Corrects company name in paragraphs 10 and 11 to MBDA instead of MBDN

By Paul Sandle

LONDON, Feb 19 (Reuters) - Europe's biggest defence company BAE Systems BAES.L said it could expand to meet surging demand if governments provide long-term guarantees on increased military spending, after it reported a record order backlog.

Shares in European defence companies have rallied in the last week after the U.S. told Europe's political leaders at a summit in Munich that they needed to increase military budgets, signalling a major change.

BAE CEO Charles Woodburn said "paradigm shifts" in European security could drive significantly higher defence spending, and that it was already having "high level" conversations with governments.

Analysts at Deutsche Bank said on Monday that correcting 10 years of underspending by NATO members to reach the current 2% target would cost 800 billion euros ($833.6 billion). They cited spending by Britain's defence ministry to show that about 40% went on equipment in 2023.

Deutsche said the European defence sector had to increase its capacity if governments wanted to bolster deterrence and avoid stoking already high defence equipment inflation.

Woodburn told reporters that any challenges to expansion could be overcome. "I think that they are things we can handle, providing we get a clear demand signal," he said on Wednesday.

"Given the threat environment, the trend is moving upwards," he said. "We can plan provided we get some clarity on the medium and longer term requirements."

Matt Dorset, equity analyst at Quilter Cheviot, said BAE stood to benefit significantly. "Not only will larger defence budgets drive demand, but Europe is also likely to focus on enhancing its own defence production capabilities rather than relying on U.S. exports."

FRAGMENTED EUROPE

BAE has benefited from a rise in budgets since Russia's 2022 invasion of Ukraine. It has also seen strong demand for combat vehicles and advancements in its fighter jet, submarine and frigate programmes.

Woodburn said defence procurement in Europe had been viewed as "challenging and fragmented", but that missiles company MBDA, jointly owned by BAE Systems, Airbus AIR.PA and Leonardo LDOF.MI, was a success.

"We should look at a company like MBDA as a potential template for the future," he said.

BAE Systems, whose biggest markets are the U.S., Britain and Saudi Arabia, has ramped up shell production since the start of the Ukraine war.

A new ammunition filling facility in South Wales will deliver an eight-fold increase in capacity from the middle of this year, Woodburn said.

He added that if the fighting stopped, Ukraine would need to rebuild, and would look to companies such as BAE to help.

BAE's full-year results showed it secured 33.7 billion pounds ($42.5 billion) of orders in 2024, taking its backlog to a record 77.8 billion pounds - three times its annual sales.

It said it was confident for the year ahead after it met forecasts with a 14% rise in both 2024 operating profit and revenue. It expects earnings to rise 8%-10% this year on sales up as much as 9%.

Its shares, which have risen 7% in the last 12 months, reached 1,369 pence on Tuesday, the highest since November. They were trading just off the high on Wednesday as it said nations were facing "increasingly varied and complex threats to security".

($1 = 0.7927 pounds)

($1 = 0.9597 euros)

(Reporting by Paul Sandle; Editing by Kate Holton, Philippa Fletcher and Jan Harvey)

((paul.sandle@thomsonreuters.com; +44 20 7542 6843; Reuters Messaging: paul.sandle.thomsonreuters.com@reuters.net))