Canada’s Defense Budget: Which Stocks Could Benefit From Ottawa’s Military Spending Push?

Q3 recap: Stocks fell as contracts started to arrive

“I would describe Q3 as a difficult quarter for a number of leading stocks, even as the underlying businesses showed encouraging signs of progress,” said Pandya. “Share prices for key defense and space companies such as MDA Space (NYSE:MDA, TSX: MDA) and Kraken Robotics (TSXV:PNG,OTCQB:KRKNF) were down significantly during the quarter,” he said in emailed correspondence, calling the drop “a useful reminder that near-term market performance can diverge sharply from the longer-term spending outlook.”

He continued: “At the operating level, the picture was more constructive,” Pandya said. “Results released during the quarter showed solid growth at companies including MDA and Calian Group (TSX:CGY,OTCPL:CLNFF), along with signs of improving profitability. These were encouraging updates, although they did not yet provide a complete picture of the most recent quarter.”

The main business drivers included “sovereign communications, surveillance, allied defense demand and commercial satellite investment.” MDA’s satellite manufacturing growth, for example, continued to benefit from its work building Telesat’s (TSX:TSAT) Lightspeed network.

“That is important because the growth of Canadian space companies is not solely tied to new domestic defense spending; commercial programmes remain a meaningful part of the opportunity,” he said.

Financing and acquisitions also gave investors more to consider.

Kraken completed its acquisition of Covelya in July, while MDA raised capital to support a a porposed majority stake in global satellite data company, CLS.

“In my view, the key question is whether that additional capital ultimately earns an attractive return, particularly after accounting for dilution and integration risk,” Pandya said.

The share-price slide hasn’t changed Pandya’s longer-term outlook.

“I still see this as the early stages of a long investment cycle,” he said. “Replacing ageing equipment, improving readiness and building industrial capacity will take years.” Canada’s Arctic needs and allies’ efforts to strengthen their own forces “extend well beyond any single budget or earnings season,” he added.

“What has changed since June is that we are seeing more concrete evidence behind the thesis,” he said. “Meaningful military communications contracts and additional manufacturing work are beginning to reach Canadian suppliers. That strengthens my confidence in the demand opportunity, while putting greater emphasis on whether companies can execute.”

In his view, NATO’s framework points to much higher defense and security spending in the coming years. “The direction is supportive, but annual funding decisions, spending priorities and implementation will determine how much of that opportunity becomes revenue for individual companies,” he said.

“So I would maintain the long-term thesis but remain selective about the stocks,” Pandya said. “The spending cycle and the stock-market cycle can move at very different speeds.”

The budget and what comes next

Canada’s security plan is a short framework.

It sets out five areas, including defense, with a detailed defense policy still to come. That leaves Thursday’s budget as the next chance to see how much money stands behind it. Pandya shared his comments before the security plan was released, but they point to areas investors could watch as the budget lands.

Ottawa has set a goal of steering most of its defense purchases to Canadian companies by 2035, a target laid out in its Defence Industrial Strategy in February.

Pandya said that Telesat’s contract with Canada’s Defence Investment Agency to provide secure military communications across the Arctic and MDA’s expansion of its work building satellites for Telesat’s Lightspeed network are “clear [examples] of government demand moving through a Canadian supplier network,” though he noted the announcements are “connected parts of the same programme rather than separate opportunities.”

“The evidence also extended beyond space,” he said. Magellan Aerospace (TSX:MAL,OTCPL:MALJF) won a contract to produce light anti-tank weapons in Canada, and Draganfly (CNSX:DPRO, NASDAQ:DPRO) received a firm initial order for tactical surveillance drones. “These are specific purchasing decisions that move the discussion beyond policy announcements,” Pandya said.

“That said, a substantial pipeline still has to convert,” he said.

Canada’s planned GlobalEye surveillance aircraft purchase is still at the term-sheet stage, which both Saab (OTCMKTS:SAABY) and Ottawa have said is not a commitment to buy, and another part of the Arctic communications program has yet to be bought. “Progress is encouraging, but I think investors should distinguish carefully between firm contracts, negotiations and longer-term plans,” Pandya said.

“I would measure progress through firm awards, delivery milestones and cash receipts,” he said. “Optional purchases and maximum contract values can make the secured business look larger than it is.” Draganfly’s deal is one example: its firm order covers a small first batch, while the government can choose to order many more systems later.

“Ottawa’s objective is to direct most defense acquisitions to Canadian firms. It is not a guaranteed allocation of the entire defense budget to Canadian public companies,” Pandya said. “The opportunity is meaningful, but suppliers will still need to win the work and execute effectively.”

“On procurement, I am watching whether reform actually shortens the time between requirements, contract awards and delivery,” Pandya said. “The proposal to establish a dedicated Defence Investment Agency could help, but the practical test will be execution.”

“In my view, secure satellite communications and surveillance should be among the strongest areas,” Pandya said, pointing to Canada’s need for better coverage of the Arctic and its coastlines.

He also expects more spending on drones and counter-drone systems, where “the commercial test will be whether successful trials lead to repeat orders at attractive margins.” He said munitions, air defense and secure production capacity should remain priorities across allied markets.

“Training, maintenance and sustainment may deserve more attention because they can generate business before major new fleets enter service,” he said, pointing to Calian’s long-term agreement supporting British Army training.

Cybersecurity should also benefit: as Canada phases cyber rules into its purchasing, he said, protecting contractor networks and connected systems “will become both a source of demand and an increasingly important condition for winning work.”

The US factor: Risks and openings

Pressures on US defense stocks, such as budget delays and higher interest rates, can reach Canadian companies too. “The spillover can be meaningful through both business exposure and market valuations,” Pandya said. “A Canadian listing offers limited insulation if a company supplies US programmes, depends on US customers or needs access to international capital.”

“US budget uncertainty can delay new awards and production increases even when the long-term requirement remains intact,” he added. Concern was evident the day after the US midterms, when defense stocks in the US fell on speculation that a Democratic-controlled Congress would put military spending under tighter scrutiny.

Companies funding factories, acquisitions or satellite networks before customers pay can also face higher borrowing costs. At the same time, stocks priced on profits that are “still several years away” can come under pressure.

“US policy can also create opportunities for Canadian companies with the right operating footprint,” he said, pointing to 5N Plus (TSE:VNP), which was selected to set up specialized component production at its Utah facility. “In my view, the best protection is company-specific: funded customers, manageable financing needs and a valuation that does not assume every programme arrives on time.”

Europe: New buyers, new trade-offs

Canada has also moved closer to Europe on defense this year. It became the first country outside Europe to join the EU’s SAFE defense funding program, which lets Canadian companies bid on European defense purchases on the same terms as European firms.

At their summit in Montreal last week, Canada and the EU agreed to expand their defense partnership, including on the defense industry and on maritime and space security.

“European procurement can help Canadian companies when it brings meaningful production, integration and long-term support work to Canada,” Pandya said. GlobalEye is one example: Saab’s system is built on a Bombardier (TSX:BBD.A,OTCPL:BDRAF) jet, and the proposal includes modification and integration work in Canada. “The ultimate benefit, however, will depend on the final agreement and the workshare that Canadian companies actually receive,” he said.

SAFE could give eligible Canadian suppliers “a better path into European procurement programmes,” he said, but “access still has to translate into contract wins.” He would focus on how much work is done in Canada, who owns the technology, whether the product can be exported and who maintains it over its life.

“There are trade-offs as well,” Pandya said. “Canadian suppliers already embedded in US platforms could miss incremental opportunities if Canada selects different equipment.” European programs can also come with rules on content, control and security. “Incorporation in Canada alone will not be enough,” he said.

Execution is the test

“The next earnings releases should provide a better indication of how effectively orders are converting into profitable delivery,” Pandya said. He will be watching growth, margins and cash flow, noting that MDA’s recent results “combined strong growth with cash outflows related to programme timing and investment.”

“The biggest operational risks are delays, cost overruns and the capital required to scale,” he said. “A strong spending outlook can still produce poor shareholder returns if a company overpays for growth, raises more capital than expected or earns disappointing margins.”

“When assessing the sector, I favour businesses with proven capabilities, the financial capacity to deliver and valuations that leave room for imperfect execution,” Pandya said.