Tanks or drones? Defense earnings reveal a more complicated rearmament boom

Drone technology and artificial intelligence are rapidly reshaping modern warfare, but the world's biggest defense contractors are finding that demand for tanks, fighter jets and other traditional military equipment remains strong.

Recent earnings from U.S. and European defense companies show conventional weapons continue to drive year-on-year growth, even alongside surging demand for advanced sensors, autonomous systems and counter-drone technology.

Rather than displacing traditional weapons manufacturers, the rise of drones and autonomous warfare is creating new business for many of the same companies.

From counter-drone defenses to advanced sensors integrated into tanks and fighter jets, the technologies transforming the battlefield are also changing, or even expanding, the markets served by legacy defense giants.

Legacy defense remains strong

Lockheed Martin reported a 24% jump in revenue from its missiles business in the third quarter, while RTX secured multibillion-dollar contracts for established missile systems. In Europe, German defense supplier Renk saw orders for its military vehicle business surge 46% in the first nine months of the year.

Yet, the same earnings also show how the boundaries between legacy weapons and emerging defense technology are increasingly blurred.

German defense electronics company Hensoldt reported a 52% jump in revenue from its optronics business, with its chief financial officer telling CNBC that much of the growth came from conventional military equipment, including tanks and armored vehicles.

Meanwhile, Rheinmetall's air defense business, which includes counter-drone systems, reported 63% revenue growth, even as the wider company cut its full-year outlook, citing project delays.

A changing battlefield

The rise of drones is transforming traditional military platforms rather than replacing them, with tanks and other weapons increasingly integrated into connected, data-driven battlefield networks, according to Morningstar.

Over the past five years and since Russia's full-scale invasion of Ukraine in early 2022, defense primes have seen their order books swell amid higher military spending among governments globally.

Yet, analysts mostly say that the rearmament boom is structural, and even an end to wars in Ukraine and Iran won't derail it. Crucially, Europe now has to play catch-up amid increasing uncertainty over U.S. security guarantees and Russia's next move, after decades of military underfunding.

However, concerns that valuations had run ahead of the industry's ability to deliver dented defense stocks this year amid several instances of project delays and contract cancellations.

Advancements in modern warfare and technology – as proven by Ukraine's use of drones on the front lines – further hit investor confidence in defense contractors amid worries that new technologies may displace demand for traditional military equipment.

Beyond the front line, NATO plans to invest more than $40 billion in counter-drone capabilities over the next five years, as Secretary General Mark Rutte warned that drones have fundamentally transformed modern warfare.

Even so, Hensoldt CFO Christian Ladurner told CNBC on Thursday that demand for traditional military equipment remains a key driver of growth.

Its fast-growing optronics business, which supplies optical and sensor technologies, is benefiting from European governments' efforts to replenish conventional military equipment, even as newer battlefield technologies attract increasing attention, Ladurner said.

He also highlighted growing demand for air defense systems, as militaries confront an expanding range of threats, from small drones to ballistic missiles, adding that the air defense market is "underinvested" despite growing by 20% a year.

Limits to Patriot interceptors produced by Lockheed Martin are being felt hard, not least in Ukraine, after the U.S. depleted much of its stockpile of the state-of-the-art system able to take down high-speed missiles in the Iran war.

U.S. midterm fears

More recently, defense stocks have come under pressure amid concerns that the Democrats' U.S. midterm victories could squeeze American military spending.

While the result has dampened expectations for defense spending, with Democratic control of Congress making a proposed $1.5 trillion budget unlikely and potentially weighing on military spending growth through 2029, nothing has materially changed the geopolitical calculations, TD Cowen analyst Roman Schweizer told CNBC's "Morning Call" on Thursday.

"This is a multi-year picture, and I think we've seen those changes both in the U.S. and also Europe," he said, referencing internal budgetary difficulties and questions around NATO's hiked spending targets.

Morningstar analyst Loredana Muharremi told CNBC Wednesday's weakness in European defense stocks was largely sentiment-driven.

"Some investors may now see a greater chance of stronger US backing for Europe, easing the pressure on European governments to spend more [but] even with stronger US backing, we expect Europe to stick to its spending plans," she said.

"It takes years of investment to close the gaps in Europe's own military capabilities and build the industrial capacity it needs to deter Russia."