Russia Still Hasn't Invaded Ukraine, but How Is Europe Preparing for It to Happen?

The Cold War continues to blow chilly in Ukraine.

Over the weekend, Ukrainian government forces continued to make efforts to oust pro-Russian separatists (who may or may not be actual Russians) from the buildings they have seized in several southern and eastern Ukrainian cities, from Sloviansk to Kramatorsk to, most recently, Odessa. So far, the approximately 40,000 troops, tanks, and warplanes that Russia has amassed along Ukraine's eastern border, however, appear to be sitting tight. Another weekend has passed without a "hot" Russo-Ukrainian war breaking out.

But that doesn't mean Europe isn't getting ready for one.

It's not just Europe prepping: America's USS Donald Cook (DDG-75) is now on patrol in the Black Sea. Photo: Wikimedia Commons

All's quiet on the eastern front
While all's still quiet on Ukraine's eastern border, to the north and south of the country a pretty astounding amount of activity is taking place -- as Western Europe and the NATO military alliance prepare themselves to deal with what comes next. What follows is a (partial) list of the major developments, where they've been developing, and who's developing them -- plus a best guess at what all this means to investors.

Poland
On April 16, Poland's defense minister called on NATO members to follow Poland's lead and increase spending on their militaries to "guarantee that capabilities would grow and not deteriorate." And Poland's putting its money where its mouth is.

Last year, Poland beefed up its ground army with the purchase of 119 Leopard 2A5 main battle tanks from Germany. The country recently invited the United States to station a dozen Lockheed Martin (NYSE: LMT  ) F-16 fighter jets in-country. Poland has also purchased 48 F-16 fighter jets of its own -- along with five of Lockheed's C-130 cargo planes and 16 Airbus (NASDAQOTH: EADSY  ) CASA C-295 transports. The country is now taking bids from United Technologies (NYSE: UTX  ) , AgustaWestland, and Airbus on a deal to acquire 70 combat helicopters, and expects to award a contract late this year or early in 2015. Purchases of additional attack helicopters could come as early as 2017.

Romania
In nearby Romania (which, like Poland, shares a border with Ukraine), the government added $215 million to its fiscal 2014 defense. That may not sound like much, but it amounts to a 20% increase over previously budgeted spending levels. Proportionally, it's like the U.S. adding $33.6 billion to our own defense budget. Romania will use the additional funds to "modernize" its existing weapons systems.

The Baltics
To the north, Estonia plans spend $155 million on new "weapons, vehicles and ammunition" this year, part of a decade-long effort to modernize the Baltic nation's defenses. In particular, Estonia is in negotiations to buy 44 Dutch CV9035 NL armored personnel carriers, and aims to deploy the first batch next year.

Twice the size of Estonia, Lithuania has promised to double its $800 million military budget by 2020. Armored vehicles and new artillery systems are on the Lithuanian shopping list, along with new aerial security and surveillance equipment that may include Lithuania participating in a European Anti-Missile Shield System. Arturas Paulauskas, chairman of the Lithuanian National Parliament's Committee on National Security and Defense, said in an interview with Defense News, "Russia's expansionism and its involvement in the Ukraine and Crimea underlines the need for Europe to have an anti-missile defense shield."

Lithuania's not alone in this sentiment. Over the weekend, Lockheed Martin CEO Marilyn Hewson told CNBC that she's seeing "strong demand for ... missile defense systems" among European government customers. "Many of our NATO partners are also looking at our F-35 fighter jet programme."

Sweden's done gripin' about Russia's provocation in 2013. Instead, it's buying Gripens. Photo: Wikimedia Commons

Self-help for Sweden
Outside of NATO, but directly exposed to Russia over the Baltic Sea, Sweden is taking steps to bolster its own defenses. Sweden's air defenses were caught unprepared during a Russian simulated air attack on Stockholm last year, failing to get a single plane in the air to challenge a flight of Russian fighter jets and heavy bombers in March 2013. Sweden's Air Force has been cut in half since days of the Cold War, to fewer than 150 planes.

Calling Russia's occupation of Crimea "deeply unsettling," Sweden announced plans last month to increase annual defense spending by 12% over the next 10 years to $8 billion. The country plans to buy 10 new JAS-39E Gripen fighter jets and two new submarines to beef up its defenses. And taking a page from the "best defense is a strong offense" playbook, Sweden announced in April that it intends to equip some of its Gripens with cruise missiles capable of striking Russian territory from long range.

The West turns east
Back in what we think of as traditional "Western Europe," NATO is not standing still. NATO Secretary General Anders Fogh Rasmussen promised last month: "We will have more planes in the air, more ships on the water ... and more readiness on the land," promising to "immediately" beef up air patrols over the Baltic Sea, and send more warships to the Baltics and the eastern Mediterranean Sea.

Already, AWACS airborne early warning aircraft are patrolling the skies over Poland and Romania. The U.S. has sent 10 F-15 fighters based in Lithuania as a quick-reaction alert force. Poland is stationing four of its MiG-29 fighter jets in Lithuania, and the U.K. is sending four Typhoons to join them. Four F-16s are heading to Estonia, and four French Rafales will fly combat air patrol out of Poland, over the Baltic nations.

Additionally, Canada has sent six of its CF-18 fighter jets to Romania.

Meanwhile, in Ukraine 
NATO says it has no intention of sending combat troops to Ukraine, but in April, a NATO spokesman first mentioned the possibility of sending a small number of "advisors" to work with Ukraine on improving its defenses.

Meanwhile, the U.S. has so far approved only $50 million in aid for Ukraine, including MREs, medical supplies, bomb disposal equipment, communications equipment, vehicles and "non lethal individual tactical gear for Ukraine's Border Guard Service." Senate Armed Services Committee Chairman Sen. Carl Levin, however, is pushing the White House to supplement this assistance with body armor, fuel, and "certain types of weapons [that] are appropriate."

Will it be enough?
U.S. Gen. Philip Breedlove, NATO's top commander in Europe, warns that the 40,000 Russian troops on Ukraine's eastern border could cross with 12 hours' notice, and capture essentially all of eastern Ukraine in under a week. With so many of Europe's promises to strengthen its defenses expected to materialize only months or years in the future, it's unlikely that any of the above could prevent a Russian annexation of eastern Ukraine.

Rather, Europe's moves to increase defense spending and move military assets east appear to be aimed at containing the fallout (figuratively speaking) of a Russian move into Ukraine -- of preventing the next domino from falling. In this respect, These defense-bolstering moves in Europe could have real significance for investors in major defense-contracting companies, such as Lockheed Martin, Airbus, United Technologies, and others.

According to NATO policy, member states are urged to spend at least 2% of their gross national product on defense. Few European countries, however, are meeting this goal -- only Estonia, Greece, and the U.K., to be precise. Across Europe, the average NATO member spends less than 1.6% of GDP on defense (and Canada, a NATO member like the U.S., spends even less -- just 1%).

So just getting defense spending levels back to targeted levels -- let alone making extra investments to make up for lost time from years past -- implies more than a 25% increase in continent-wide defense spending. Individually, sure, an extra $100 million spent in a small country like Estonia or Romania won't have much effect on a U.S. defense contractor's bottom line.

Ballistic missile defense systems based on America's Standard Missile-3 could become high priority projects in European rearmament. Photo: Wikimedia Commons

But consider that United Technologies has a $30 billion defense business, and got 27% of its sales from Europe last year. That suggests that the company is already doing $8.1 billion or so in defense sales to Europe -- and could potentially add $2 billion to annual revenues from European rearmament. Lockheed Martin did $7.8 billion in sales internationally, with much of its business coming from Europe. A 25% defense spending boost there could add upward of $1 billion to Lockheed's revenue stream -- perhaps more, if Lockheed's CEO is right about European demand for its advanced F-35 fighter jet, and if Russia's extracurricular activities in Ukraine spur Europe to proceed with plans to build its European Anti-Missile Shield System.

Foolish final thought
The biggest winners from European rearmament, however, should be Europe's own defense companies. Airbus, for example, does $21 billion in defense business annually. That's small potatoes next to America's defense contractors -- but with more than 35% of its business coming from Europe, it amounts to a sizable $7.5 billion in sales annually.

Defense companies can pay dividends -- literally 
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. And did you know that in addition to offering impressive growth potential from European rearmament, defense stocks also pay some of the best dividends around? Knowing how valuable a portfolio rich with dividend stocks can be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.


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