Despite solid profits in recent years and a decade of stock market outperformance, the global Aerospace and Defense (A&D) industry cannot afford to be complacent in the face of an increasingly dynamic business environment, according to a comprehensive new industry report from AlixPartners, the global consulting firm.
The global A&D industry will need to successfully navigate a number of headwinds including, uncertainty in international trade relations, a rising oil price, significant stresses in a supply chain struggling with continued aggressive product ramp-ups, looming over-capacity in certain sectors of the industry, and wholesale changes in defense spending around the world.
AlixPartners has identified three key themes that will shape the industry in the face of these challenges in the years ahead:
1. A new era has arrived, centered on services, new business models and partnerships
· The leading aircraft OEMs have significant services-focused ambitions with the four leading players (Airbus, Boeing, Bombardier, Embraer) looking to increase services revenues by more than three times over the next 10 years from today’s $20bn per year to $66bn.
· A key driver to achieving this revenue goal will be a growing focus on insourcing and partnership initiatives which will reshape many existing customer and supplier relationships. Target areas will include continued investment in the growing Manufacturing, Repair & Operations (MRO) sector as well as new product development, training and data management.
2. These ambitions will drive continued M&A across the industry
· 2017 was a record year for A&D industry M&A and this momentum will continue as companies throughout the industry look to cut costs and seek new avenues for growth
· The top 10 M&A deals in 2017 had a total enterprise value of some $63 billion. almost three times 2016’s $24 billion figure. Significant levels of M&A activity will continue driven by strong appetite from both corporates and private equity with continued access to capital
3. Digital transformation will be a key driver of success
· The digital revolution offers significant potential for the industry. Companies that adopt comprehensive digital transformation across their businesses – from inbound logistics to product development and marketing – could see efficiency gains of up to 20% within three years, in addition to generating new revenue opportunities for those quickest to transform
· A&D companies are currently leaving cost savings of between 1% and 3% on the table by failing to appropriately leverage existing data. These quick-wins require no significant IT investment and yet are being lost as digital is still not a tier one priority for many.
David Wireman, Global Co-Leader of the Aerospace, Defense & Airlines practice at AlixPartners, said, “A new era is coming to this industry, one centered on new business models, on an industrial step-change in services, on partnerships and on digital transformation. Players in the industry are already moving at maximum velocity, but they can’t afford to be left behind in any of these areas. First-mover advantage will be critical to success.”
Wireman added: “While the industry has certainly recovered in recent years, it faces big challenges ahead. Between big ramp-ups, new demand from end-user customers and big structural changes inside the industry, the entire sector is being stretched to capacity. OEMs and suppliers alike need to be extremely vigilant that nothing reaches breaking point—and that means anticipating problems before they arise and employing the latest in digital technologies to predict and combat them.”
AlixPartners A&D Market Segment Overview
Airlines: profitability declining in the face of increased competition and capacity growth
While global airline revenue for 2018 is predicted to reach a record $834 billion, up from $754 billion in 2017, profits have declined from the peak of 2015/16 and are expected to remain flat at $57 billion this year. North America remains the world’s most profitable region, albeit margins are likely to decline here in 2018.
Fuel prices are expected to rise by 26% in 2018, following the record lows in 2016. While fuel cost’s share of global commercial airlines’ total operating costs has decreased by 25% between 2006 and 2017, 2018 is likely to be the third consecutive year of growth in this metric, to 28%.
Middle-East carriers are expected to face over-capacity, driven by an expected fleet increase (including no new orders) of at least 80% by 2025. This will require significant action, for instance through operational improvements and partnerships with other carriers.
Commercial aircraft: Narrowbody record backlog, Widebody production stabilising
The global passenger jet fleet is expected to almost double in the next 20 years, driven by growing air traffic. While the Airbus/Boeing duopoly will remain, ‘newcomers’ are representing an increasing challenge.
The Narrowbody sector is seeing a record backlog of 9.9 years on average, with production expected to ramp up but engine availability remaining the key roadblock. In contrast, the Widebody backlog is at its lowest level since 2010, at an average of 5.9 years, as production rates are expected to stabilise following a doubling between 2010 and 2017. Nevertheless, there are serious tensions in deliveries ramp-up, with selected suppliers facing strong difficulties.
Business jets: size matters
While deliveries hit a record low in 2017, with only 654 jets delivered globally, this is likely to pick up to an average of 854 between 2018 and 2026 – with almost 7,700 new jets delivered during the next eight years.
Large jets are likely to drive this growth, having seen a resurgence in deliveries in 2017. However, political uncertainty (e.g. around the Iranian nuclear treaty) remains a threat to the whole sector. The medium and light categories continue to see declining deliveries, signalling a shift in aircraft preference.
Aviation services: ripe for consolidation
The aviation services market is large (worth $257bn in 2017) and growing globally in line with manufacturing output. The world’s four leading aircraft OEMs are looking to increase their services revenue by more than three times in the next 10 years, with a growing focus on digital capabilities.
2017 saw 30 deals in MRO and aviation services alone. On top of this, several mega-deals involving system/equipment suppliers added up to more than $10 billion. This will continue as major OEMs increase their focus in this area and diversify their revenues.
Defense: panic buying
Global defense spend is accelerating, driven by increasing ‘threat perceptions’ and ongoing conflicts in the Middle East, South China Sea and Ukraine.
The US market, the world’s largest, is growing at 7.5% per year and the top 10 contractors are growing both profits and R&D investments in response to Department of Defense ‘offset strategy’ policies. Spend is likely to continue as the US responds to the growing stature of China and Russia, with hypersonics the government’s number one priority. Research into hypersonics is expected to grow by 136% between 2018 and 2019.
European spending is growing at around 1.5% per year on average, although most European countries remain far below the NATO growth target of 2% of GDP. After falling sales in 2013 and 2014, European defense players have returned to growth – albeit with flat margins. The PESCO agreement, signed in December 2017, will see a dramatic reduction in major weapons systems in the EU (from 180 to about 30). The industry is likely to see increasing collaboration, although driven primarily by political – rather than business – rationale. The combined impact of Trump and Brexit will see a concurrent ‘emancipation’ from US dependence and renewed motivation to reinforce the region’s defence ambitions.
Helicopters: eroding profitability to drive consolidation?
Despite growing revenues and deliveries increasing, albeit still 27% lower in 2017 than in 2013, EBIT margins continue to lag: 15% lower than in 2014. A combination of market pressures and a requirement for significant investment suggests the helicopter market is on the cusp of consolidation.
Aerostructures: dynamic, fragmented, consolidating
Demand is expected to rise only moderately through 2026, to $76 billion, vs. $62 billion in 2017. This is a fragmented segment where consolidation and M&A are already underway. This will accelerate, driven by technology portfolio broadening, outsourcing of non-strategic assemblies from OEMs, vertical integration from suppliers, and the acquisition of low cost countries’ capabilities.
Space: disruption and pressure in a growing industry
The $259 billion space market is growing by more than 5% per year, led by the ground equipment (+18.3%) satellite manufacturing (+7.7%) segments.
The satellite industry is undergoing a paradigm shift, from larger and more expensive geosynchronous orbit (GEO) constellations, to smaller, lower cost and shorter-life cycle non-geosynchronous orbit (NGSO) units targeting the consumer market. Pricing competition is putting margins under increasing pressure, however. An increasing number of space launchers are coming to market, playing catch up with SpaceX.