earnings visibility for the region's defence companies.

• Fundamentals continue to strengthen. Defence order books remain at record highs, South Korean systems are gaining global recognition following proven combat performance, and Asian defence companies are becoming increasingly integrated into Western defence supply chains.

• India's earnings weakness reflects execution timing, not weaker demand. Weaker earnings reflect procurement timing and contract delays, not weakening demand, as order books and defence spending continue to rise.

• The pullback offers an attractive buying opportunity. We continue to favour the WisdomTree Asia Defence Fund (Nasdaq: WDAF) for diversified exposure to Asia's multi-year defence growth story. Based on our estimates, the ETF offers 44% upside by FY2028.

After a strong rally earlier this year, Asian defence stocks have pulled back over the past month, prompting investors to question whether the sector's recent momentum has begun to fade. The WisdomTree Asia Defence Index has retreated from its 6 May peak, falling approximately 18% in SGD terms, as a combination of geopolitical developments and company-specific disappointments triggered profit-taking across the sector.

Three events largely explain the recent correction.

The first was the announcement on 17 June of a 60-day memorandum of understanding between the United States and Iran aimed at de-escalating tensions and reopening the Strait of Hormuz. The agreement pushed Brent crude prices back towards USD70 per barrel, prompting markets to unwind part of the geopolitical risk premium that had been supporting defence-related equities.

The second was Germany's decision on 24 June to cancel its F126 frigate programme, raising concerns that even record defence order books may not necessarily translate into future revenue if large procurement projects encounter execution problems.

The third came from India, where several leading defence platform manufacturers, including Hindustan Aeronautics (HAL) and Bharat Dynamics, reported disappointing FY2026 earnings as revenue recognition slowed despite record order books.

Taken together, these developments have understandably led investors to ask whether the structural re-rating of Asian defence stocks has already run its course. We believe the answer is no.

Why the recent pullback doesn’t break the investment case

The Middle East ceasefire does not change Asia’s rearmament cycle

The argument that a Middle East ceasefire undermines Asian defence stocks rests on a fundamental misunderstanding of what is driving defence spending across the region. While the conflict in the Middle East undoubtedly heightened awareness of geopolitical risks, Asia's rearmament cycle was already well underway long before the latest tensions emerged.

Japan's commitment to raise defence spending to 2% of GDP and its record defence budget of approximately JPY8.9 trillion were approved in early 2026 as part of a long-term strategy to strengthen deterrence against China's military expansion and North Korea's missile programme. Likewise, South Korea increased its 2026 defence budget by 7.5% to KRW65.86 trillion to enhance its "self-reliant defence" capabilities against North Korea’s provocation while Taiwan approved a supplementary TWD780 billion defence budget aimed at strengthening deterrence across the Taiwan Strait.

These decisions predate the latest Middle East tensions and reflect a broader shift in Asia's strategic landscape. Rising regional security risks and growing uncertainty over US security commitments have accelerated defence spending, with recent developments reinforcing that trend. In May, Chinese President Xi Jinping warned that mishandling Taiwan could trigger military conflict, while China stepped up Coast Guard and maritime activities around Taiwan throughout June. Separately, North Korea conducted missile drills on 25 June demonstrating its ability to strike South Korean airfields and critical infrastructure. Whether tensions in the Middle East ease or escalate has little bearing on the underlying security challenges facing Japan, South Korea, Taiwan and other regional governments.

The F126 cancellation reflects contractor failure not a spending retreat

Germany's cancellation of the F126 frigate programme has also been interpreted by some investors as evidence that government is pulling back defence effort. The reality is quite different.

The programme was cancelled after prime contractor Damen Schelde Naval Shipbuilding concluded it could no longer deliver the six vessels within the agreed budget or timeline. Rather than transferring the project to Rheinmetall's NVL division, which would have pushed total costs above EUR18 billion with deliveries beyond 2032, Germany opted for a more cost-effective alternative. It is now expected to procure eight MEKO A-200 frigates from ThyssenKrupp Marine Systems (TKMS) for approximately EUR11.6 billion, with the first deliveries scheduled as early as 2029. The underlying message is therefore one of procurement optimisation.

More importantly, the issues that plagued the F126 programme are not representative of Asia's leading defence contractors. The F126 project involved a highly customised first-of-class naval platform led by a foreign contractor operating within a complex multinational procurement framework - precisely the type of programme that has historically been vulnerable to delays and cost overruns.

By contrast, many of Asia's flagship defence programmes are built around mature domestic platforms with established production capabilities and proven export records. South Korea's Cheongung-II air defence system, K2 main battle tank and KF-21 fighter programme have all progressed beyond early development stages and are now seeing growing international demand. India's Project 17A frigates are backed by strong government demand, with several vessels already operational and the programme progressing without major delivery delays. In other words, Germany's procurement challenges should be viewed as an isolated contractor issue rather than evidence of weakening global defence demand.

India's delivery lag is a procurement-timing issue, not a demand problem

The most widely discussed concern in recent weeks has been India's defence sector, where several leading platform manufacturers reported disappointing FY2026 earnings despite maintaining record order books. At first glance, the numbers appear worrying. Hindustan Aeronautics (HAL) ended FY2026 with a record order book of INR2.54 trillion, up from INR1.89 trillion a year earlier, yet revenue increased by only 7% to INR330.9 billion. Bharat Dynamics reported an even weaker set of results, with revenue falling 27% while inventories surged 75%.

The slowdown reflects the mechanics of India's procurement system rather than any deterioration in underlying demand. Unlike many industrial companies, Indian defence manufacturers recognise revenue only after equipment has been formally accepted by the Ministry of Defence against contractual milestones. Production alone does not generate revenue. During FY2026, an unusually large gap emerged between procurement approvals and contract execution. The Ministry of Defence approved Acceptance of Necessity (AoN) projects worth approximately INR6.81 trillion during the year, yet only INR2.28 trillion of contracts were formally signed. This left more than INR4.5 trillion of approved procurement awaiting contract conversion.

As a result, manufacturers continued producing equipment while awaiting formal contract milestones, causing inventories and working capital to rise even as reported revenue lagged behind operational activity. This is largely a timing issue rather than a demand issue.

The strength of India's procurement pipeline remains clearly visible in companies that operate outside complex platform manufacturing. Component and subsystem suppliers have continued to deliver strong earnings because their products move through the procurement process more quickly. In FY2026, Solar Industries India recorded a 94% increase in defence revenue on the back of accelerated Pinaka rocket deliveries, while Astra Microwave grew revenue by 10.6% and increased profits by 25.7% through expanding margins.

In essence, the slowdown is concentrated among large, milestone-based defence platforms rather than across the broader defence industry. Demand has not weakened; instead, procurement administration has temporarily become the bottleneck. For investors, this distinction is critical. Execution risks should continue to be monitored over the coming quarters, but they should not be mistaken for the end of India's structural defence expansion.

Asia’s defence fundamentals continue to strengthen

Short-term market sentiment often focuses on headlines, but long-term investment returns are ultimately driven by fundamentals. Viewed through this lens, the investment case for Asian defence has arguably become even stronger over the past two months.

Combat validation has accelerated global demand for Korean defence systems

The Middle East conflict provided real-world validation for South Korea's rapidly expanding defence industry. The Cheongung-II air defence system reportedly achieved a 99% interception rate against ballistic missiles and a 93.7% success rate against drones during the Iran conflict. Its combat performance significantly strengthened international confidence in Korean air defence technology, with several Gulf states reportedly accelerating procurement discussions following the conflict. South Korean defence companies have already completed contracts worth approximately KRW9.5 trillion to supply the system to Middle Eastern customers, while negotiations for additional orders are progressing.

The momentum is evident across Korea's four largest defence contractors, Hanwha Aerospace, Hyundai Rotem, LIG D&A and Korea Aerospace Industries (KAI). Together, these companies reported a combined order backlog of approximately KRW100 trillion at the end of the first quarter of 2026, nearly double the level recorded just eighteen months earlier. At the same time, the group has now delivered four consecutive quarters of combined operating profits exceeding KRW1 trillion (Figure 1).

Figure 1: South Korea’s big 4 defence contractors’ operating profit have exceed KRW1 trillion for 4 consecutive quarters

This combination of expanding order books alongside record profitability is particularly encouraging. It demonstrates that companies are successfully converting existing contracts into earnings while simultaneously securing enough new business to replenish and continue expanding their future revenue pipeline.

Hanwha Aerospace illustrates this trend particularly well. Its export backlog increased from KRW26.6 trillion at the end of 2025 to more than KRW29 trillion by the first quarter of 2026. The company's growing international competitiveness was further recognised on 22 June when S&P Global Ratings assigned it an A- credit rating, the first global investment-grade rating awarded to a South Korean defence company, with its record order backlog cited as a key driver of future earnings visibility.

India's defence transformation continues to accelerate

Despite the temporary earnings slowdown, India's broader defence transformation continues to gather pace. Defence exports reached a record INR384.2 billion in FY2025-26, representing annual growth of 63%, while the government has set an ambitious target of achieving INR500 billion in annual defence exports before FY2029. At the same time, India's FY2026-27 defence capital expenditure increased by 21.8% to INR2.19 trillion , reinforcing the government's commitment to modernising its armed forces and strengthening domestic manufacturing capabilities.

HAL's record order book provides perhaps the clearest illustration of the underlying demand environment. Despite slower revenue recognition, its order backlog expanded by more than one-third during the year, indicating that customer demand is accelerating faster than the procurement system can currently process. For long-term investors, this is a favourable problem to have, provided the procurement backlog converts to revenue within a reasonable timeframe. It reflects capacity constraints within the procurement process rather than any shortage of demand for India's indigenous defence platforms.

Asian defence companies are becoming global defence partners

Another encouraging development is that Asian defence companies are no longer simply exporting equipment, they are becoming integrated into Western defence supply chains.

In June 2026, South Korea's LIG D&A announced plans to establish a European joint venture with Rheinmetall Air Defence to develop a multi-layered European air defence network. Hanwha Aerospace also expanded its partnership with France's Thales to integrate its Chunmoo guided rocket system with Thales' X-Fire mobile launcher platform, enhancing interoperability for European customers. Meanwhile, on 3 June 2026, US defence technology company Anduril Industries signed a memorandum of understanding with Taiwan's government-backed Metal Industries Research & Development Centre (MIRDC) to jointly develop uncrewed aerial vehicles, with a focus on autonomous systems and critical drone components.

Rather than competing solely as lower-cost exporters, Asian defence manufacturers are increasingly positioning themselves as long-term strategic partners within NATO and allied defence ecosystems. This not only broadens future revenue opportunities but also strengthens the resilience of their order books through deeper industrial integration.

A better entry point into a multi-year growth theme

The recent correction in Asian defence stocks has not been driven by weakening demand. Instead, the sector's long-term structural drivers have continued to strengthen. The region's geopolitical risks remain elevated. Defence budgets continue to expand. Order books across leading contractors are at or near record highs. Export momentum continues to accelerate, while Asian defence companies are becoming increasingly integrated into global defence supply chains.

We therefore maintain a constructive view on Asian defence and believe the WisdomTree Asia Defence Fund (NADSAQ: WDAF) remains one of the most compelling ways to gain diversified exposure to one of Asia's strongest long-term structural growth themes.

Based on our estimates, the WisdomTree Asia Defence Index could reach approximately USD509 by FY2028, implying around 44% upside from current levels. This translates into an estimated target price of approximately USD44 for the WisdomTree Asia Defence Fund by FY2028 (Table 1).

Table 1: Earnings estimates of the WisdomTree Asia Defence Index

WisdomTree Asia Defense Index	2025A	2026E	2027E	2028E
PE Ratio	37.3	33.2	25.3	20.8
EPS	9.5	10.7	14.0	17.0
Expected Earnings Growth	-	12.5%	31.3%	21.5%
Dividend Yield	0.7%	0.9%	1.1%	1.3%
Target Price (USD)				509
Upside Potential (based on fair PE ratio of 30X)				44%
Source: Bloomberg Finance L.P, iFAST Estimates. Data as of 29 June 2026.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.