A&D sector faces new wave of structural challenges
London, July 10, 2014
After a record year, the aerospace and defence (A&D) industry is likely on the verge of a new wave of major structural transformation and possible M&A moves, at the same time that commercial aerospace may be reaching its peak and as the “war on costs” intensifies in the defence sector.
New players and technologies, that many thought unheard-of just a few years ago, are also entering the industry. That’s according to a new study by AlixPartners, the global business-advisory firm.
2013 proved to be a record profit year for the industry with a 9.4 per cent Ebit margin, mainly driven by the boom in commercial aerospace. Average profitability of the top 100 companies in the industry reached a record level, close to a 10 per cent Ebit margin, with continuous growth since 2009.
Airline-industry Ebit remains much lower, at 3 per cent in 2013, with an increase to 4.3 per cent expected for all of this year.
However, what’s on the horizon for the A&D industry is likely not without turbulence, especially given declining defense budgets in Europe and North America, and the potential prospect of a cycle peak for commercial aerospace, considering the record backlog for Airbus and Boeing jets, up 17 per cent from 2012.
The AlixPartners study focuses on three main levers of structural and strategic change facing the industry today:
*the battle for the profit pool in commercial aerospace,
*signs of a new M&A rebound that could be on its way,
*disruptive innovations, led by SpaceX (Space Exploration Technologies Corp.), 3D printing and Internet giants such as Google and Facebook.
The overall A&D industry increased its profitability, driven by the commercial aerospace segment, whereas defence budgets declined for the second consecutive year in Western countries.
Profitability among the industry’s top 100 players reached a record level in 2013, nearly 10 per cent average Ebit margins; but a “cash culture” gap remains between Europe and North America.
In 2013, the A&D Top 100 revenue grew at a still-healthy 4.8 per cent, slightly down from 2012, driven by robust aircraft deliveries in the civil sector. Profitability improved significantly to a record 9.4 per cent of Ebit margin, rising above pre-crisis levels thanks to sales growth and better cost control.
Suppliers structurally enjoy higher profits than OEMs, a gap of 3.9 percentage points due partly to higher exposure to profitable aftermarket business. This is a clear cash profitability advantage for suppliers.
The dominance of North American players (9.5 per cent) over European ones (5.2 per cent) has never been so marked, driven by a combination of better profitability, working-capital management and asset utilization.
Commercial-aerospace revenues and fleet growth have been sustained by global air-passenger traffic, says the study, steadily rising at 4.8 per cent annually in the last 20 years and expected to grow at about the same rate for the next 20.
The passenger-jet fleet reached 19,200 aircraft at year-end 2013, up 78 per cent in 20 years, and the study forecasts that this will increase by 91 per cent over the next 20 years, with more than 32,000 new deliveries expected.
Asia Pacific could be the biggest beneficiary, with that region accounting for 37 per cent of the global passenger jet fleet by 2033, compared to 27 per cent today, said the study.
Yet, with a record backlog for Airbus and Boeing jets at 10,600 (up 17 per cent from 2012), 2013 may turn out to be the peak of the current commercial aircraft industry cycle, suggests the study.
The last few months have proven less than prolific in new orders. The sector might be entering a slower order-intake phase, as backlog at the end of 2013 is more than eight years’ worth of production and airlines are constantly adapting to changing market conditions, reassessing fleet growth plans and scaling down the type of mega-orders seen in recent years.
Commercial airline revenues are up but profitability remains low, diverging between much-improved US carriers and still-struggling legacy carriers.
Commercial airline revenues grew by 49 per cent from 2009 to 2013, with Ebit improving from 0.4 per cent in 2009 to 3.0 per cent in 2013, a level which is forecasted to grow to 4.3 per cent in 2014 – an improvement, to be sure, but still below many investors’ expectations.
The sector is also being driven by the continued expansion of Middle East-based carriers, led by Etihad Airways, Emirates and Qatar Airways, which are increasing their scale and scope through massive fleet orders and acquisitions and commercial agreements.
Due to their importance as launch customers and the sheer size of their order books, Gulf carriers are exerting significant influence on aircraft OEMs, in terms of new aircraft design, product strategy and production, and MRO footprint. European legacy carriers and cargo operators continue to face major challenges.
At the opposite end of the spectrum, the defense sector faces a major transformation as it faces declining sales, more-demanding challenges internationally and high cost structures.
Western defence spending continues its steep decline (down 13 per cent from 2010 to 2013); this may translate for some key players into a 20 to 30 per cent top-line reduction in the next three to five years.
Despite this trend, the US market remains the largest in the world with growth opportunities (in UAVs, cyber, mini-satellites, MRO, etc.), especially if companies succeed in creating agile business models, more partnerships and lower-cost solutions. The European market keeps declining with no clear sign of an upturn.
Growth markets such as China and Russia are mainly captive markets with most of the business directed toward domestic players, said the study by AlixPartners.
The few accessible international markets for Western players, such as Saudi Arabia, India and Brazil are therefore increasingly competitive. Consequently, European leaders are embarking upon a tough journey to execute much-needed structural changes to downsize and reshape their industrial base, at the right pace.
The new marketplace is highly competitive and fragmented. Most players are reshaping their footprint and offering to adapt to the lower structural Pentagon budget of around $550 billion, down 40 per cent from 2010.
Acording to the study, space is a solidly growing market, still heavily funded by governments, but where industrial players are facing new challenges.
Space is a solidly growing market ($270 billion in 2013), growing at an average 8.6 per cent per year since 2007, but still sustained by public funding by up to 30 per cent.
The study shows how the value is mostly in “downstream”, in satellite operators, with launch services and satellite manufacturers accounting for only 10 per cent of revenues in 2013 (US$20 billion) versus 90 per cent for satellite operations and services ($170 billion).
Legacy launcher OEMs must reinvent themselves quickly to respond to SpaceX challenges. The recently announced Airbus/Safran joint venture could be a clear step in the right direction to restore Ariane competitiveness, as is the announced merger between Orbital and ATK, integrating propulsion and launcher players.
Meanwhile, miniaturized satellites, or nanosats, are opening up space to a whole new range of users: these new, smaller satellites provide a degraded functionality compared to traditional satellites, but for a fraction of the cost – from about $150,000 to $1 million for such a satellite, including launch, vs. about $200 million to $1 billion for full-sized satellites, the study added.-TradeArabia News Service