Asian defence: The rally has stalled, but the growth story isn’t over

• South Korean defence stocks face near-term headwinds: Delayed export contracts in the Middle East, Europe and Latin America have weighed on sentiment, although the four major contractors still hold nearly KRW99 trillion in combined order backlogs.
  
  
• Rising Asian defence budgets underpin long-term growth: South Korea's proposed 2027 defence budget is set to rise 8.2%, India is considering a 25–35% increase in military modernisation spending, while Japan is preparing for further multiyear defence expansion.
  
  
• Earnings growth could accelerate from 2027: Despite strong 2Q2026 results, delivery delays may weigh on earnings in 2H2026. As deliveries resume and delayed contracts materialise, earnings momentum could strengthen in 2027 and beyond.
  
  
• Valuations offer a more attractive entry point: Following the correction, the WisdomTree Asia Defence Index trades at approximately 28X forward earnings, below our 30X fair P/E estimate. We project around 43% upside by FY2028, subject to earnings delivery and valuation assumptions.
  
  
• Stay constructive, but watch execution risks: We favour the WisdomTree Asia Defense Fund (NASDAQ: WDAF)  as a modest satellite allocation.

The Asian defence theme has encountered a difficult stretch after attracting considerable investor interest earlier this year. The WisdomTree Asia Defense Fund (NASDAQ: WDAF) saw its year-to-date performance turn flat in October 2026, reversing much of the enthusiasm that accompanied escalating geopolitical tensions in the Middle East.

Figure 1: Share price performance of the WDAF

The weakness reflects more than a change in geopolitical sentiment. Investors are increasingly concerned about the pace of new defence contracts, particularly among South Korean manufacturers, where several major export opportunities have encountered political, budgetary and delivery-related delays.

This is particularly significant for WDAF, given its substantial exposure to South Korean defence companies, which accounted for approximately 39% of the ETF as of 16 October 2026. Its major Korean holdings, including Hanwha Aerospace, Korea Aerospace Industries (KAI) and Hyundai Rotem, have all recorded negative year-to-date returns in Korean won terms, making them key contributors to the ETF's recent weakness.

South Korea: A strong order book, but slower contract momentum

South Korean defence manufacturers entered 2026 with substantial order backlogs built on years of successful overseas expansion, particularly in Europe and the Middle East. However, the pace of new contract awards has moderated.

For defence manufacturers, large contracts are crucial to both earnings visibility and equity valuations. A single export agreement can secure years of production, while delays in new contracts can raise questions about future backlog replenishment, even when existing deliveries remain healthy. That is precisely the challenge currently facing South Korean contractors.

Hanwha Aerospace's Saudi National Guard modernisation programme has reportedly been delayed by the Middle East conflict, while Korea Aerospace Industries (KAI) has seen a potential Indonesian aircraft order scaled back due to budget constraints. Hyundai Rotem faces even greater setbacks, with its prospective K2 tank deal in Iraq delayed by political uncertainty. In Peru, its proposed sale of 54 K2 tanks and 141 K808 armoured vehicles face budgetary and procurement hurdles, while a potential Romanian tank contract has been postponed amid political instability following a no-confidence vote.

These examples illustrate an important characteristic of the defence industry: strong military demand does not always translate into immediate contract awards. Defence procurement is heavily influenced by fiscal negotiations, political transitions, government approvals and lengthy tender processes.

This slowdown is beginning to show in order backlogs. By the end of June 2026, the combined backlog of South Korea's four major defence companies — Hanwha Aerospace, Hyundai Rotem, KAI and LIG Nex1 — had declined from approximately KRW100.4 trillion as of 1Q26 to KRW98.8 trillion (Figure 2).

Figure 2: Combined order backlogs of South Korea's four major defence contractors

Delayed contracts could revive South Korea's order momentum in 2027

We believe the recent weakness in South Korean defence stocks reflects an interruption in contract momentum rather than a fundamental deterioration in the industry's long-term prospects. The four major contractors still hold a combined order backlog approaching KRW 99 trillion. Excluding Hyundai Rotem, the other three companies have order backlogs equivalent to approximately four to five times their annual revenue, providing substantial revenue visibility over the coming years. Although the timing of new export agreements remains uncertain, underlying demand for military modernisation remains intact, supported by rising defence budgets globally.

Table 1: South Korea's major defence contractors hold order backlogs equivalent to up to six years of annual revenue

Korean defence contractors	Backlog-to-revenue ratio
Korea Aerospace Industries	5.9X
LIG Defense & Aerospace	5.2X
Hanwha Aerospace (Land Systems)	4.5X
Hyundai Rotem (Defence division)	1.6X
Source: Bloomberg Finance L.P., iFAST Compilations. Data as of 30 June 2026.

Importantly, there are already signs of progress. In September, Hanwha Aerospace secured a EUR411.8 million (roughly KWR 640 billion) contract with Croatia to supply 18 K239 Chunmoo multiple rocket-launcher systems and related equipment. While relatively modest compared with the substantial backlogs held by major Korean defence contractors, the deal highlights Hanwha’s continued expansion in Europe, with Croatia becoming the fourth European country to adopt the Chunmoo platform. In October, its US subsidiary also unveiled the XM1776 Mobile Tactical Cannon alongside the US Army, securing an initial order for nine prototypes with an option for nine more. While still at the development stage, the programme could open another significant export opportunity. Other Korean manufacturers also have potential catalysts ahead. Hyundai Rotem stands to benefit from deliveries under its second Polish K2 tank contract. Meanwhile, KAI's KF-21 fighter is progressing towards operational deployment, supporting domestic orders while laying the groundwork for future exports.

Beyond existing weapons platforms, Korean manufacturers are also strengthening their technological competitiveness. Hanwha Aerospace and Hyundai Rotem are developing autonomous ground vehicles and manned-unmanned combat systems, while KAI is integrating artificial intelligence and unmanned capabilities into military aviation. These investments position Korean manufacturers to benefit from the growing demand for smarter, more automated defence systems.

Nevertheless, these technological developments will take time to translate into commercial orders. For 2027, the more immediate earnings catalysts remain the execution of existing contracts and the conversion of delayed export opportunities into firm orders.

Home governments are funding bigger domestic orders

While export timing remains uncertain, the domestic spending outlook across Asia is becoming increasingly supportive.

South Korea: Military modernisation accelerates ahead of operational command transfer

South Korea has proposed an 8.2% increase in its 2027 defence budget to KRW73.3 trillion, or 2.33% of GDP, marking its largest increase in nearly two decades. A key driver is the Lee government's ambition to regain wartime operational control (OPCON) from the US by 2030, requiring stronger intelligence, command-and-control, missile defence and precision-strike capabilities.

This creates opportunities across different parts of the domestic defence industry. Hanwha Systems is positioned to benefit from demand for military communications, surveillance and command systems. LIG Defense & Aerospace and Hanwha Aerospace have exposure to missile and air-defence programmes, while KAI is a major beneficiary of investment in fighter aircraft, including the KF-21.

Crucially, these priorities are being reflected in actual budget allocations. The proposed spending on force improvement, including weapons acquisition and capability development, is set to rise 13.8% to KRW22.7 trillion in 2027.

India: Bigger procurement budgets, with domestic manufacturers the primary beneficiaries

India's defence modernisation offers another important growth opportunity, with the government considering a 25–35% increase in its military modernisation budget for FY2027–28. In September 2026, India's Defence Acquisition Council approved in principle approximately INR1.1 trillion in procurement proposals, covering helicopters, radar systems, reconnaissance vehicles and other military equipment. Notably, around 98% of the proposed procurement is expected to be sourced domestically, benefiting manufacturers such as Hindustan Aeronautics, Bharat Electronics (BEL) and Bharat Dynamics.

However, the key challenge remains converting procurement approvals into binding contracts. Major programmes continue to face lengthy technical evaluations, commercial negotiations and government clearances. For example, the approximately INR300 billion Quick Reaction Surface-to-Air Missile (QRSAM) programme, a significant potential order for BEL, is still awaiting final contract approval.

To address these bottlenecks, the government is working to streamline its Defence Acquisition Procedure. Combined with higher capital spending and domestic sourcing requirements, faster procurement could strengthen order growth and earnings visibility for Indian defence manufacturers.

Japan: A sustained military expansion supported by dedicated funding

Japan is undertaking one of the most significant defence expansions in its post-war history. Having brought forward its defence-spending target of 2% of GDP to FY2025, the government allocated approximately JPY8.8 trillion to defence buildup programmes in FY2026. The government is also considering further increases over the next five years as part of its national security strategy review, although the scale and funding remain undecided.

To support its existing military buildup, Japan introduced a 4% defence-related corporate tax surcharge from April 2026, while a new 1% surcharge on individual income-tax liabilities is scheduled to take effect in January 2027, offset by a corresponding reduction in the reconstruction income-tax surcharge. These measures demonstrate the government's commitment to securing longer-term funding for defence modernisation, rather than relying solely on annual budget increases.

This multiyear expansion could provide sustained order growth for domestic defence suppliers, including Mitsubishi Heavy Industries in naval vessels, missiles and fighter aircraft; Kawasaki Heavy Industries in submarines and military aircraft; and IHI in military aircraft engines and propulsion systems.

Earnings: Strong underlying demand, but recovery will be uneven

Despite near-term contract delays, Asia's defence earnings outlook remains supported by substantial order backlogs and sustained military modernisation, although growth drivers differ across markets.

For South Korean defence contractors, previously secured export contracts continue to support strong revenue and earnings growth. In 2Q2026, the four major contractors recorded combined revenue exceeding KRW10 trillion, while aggregate operating profit surged 45.6% YoY (Figure 3). This highlights the strength of their existing order backlogs, which continue to translate into deliveries and earnings despite a slowdown in new contract awards.

Figure 3: South Korea's four major defence contractors recorded 45.6% YoY operating profit growth in 2Q2026

However, quarterly earnings may fluctuate with delivery schedules. Defence revenue is often recognised as manufacturing or contractual performance obligations are fulfilled, making the timing of deliveries an important determinant of reported results. Hanwha Aerospace's Polish K9 howitzer deliveries are increasingly concentrated in 2027, while Hyundai Rotem's accelerated K2 tank deliveries to Poland in 2Q2026 leave fewer units scheduled for the remainder of the year. Both could weigh on earnings in 3Q2026. A stronger Korean won could also weigh on foreign-currency earnings, depending on hedging and contractual arrangements.

In India, earnings growth is supported by domestic procurement and import substitution. Hindustan Aeronautics (HAL) targets 10–12% revenue growth and an EBIT margin of approximately 30% for FY2027, although delayed GE engine deliveries remain a constraint on its Tejas fighter programme. Bharat Electronics (BEL) targets around 15% revenue growth and a 28% EBITDA margin, with the pending QRSAM contract offering further order-book upside. Meanwhile, Solar Industries India's expansion into higher-value defence ammunition and explosives provides another growth driver alongside its established industrial explosives business.

Japan's major industrial groups, including Mitsubishi Heavy Industries, Kawasaki Heavy Industries and IHI, are also benefiting from growing defence demand, alongside their broader aerospace, energy and industrial operations.

Overall, we remain constructive on the region's medium- to long-term earnings outlook, despite revising down our 2026 revenue expectations. Delayed deliveries and revenue recognition could weigh on 3Q and 4Q2026 results, but we believe much of this represents deferred rather than lost revenue. As deliveries resume and existing contracts are fulfilled, earnings growth could accelerate from 2027.

What could challenge our 2027 earnings recovery thesis?

The investment case remains subject to several important risks.

First, delayed contracts could be postponed further, scaled down or cancelled. Political support for defence modernisation may remain strong, but individual programmes still compete with other government spending priorities.

Second, a large order backlog does not guarantee strong profitability. Cost overruns, localisation requirements, production bottlenecks and delivery delays can reduce margins even when revenue visibility is healthy.

Third, valuations could remain under pressure if interest rates rise higher. Defence stocks may benefit from structurally growing demand, but they are not immune to broader market repricing.

Finally, geopolitical events can have conflicting effects. Rising military tensions may encourage governments to increase defence spending, but they can also interrupt negotiations, logistics and project financing, as seen in some of the Middle East-related contract delays.

We would therefore monitor two key developments over the next two to three quarters:

• South Korea's order backlog: Whether the combined backlog of the four major contractors stabilises and returns to growth and whether at least one significant delayed overseas contract is secured by mid-2027, particularly in the Middle East or Europe.
• India's procurement conversion: Whether large programmes such as QRSAM and Project-75(I) progress from approvals to binding contracts, providing greater earnings visibility for domestic manufacturers.

If backlogs continue to shrink and major contract awards are delayed beyond mid-2027, we would reassess the timing and strength of the expected recovery.

WDAF: A diversified way to participate, but position sizing matters

Overall, we remain constructive on the long-term outlook for Asian defence equities and believe the next phase of returns will be driven increasingly by actual contract awards, backlog replenishment and earnings delivery.

The WisdomTree Asia Defense Fund (NASDAQ: WDAF) provides exposure to defence manufacturers across South Korea, India, Japan and small exposure to Australia, Singapore and Taiwan (Figure 4).

Figure 4: The ETF’s geographic exposure

Following the recent correction, the underlying index is trading at approximately 28X forward earnings, below our assigned fair P/E multiple of 30X. This suggests a more attractive entry valuation compared with the earlier rally, offering potential upside as earnings growth and new contract momentum recover.

Based on our earnings forecasts and valuation assumptions, we project the WisdomTree Asia Defence Index could reach approximately USD473 by FY2028, implying around 43% upside from current levels, with a corresponding WDAF target price of USD40.

However, investors should remain mindful of WDAF's concentrated thematic exposure. As an ETF focused exclusively on Asian defence equities, with significant allocations to South Korea and India, it is particularly sensitive to country-specific risks, defence procurement cycles and shifts in investor sentiment towards the sector.

An additional concern is its shrinking fund size. Significant net redemptions since August have reduced assets under management to below USD10 million, raising potential fund-closure risk. While the reasons behind these outflows remain unclear, the smaller asset base adds another layer of uncertainty.

Given the sector's concentrated exposure and sensitivity to contract awards, alongside the ETF's small fund size, we favour WDAF as a modest satellite allocation rather than a core portfolio holding. This allows investors to participate in Asia's structural defence growth opportunities while managing the risks associated with a narrowly focused investment theme.

Table 2: Earnings estimates of the WisdomTree Asia Defence Index

WisdomTree Asia Defense Index	2025A	2026E	2027E	2028E
PE Ratio	35.0	31.5	25.4	21.0
EPS	9.5	10.5	13.0	15.8
Expected Earnings Growth	-	11.1%	23.9%	21.0%
Dividend Yield	0.8%	0.9%	1.1%	1.3%
Target Price (USD)				473
Upside Potential (based on fair PE ratio of 30X)				43%
Source: Bloomberg Finance L.P, iFAST Estimates. Data as of 19 Oct 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.