ALEXANDER CAMPBELL / LONDON & GRAHAM WARWICK / WASHINGTON DC
The 11 September attacks prevented industry achieving the potential growth evident in the 2001 financial performance of the Top 100 aerospace companies
In 2001, commercial aircraft deliveries were heading for a peak, the finan-cial performance of merger-inflated industry giants was improving and defence spending was recovering from a years-long decline. Then came the terror attacks on the USA.
Barely three months later, the world's aerospace companies began reporting their 2001 annual results. As revealed by Flight International's Aerospace Top 100, produced in association with Roland Berger Strategy Consultants, and despite the aftermath of 11 September, the industry had a good year. The worst effects of the terror attacks have been reserved for 2002 and will linger into 2003. But the 2001 figures show an industry that was shaping up well after a difficult decade.
The economy in 2001 was expected to enter a brief "soft downturn", and the headline figures for the industry reflect this. Overall aerospace revenues rose 7.6% to $319 billion - the biggest rise since 1998 and up from just 1% growth in 2000. Most of the increase came from commercial aircraft. Deliveries of civil aircraft were expected to be higher in 2001 than in 2000, but represented "the hind end of the commercial cycle, "according to Gareth Evans, an aerospace and defence principal at consultants AT Kearney.
"Everyone realised there would be a downturn, but 11 September accelerated the forecast trend and no doubt prolonged it. Instead of the cycle following a sine-wave pattern it has bottomed out and may have plateaued for some time," says Evans. After 11 September, market projections were revised sharply downward. A sharp fall in civil aircraft deliveries is forecast for 2002 and 2003. "We know the sector has fallen off a cliff," he says, "and it has some way to fall yet."
Heroic customer-financing efforts in the final quarter enabled commercial aircraft manufacturers to end 2001 close to their delivery forecasts, but at the expense of this year and next. Airbus delivered 325 aircraft against a planned 334, but cut its 2002 forecast from 400 aircraft to 300. Boeing delivered 527 of a planned 530 aircraft, but slashed its 2002 output from 530 aircraft to 380. Airbus expects its deliveries to remain flat at 300 aircraft in 2003, while Boeing forecasts a further slide in its output to 275-300 aircraft.
Airbus is not listed as a separate company (see table p35), as it is jointly owned by EADS and BAE Systems, but its 2001 revenue of c20.5 billion ($20.8 billion) from the sale of 325 aircraft would rank it fifth in the list - still well behind Boeing Commercial Aircraft which reported $35 billion sales from 527 deliveries. Canada's Bombardier is the only manufacturer planning to increase airliner production in 2002, although the downturn in business jet sales will offset higher regional jet deliveries and the year-end total is forecast to remain unchanged from 2001 and 2000. Rival manufacturer Embraer will struggle to maintain its position in next year's Top 100, based on sharply lower orders for its regional jets, while Fairchild Dornier will exit the survey following its liquidation.
Boeing stays top
Boeing retained pole position in the Top 100 with its aerospace revenues increasing 13% to $57.9 billion, keeping the US giant almost $26 billion ahead of its nearest rival. Boeing Commercial Airplanes' share of total revenues was unchanged at 60%, but Military Aircraft & Missiles and Space &Communications - which have since been combined into a single entity - achieved a combined growth of 14%, largely due to the late-2000 acquisition of Hughes Space and Communications.
Projected growth in the merged Integrated Defense Systems sector will help Boeing retain its Top 100 position in 2002 and 2003, although revenues are forecast to decline to $54 billion and $52 billion, respectively, on lower commercial aircraft deliveries.
With healthy commercial aircraft deliveries, and the US defence build-up yet to kick in, EADS pushed Lockheed Martin into third place in the Top 100. While Lockheed Martin saw its aerospace sales fall 2% to just under $24 billion, EADS's rose 26% to $28.6 billion. Almost all the European group's growth was due to the continuing rise in sales at Airbus, which is 80% owned by EADS. Airbus revenues rose 38% in 2001, to 67% of EADS's total.
EADS is unlikely to hold on to its number two position, says Neil Hampson, an associate partner at Roland Berger. "Airbus is at the top of its delivery cycle, and Lockheed Martin has dropped two years running - but that is to do with how its contracts are timed." In 2002 and 2003 Lockheed Martin is likely to regain its old position. Airliner deliveries will take until at least 2004 to recover, hitting EADS as well as Boeing.
Northrop Grumman jumped from ninth to seventh place, displacing General Electric, as aerospace revenues rose 47% to almost $11.5 billion after acquisitions including Litton Industries. Including shipbuilding, total sales were $13.6 billion - up almost 80% over 2000 - and are forecast to approach $18 billion in 2002. Most of that growth will be in shipbuilding, but the acquisition of TRW's defence business later this year will boost aerospace's share of Northrop Grumman's 2003 revenues, forecast at $26 billion. Combined Northrop Grumman/TRW aerospace sales were $16.6 billion in 2001, which would have ranked the merged firm fifth in the Top 100.
Other companies moving significantly up the 2001 revenue rankings as a result of acquisitions include: General Dynamics, from 17 to 15 on sales up 12% to $6.8 billion; Alliant Techsystems, 50 to 33 on sales up 58%; Precision Castparts, 44 to 38 on sales up 39%; Israel's Elbit Systems, 56 to 47 on sales up 29%; and Canada's CAE, 55 to 49 on sales up 26%.
Fallers include Mitsubishi and Kawasaki Heavy Industries, hit by reduced Japanese military sales. Loral's revenues fell 19% in a depressed satellite sector, while Kaman's sales dropped 21% as the helicopter market dried up.
New entrants in the 2001 Top 100 include UK distribution services firm Umeco, in at 85 with sales up 16% to $275 million; UK components company Doncasters at 92; Swiss structures and support specialist Ruag Aerospace at 93;US structures and components firm DuCommun at 96: and French fastener specialist LisiAerospace (formerly GFI) at 99.
Sacrificing margins
Roland Berger's analysis (see table p39) shows little relation between a company's size and its profitability, measured by operating margin. But there is a link between a company's margins and its position on the supply chain. "It has always been the case that Tier 2 suppliers make more money," Hampson says. "Their products represent a small percentage of total [aircraft] cost, so there is less pressure on them to tighten margins. You are talking about $20,000-30,000 out of perhaps $30 million."
Despite this, many companies have declared their intention to move downstream - such as Smiths of the UK (at 32 in the Top 100) - sacrificing margin for greater control over a project. "Clearly this is the trend right now," says Jon Kutler, chief executive of investment bank Quarterdeck. "The industry is very insular, and tends to be dominated by trends - where one goes the others all follow.
Risk-sharing
"Traditionally, subcontractors have higher margins and the primes take more risk...but there is now pressure from the primes to reverse this trend, "Kutler believes. "Primes are moving risk and work upstream." Bombardier has led the charge with its risk- and revenue-sharing aircraft programmes, and now Airbus and even Boeing are following suit.
Evans believes this shift is one part of a larger trend in civil aerospace - namely, airframers are starting to see themselves more as service providers leasing out aircraft rather than metal-bashing manufacturers. Boeing Capital and Airbus Finance are set to grow significantly, he believes, which could impact independent lessors such as International Lease Finance.
"The manufacturers may cut them out by offering a full service package, "Evans says. "I can easily see in the not too distant future a portion of the market moving to [the airframers], who will be required to become banks, provide insurance and offer full-service solutions. They will need to move away from being manufacturers."
In the old model, a manufacturer takes the risk of investing capital in producing an aircraft that might not sell - but once the sale is made, whether to an airline or a lessor, the risk is over. If a manufacturer is to take on the extra risk of entering the leasing and finance business, it will need to balance this by reducing the manufacturing risk - pushing it down the chain by becoming a systems integrator and final assembler rather than a vertically integrated manufacturer.
No more mergers
Major mergers have been a defining feature of the aerospace industry for the past decade. As a result, in the USA, only four aerospace prime contractors are left: Boeing, Lockheed Martin, Northrop Grumman and Raytheon. If approved, Northrop Grumman/TRW is likely to be the last major merger for some time. Hampson explains: "Mergers are now something of a waiting game. Some super-primes have emerged...[and] further consolidation in the US will be difficult. Everyone is now valued at the same level, so there are no good deals left - the value point of mergers has gone away."
Large mergers are also unlikely further down the supply chain. The General Electric/Honeywell merger would have created a Tier 1 giant, with a $21 billion annual turnover, but its failure to win European Commission approval in 2001 chilled other suppliers that might have planned similar mergers. There were few mergers involving Top 100 companies in 2001, Hampson points out.
Northrop Grumman, which bought Litton Industries, Newport News Shipbuilding and the defence business of Aerojet-General for a combined $6.2 billion in 2001, could take several years to fully digest its acquisitions, "Northrop will have the same problems that Lockheed Martin had for three or four years," Hampson says. "It will be boosted by increased [USdefence] spending, but it will still be difficult for it to maintain margins."
Mergers are more likely among smaller suppliers than prime contractors, Kutler believes, reacting to a contraction intheir customer base. "Pricing is now veryattractive," he says. Evans agrees:"Consolidation is finished in the higher tiers. There will be some internal consolidation...and more mergers of companies further down the supply chain - it is still pretty fragmented".
Most mergers fail to provide the added value they promise for several years. Northrop Grumman's aerospace margins declined last year from 7.7% to 6.7%, while Lockheed Martin's rose from 5.8% to 7.5% after painful post-merger portfolio shaping. A slight decline in margin was common among companies that had undergone significant mergers or takeovers in the past two years - on average their operating margin was 9.01%, compared with an overall 9.64% for the Top 100.
A combination of merger activity and movement up the supply chain will cause Tier 1 and Tier 2 suppliers to show lower margins in the years to come.
Engine sales grew more slowly than aircraft sales in 2001 (see table p36). The major engine manufacturers saw only 3.3% sales growth, while commercial aircraft builders recorded an 11.2% increase. This discrepancy signals an important shift in strategy by engine manufacturers, Hampson says. "The engine industry is being transformed to providing power by the hour, having previously sold engines and made money from selling spare parts."
The old strategy has its weaknesses, especially in the current downturn: older, more maintenance-intensive engines tend to be in older aircraft now temporarily or permanently grounded, costing the manufacturers lucrative spares sales. Under power-by-the-hour contracts manufacturers are paid a fixed fee per operating hour, regardless of the maintenance required.
This shift could explain the lower growth in sales - the engine business is now "a 20-year game", says Hampson. But the changing business model is also "a major mood shift - they are no longer designing for failure, but designing for service," says Evans. "They have to rethink their entire design process."
Space in free fall
The space sector is expected to continue to perform poorly. Over capacity and a drop in demand for communications satellites have hurt both satellite and launcher manufacturers. BAE Systems has pulled out of its Astrium joint venture with EADS. Others may follow: Lockheed Martin is rumoured to be considering combining its satellite manufacturing business with that of Loral.
Three years ago the picture was different - the explosion that was forecast in broadband internet service was to have created unprecedented demand for satellite capacity. But the collapse of the dot.com and telecommunications industries has left the sector struggling. Satellite launches are not forecast to recover to 2001 levels until 2006 at the earliest.
Performance in the military sector was at best adequate in 2001 - total sales of the 10 largest companies increased 2%, compared with a 7% drop in 2000 - but the future of defence aerospace looks brighter. The attacks on America have spurred a sharp rise in US defence spending - although too late to affect the 2001 figures.
"The military sector is less cyclical, and will grow more in the next few years [than the commercial sector]," Hampson says. This is due to increases in procurement spending and production ramp-up on several large projects, such as the Boeing F/A-18E/F, Eurofighter Typhoon, Lockheed Martin/Boeing F-22 and Lockheed Martin F-16 Block 60. Also getting under way is development of the Airbus Military A400M and Lockheed Martin F-35 Joint Strike Fighter.
These programmes are more important to the industry than the overall rise in US defence spending, the effects of which have been overestimated, Kutler believes. There may even be initial negative consequences of the rise in spending, as the US Department of Defense, distracted by the exigencies of war, causes a "logjam" in project approvals, he says. But the initial delays are probably overand the additional cash is now starting to flow. The results should be evident in next year's Top 100.
Kutler says the market may have overestimated the impact of the planned $39 billion increase in US fiscal year 2003 defence spending, pointing out that much of it will go on operational expenses rather than procurement - although an increase in operational tempo will drive demand for spares and support. The higher defence spending will not be enough to reverse inevitable cuts in total F/A-18, F-22 and F-35 procurement numbers. "The cuts in JSF numbers were visible five years ago, but the decision was deferred for political reasons. One of the three programmes should have been cut. We still can't afford them," he says.
UAVs no substitute
The next step in military aerospace - especially according to Boeing, the losing competitor in the winner-takes-all JSF contest - is the unmanned air vehicle (UAV). But, Kutler warns, "an increase in UAV spending will not offset the cuts in F-22 and JSF numbers".
Also, the benefits to industry of the rise in defence spending will not be evenly spread. European nations have not increased their defence budgets significantly in the last 10 years and, Evans points out, the US government will predominantly spend with US companies, at least at prime contractor level. Non-US companies with a significant US presence (such as BAE Systems), as well as companies further down the supply chain, could pick up some of the benefits.
The electronics sector - including communications, sensors, avionics and information technology - is the most reliable performer, growing strongly in 2001 and is set to grow faster in the years ahead. Companies such as BAE, L-3 Communications and Raytheon stand to benefit from the latest military revolution known as "network centric warfare" or more simply called "transformation".
"If there is one value-adding area that will keep bringing the revenue in, it will be electronics," Evans says. And not only on the military side: he cites in-flight entertainment and communications as a long-term market, while acknowledging that the airlines' desire to keep costs down over the next few years will prevent the sector taking off immediately.
Increasing airspace congestion, tightening environmental restrictions, and heightened security concerns will all have their impact on future prospects for the aerospace industry. Evans sees increased potential for military-civil crossover. "Interviews we have done...suggest there is interest from commercial aircraft and airport operators in defence systems, both on aircraft... and on the ground." The perceived threat of attacks on civilian aircraft using shoulder-launched surface-to-air missiles is making operators consider using military countermeasures such as decoys to protect their aircraft, he says.
The headline events of last year happened almost too late to affect the aerospace business's final results for 2001. The terrorist attacks, the subsequent airline crisis and its knock-on effects for the manufacturing industry all came in the last few months of the year. Figures for 2002 will give a better idea of the industry's response to one of the greatest crises in its history - but the 2001 figures highlight that the outlook is not uniformly bleak.
Source: Flight International