Top 100 aerospace manufacturers: as good as it gets

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Last year could be as good as it gets for an aerospace industry giddy at its own success - for a while at least. A torrent of orders - particularly in the commercial aircraft sector - saw the world's largest 100 manufacturers continue to grow their businesses during 2007: revenues increased by 13% and profits by a massive 26% (after restatements and including acquisitions). This compares with equivalent growth rates of 12% and 8% respectively in 2006, and 8% and 17% the previous year.

That is according to the latest Flight annual Top 100 survey, compiled in association with PricewaterhouseCoopers and based on company returns for the previous financial year.

The survey also found that average operating margins of almost 9.4% in 2007 were the highest they have been since the previous peak in 2000, just before the World Trade Center attacks sent the airline and business aviation sectors into tailspin. By 2003, operating margins had sunk as low as 6.9%. They have been climbing more or less steadily since.

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The reason for the upswing in revenues has been bulging orderbooks, with original equipment manufacturers and their supply chains enjoying near-unprecedented demand for their end products, particularly narrowbody airliners, but also widebodies such as the Boeing 787 and business jets, and the technologies and systems deployed on them. However, with manufacturers struggling to hit some of their delivery schedules last year, there were signs that the wheels on a seemingly unstoppable aerospace wagon were starting to wobble.

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Capacity constraints, either through an inability or an unwillingness to ramp up too quickly, have almost certainly been the biggest brake on growth figures being even more impressive. OEMs and suppliers simply have not been in a position to recruit the skilled staff or add production infrastructure quickly enough without compromising quality. Bottlenecks in the supply chain have been the main cause of delays to a number of programmes, most notably the 787.

787 production 
 © Boeing

At the same time, the industry has been clobbered with the double whammy of a weakening air travel market when orderbooks are at their fullest, while - like the airlines with the price of oil - having to contend with rising commodity costs. For the manufacturers, this includes everything from metals and resins to the electricity needed to power their equipment. Although 2007's high margins suggest that most companies were able to absorb these thanks to soaring revenues, they are likely to seriously affect the bottom line over the next 12 months.

Matthew Alabaster, director of strategy at PricewaterhouseCoopers, expects the momentum to continue for now and for 2008 to remain a strong year in terms of overall profitability for the Top 100 companies. "The demand environment is beginning to shake, but it should be solid throughout this year," he says. However, 2009 could see some softening of demand with little sign that raw material prices will begin to fall. "There are clearly storm clouds brewing," he warns.

ARTIFICIALLY STRONG

The rosy figures for 2007 also disguise other concerns for many members of the Top 100, particularly the Europeans. As always our figures have been "dollarised" on a fixed exchange rate for the entire 12 months, and last year's figures have been adjusted where appropriate to make for more transparent year-on-year comparisons. The strength of the euro against the dollar means that results for companies that report in the European currency look "artificially" strong as the exchange rate used for our survey moved from almost 0.8 euros to the dollar to 0.73 over the period.

This means EADS, for instance, grew revenues from just under $49.5 billion to $53.5 billion, even though, in euro terms, its turnover actually fell slightly between 2006 and 2007. In fact, taking the tumbling dollar into account and using last year's exchange rates, "real" growth for the Top 100 was 10% rather than 13%, says PricewaterhouseCoopers.

The weak greenback has been an increasing problem for companies whose revenues are in dollars but most of whose costs are in a local currency. It is not just those in the eurozone that are affected. The dollar fell against the UK pound from 0.54 to 0.49 between our two most recent surveys, while currencies including the Swedish kroner, Canadian dollar and Japanese yen have all appreciated to the detriment of domestic companies selling to global customers, who face either raising their dollar prices or cutting their costs to retain their margins.

The problem has been diluted for manufacturers that have significant US cost bases, such as BAE Systems. The UK's aerospace and defence champion saw its sterling revenues rise significantly (partly due to US acquisitions including Armor Holdings). In fact, many European businesses have taken advantage of the weak dollar to buy US assets at knockdown prices. The amount spent by European companies on stateside acquisitions quadrupled in 2007, says Alabaster, with the attraction being not only the ability to hedge against currency fluctuations but a foot in the door to the lucrative US defence and domestic security market.

This has been easier for some European companies - particularly those further down the supply chain - than others. EADS, still comfortably the world's second biggest aerospace and defence company, has been hit hardest, a victim of its large European industrial footprint and inert inability - largely for political reasons - to dollarise its cost base. Although the group has established some US production, most notably with its American Eurocopter business and, it hopes, an assembly plant for Airbus refuelling tanker aircraft, the vast bulk of its workforce and supply base remains rooted in its home markets. Initiatives such as the Power8 cost-cutting drive at Airbus have slowed rather than stemmed the bleeding of cash, with the mounting costs for the development of the A350 and delays to the A380 and A400M adding to the European giant's problems and forcing EADS into the red in 2007, despite its swollen orderbook.

CURRENCY EFFECT

The currency effect can be overstated, however. Even when the exchange rate change is discounted, two thirds of Top 100 manufacturers still enjoyed double-digit growth rates in aero sales. These included 16 of the biggest 25 companies: BAE Systems (14.1%), United Technologies (16.6%), Thales (19.8%), General Electric (29.2%), L-3 Communications (11.9%), Safran (11.4%), Honeywell (10%), Bombardier (17.1%), Textron (17.9%), Goodrich (11.8%), Dassault Aviation (22.6%), Embraer (39.5%), ITT (14%), Eaton (12.5%), Rockwell Collins (14.3%) and Spirit AeroSystems (21.6%).

US companies did better in terms of profitability, increasing average operating margins from 10% to 12%, while European companies were flat at 6%.

Neil Hampson, global head of aerospace and defence at PwC, puts the fact that margins are rising generally down to manufacturers learning lessons from the previous downturn and taking action to get their production and procurement processes in order. "A lot of companies between 2002 and 2004 spent time getting their supply chains sorted out," he says. "In the previous peak it was all about meeting demand at all costs. This has meant reorganising and streamlining operations. That industrial process has set many of them in good stead as demand has come back on line." In general, he says, today's Top 100 companies have more efficient businesses and more advanced supply chain management techniques than in the last upturn.

Although the margin figures hide large disparities between the best and poorest performers, overall, aerospace fares very well in the wider engineering and manufacturing sector. Rockwell Collins, Precision Castparts, Hindustan Aeronautics, Chemring and Garmin all notch up operating margins above 20% and many others are in the mid to high teens. "There are some incredibly high margins. When you are in the 20-25% range in a business of scale, you are doing exceptionally well," says Hampson.

With quite a lot of merger and acquisition activity in the industry, there has been some change in the overall Top 100 rankings this year. GE's acquisition of the Smiths Group's Aerospace business saw the latter disappear from the list for 2007. A similar fate befell brake manufacturer K&F Industries, acquired by the fast-growing Meggitt, which vaulted four places to 43 partly as a result of the takeover, as well as EDO, which was snapped up by ITT Industries, and United Industrial, now part of Textron.

With Circor International dropping out of the lower reaches, three new entrants have made it into the listing: Héroux-Devtek, Diehl, and Hampson Industries. South Africa's Denel makes a return at anchor position having dropped out last year, although the restated figures mean it would have come in at number 98 in 2007. Britax has been renamed PAIG and the former Melrose aerospace business is now McKechnie. Hawker Beechcraft - previously the aircraft division of Raytheon - enters the Top 100 in its own right at number 31, while its erstwhile parent drops a place to 8th, partly as a result of the divestment.

The upper echelons of the ranking have a familiar feel, with the big US primes and equipment makers dominating the scene with seven of the top 10 places (eight if you count the increasingly American BAE Systems). The top four are the same, with BAE Systems and General Dynamics swapping places at five and six and United Technologies and Raytheon doing the same at seven and eight. Thales has broken into the top 10 at number nine, exchanging with Finmeccanica, which is now 11th.

Further down the listing, those on the up (based on last year's restated rankings) include Precision Castparts (from 30 to 27), Saab (32 to 29), Elbit (43 to 41), B/E Aerospace (50 to 47), Latécoère (75 to 71) and Chemring (87 to 82). Vought, Volvo Aero and three Japanese companies - Mitsubishi Heavy Industries, Kawasaki Heavy Industries and Jamco - have all dropped places.

The 80/20 rule still applies, with the top 20 manufacturers responsible for four-fifths of overall sales and 77% of operating profits. The top 20 lose their edge slightly on operating margins, with average margins of 9.0% compared with almost 9.4% for the Top 100 as a whole. However, much of this discrepancy is down to the problems at EADS, which made a loss of $45 million in the financial year, dragging the average down. Nevertheless, despite EADS's difficulties, the top 20 increased their operating margins from 8.0% in 2006.

As in recent years, defence businesses had a quiet 12 months as budget pressures in the USA and elsewhere continued to affect procurement on high-profile programmes. Boeing's Integrated Defense Systems unit failed to grow in 2007, while other pure defence companies such as Lockheed Martin (5.7%), Northrop Grumman (6.3%) and Raytheon (8.1%) returned modest growth numbers.

DEFENCE SPENDING

The continuing tempo of campaigns in Afghanistan and Iraq and the terror threat mean defence spending remains relatively strong compared with the "peace dividend" years in the 1990s, delivering reasonable profitability. However, the profile of that spend is changing, says Alabaster. "There is a refocusing into the homeland security and C4ISR segments and manufacturers are trying to redefine themselves from defence contractors into defence and security specialists. This can cover everything from security of businesses to internet threats." Most traditional suppliers have some way to go, however. "A lot of companies are redefining their positions, but no one has yet really cracked it," he says.

Business aviation - in the doldrums in the early part of the decade after the dot com bubble and a wave of corporate scandals - has rebounded exceptionally strongly in the past three years. But it has been new markets in Asia, Russia, the Middle East and Latin America, and a move to attract new customers into areas such as air taxis, charter and fractionals on innovative product such as very light jets, rather than traditional US big business, that have driven the expansion. These growth areas are likely to continue more than compensating for any softening of demand among boardrooms in North America.

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As a result, manufacturers enjoyed a buoyant year. General Dynamics' Aerospace business (which includes Gulfstream), Bombardier, Textron's Cessna division, Dassault's Falcon operation, the executive aviation arm of Embraer and the now independent Hawker Beechcraft all saw a significant increase in revenues, while the sector's success undoubtedly had an impact on engine manufacturers and others down the supply chain.

Looking after equipment throughout its life rather than simply manufacturing and selling it can, of course, be very profitable and companies with large aftermarket businesses are among those with the highest margins in our survey, including Chemring, General Electric and Meggitt. The electronics and avionics sector also seems to deliver its manufacturers healthy returns. Strong performers here include Garmin, Rockwell Collins, Honeywell, Cobham, Harris and CAE.

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Three regions conspicuous by their absence from the Top 100 are China, Russia and the Middle East. In the first two instances, lack of financial transparency and the heavily state-influenced structure of these industries makes it difficult to obtain reliable results for the likes of Sukhoi, Irkut and China's two Aviation Industry Corporations, all of which in terms of scale would be Top 100 contenders. In the case of Russia, this could be changing as Moscow opens up more of its aerospace industry to private domestic and overseas investors and markets its first real "Western" airliner, the Sukhoi Superjet 100 regional jet, to the world.

Middle Eastern institutions have been buying into the West's aerospace industry for some years, with companies ranging from Doncasters and Islander manufacturer Britten-Norman to US light aircraft builders Liberty Aerospace and Cirrus Design now majority-owned by Gulf investors. But the emergence of Dubai Aerospace Enterprise and Abu Dhabi's Mubadala in the past two years as groups with ambitions to build global aerospace portfolios changes the game somewhat. So far, both companies have tended to focus on the maintenance, repair and overhaul and flight training sectors, with DAE also moving into aircraft leasing and Mubadala securing an interest in Italy's Piaggio, maker of the Avanti twin-pusher business aircraft. Manufacturing, or at least high-value engineering and design, is set to be next with both companies' strategies pitched at diversifying their national economies by creating high-skilled jobs.

"I expect to see Middle East investors continuing to build their capabilities in infrastructure, OEMs and the aftermarket," says Alabaster. "They provide technology transfer opportunities and fulfil their aims of creating knowledge-based economies. It's the sweet spot for them."

The Chinese too "clearly have aspirations to be world class in the global market and will possibly look at European assets", he adds. At the root of it is the growing imbalance between the regions where demand for the industry's end products is growing fastest - the "BRIC" countries of Brazil, Russia, India and China, plus South-East Asia and the Middle East - and the regions where manufacturing is concentrated: only five of our Top 100 companies are based outside North America, Europe (including Israel) or Japan.

Governments whose airlines and businesses are contributing most to the aerospace industry's revenues and profits are keen to have a bigger return in terms of the substantial intellectual capital the sector brings with it.

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