The global aerospace industry touched bottom last year, but latest half-year results suggest the downturn is over, with sales and profits up
Prepared by Roland Berger Strategy Consultants, Flight International's annual Aerospace Top 100 survey reflects the bottom of a deep downturn, because it is based on 2003 results, but also shows an industry poised for recovery.
Although commercial revenues fell from 2002 levels, defence sales increased, and pricing pressures in the civil market are beginning to ease. Profit margins reached a low point, but largely because of restructuring efforts among the majors that are likely to have positive effects in 2004.
Roland Berger partner Neil Hampson sees reason for optimism in the 2003 figures. "Like-for-like, it was a flat market," he says. "There was not a lot of organic growth from 2002 to 2003. But there are indications that 2003 was the bottom of the trough, and there are signs of real optimism this year."
Boeing holds on to pole position in this year's Top 100, although its lead narrows yet again as revenues fell 7%, while sales edged up 1% at second-placed EADS, which has vowed to seize the number one slot within 10 years. Commercial aircraft revenues fell 21% at Boeing, compared with only 2% at Airbus, but were offset by a 10% increase in defence sales.
Boeing is projecting a recovery in revenues to $52 billion for 2004 as commercial aircraft deliveries stabilise and defence sales continue to grow at around 10% a year. EADS is projecting 2004 revenues exceeding $37 billion based on growth in its non-Airbus businesses. That will leave the gap between the two companies essentially unchanged.
Getting interesting
Things will begin to get interesting next year, with Boeing projecting a revenue jump to $57-59 billion in 2005 as airliner deliveries pick up and Airbus is talking about boosting production to 450 aircraft a year from 2006. With deliveries of the ultra-large A380 to begin in 2006, EADS is expecting revenues approaching $48 billion in 2007.
The world's largest defence contractor, Lockheed Martin, stays in third place in the Top 100 despite a 20% increase in revenues, largely driven by an almost 60% jump in military aircraft sales.
As expected, Northrop Grumman moves up to fourth place, with its sales boosted 52% by mergers, pushing BAE Systems down to fifth, where it is in danger of being overtaken by sixth-placed Raytheon.
BAE Systems is able to benefit only partially from the growth in US defence spending that is boosting rival firms, with its North American arm contributing to the company's modest 4% revenue growth in 2003. With Raytheon achieving 8% growth in 2003 and projecting slightly higher revenues of $20 billion in 2004, BAE's current ranking in the Top 10 may now be at risk.
Even after abandoning a merger with US government IT specialist Titan, Lockheed Martin is projecting increased revenues of $33.8-34.8 billion in 2004, so its ranking in the Top 10 looks secure - as does that of Northrop Grumman, which is forecasting sales of $29 billion in 2004.
The most significant change in rankings is General Dynamics' entry into the Top 10 at number seven, up from last year's 12 on the back of several acquisitions. With GD projecting increased revenues of $19 billion for 2004, the acquisitive US aerospace and defence company is clearly heading for the higher reaches of the Top 10.
Dislodged to eighth place by insurgent GD, United Technologies had a flat year for aerospace sales, with a 2% drop in revenues at engine manufacturer Pratt & Whitney offsetting a 2% increase at its Flight Systems sector, which combines systems supplier Hamilton Sundstrand and helicopter maker Sikorsky.
UTC is expecting growth in 2004, as is ninth-placed General Electric. GE's aircraft engines business saw revenues slip 1.5% in 2003, but projects a recovery to record sales of $12 billion in 2004, driven by increased commercial aircraft utilisation and a robust military business.
Thales holds on the 10th place, despite a 5% fall in revenues. Sales at Honeywell International slipped only 1%, but the company drops out of the Top 10, to 11th position, just ahead of Bombardier, which saw revenues stay flat as lower business jet sales offset higher regional jet deliveries.
Significant activity outside the Top 10 included L-3 Communications' rise to 16th place on a 26% increase in revenues driven by around $1 billion in acquisitions. The US company is projecting a 30% jump in sales in 2004, to $6.6 billion, which will put pressure on 15th-ranked Rolls-Royce.
Another acquisitive company, DRS Technologies, climbed to 48th place and the 22% jump in revenues forecast for 2004 is likely to lift the defence-electronics specialist to around 40th position. UK company Meggitt, by following the US acquisition model, is likely to jump from its current 64th place into the mid-40s of the 2004 Top 100 on the back of its take-over of Dunlop Aerospace's design and manufacturing business.
Other companies improving their ranking by achieving double-digit revenue growth in 2003 include Goodrich (18), Eaton (24), ITT Industries (25), Cobham (37), Sagem (40), Harris (42), Hindustan Aeronautics (50), B/E Aerospace (54), Denel (58), Esterline (61), EDO (72), RUAG (79), United Industrial (88), Latecoere (94) and Martin Baker, which enters the Top 100 for the first time at 98. If nothing else, this proves that good growth is not restricted to the USA.
Bottom of the downturn
Barring unforeseen events, 2003 was the bottom of the latest downturn in the cyclical commercial aircraft business. According to Roland Berger's analysis, this trough was no deeper in percentage terms than the downturns of the early 1980s and mid-1990s, says Hampson. Tempering the most bullish claims of Airbus and Boeing, and factoring in business and regional aircraft, the consultancy estimates annual deliveries will grow 51% over the next five years - from an expected total of around $50 billion in 2004 to almost $75 billion in 2009.
Based on a forecast growth in airline capacity of 7.2% annually over the next five years, Roland Berger expects Airbus deliveries to outstrip Boeing's, growing at 9.3% a year compared with 6.4% (in dollar terms). The consultancy expects business aircraft deliveries - down over the past two years - to grow by 6.1% a year, while regional aircraft deliveries - the bright spot of this downturn - are forecast to decline by 0.9% a year, again in dollar terms.
Airbus will take pole position in commercial-aircraft revenues in 2004, with deliveries expected to exceed the 305 aircraft forecast. Boeing is sticking to its 285-unit projection for 2004, but has raised its delivery forecast for 2005 from 300 to 315-320 aircraft because of increased demand for 737s. Airbus, meanwhile, is talking in terms of about 340 deliveries next year, with the emphasis on narrowbodies.
An expected recovery in business jet sales will benefit Bombardier, GD subsidiary Gulfstream and Textron-owned Cessna - respectively ranked third, fourth and fifth among commercial aircraft builders - as well as seventh-ranked Raytheon Aircraft and eighth-ranked Dassault Aviation. Although the regional-jet market may have peaked, the shift to larger aircraft will boost revenues at Embraer, which plans to deliver 170 aircraft next year - up from 160 in 2004.
US companies are the obvious winners in the defence aerospace sector, while their European counterparts continue to struggle with a flat and fragmented market. The growth in US military spending began feeding through to company bottom lines in 2003, giving sector leaders Lockheed Martin, Boeing, Northrop Grumman and Raytheon double-digit defence growth that is continuing through 2004.
While Lockheed Martin's greatest growth was in military aircraft, the systems integration businesses at all the US defence primes advanced strongly in 2003. "There will be a long-term shift to non-platform business," says Hampson. "But there is a huge commitment to platforms and it will only change slowly. While there are big non-platform programmes, they are a low percentage of the total."
Niche acquisitions
BAE Systems turned around its UK programmes business in 2003, with revenues rising 12%, but there is little prospect of growth in the domestic defence market. The company is focusing on the US market, where it has begun making niche acquisitions, while it works to improve the performance of its European joint ventures. France's Thales is also struggling to find growth in Europe.
Italy's Finmeccanica has set itself aggressive growth targets, aiming to increase its aerospace and defence revenues from $7.2 billion in 2003 to about $12 billion by 2006, which could take the company into the Top 10. Its latest step is to buy out GKN's 50% stake in their joint venture AgustaWestland, which had sales of $2.75 billion in 2003 - sufficient to place the helicopter manufacturer among the top 15 defence contractors in its own right.
Homeland security may be viewed as a logical adjunct to the defence market, but there was little sign in 2003 of any incremental revenues feeding through to aerospace companies. "Most majors are getting nowhere near their appropriate share of the homeland security market," says Hampson. The US Department of Homeland Security (DHS) has a budget of $40 billion, which is growing by 19% a year, but "most of the spending is going into administration, restructuring and IT tools, and traditional suppliers are not getting a fair share," says Hampson.
The picture may change when the DHS begins to make major equipment and system procurements. "The majors' opportunity will come when the big system integration jobs start, because the government is used to dealing with these companies," says Hampson. "Meanwhile, they need to go out and create the market."
All the major aeroengine manufacturers saw deliveries fall, and aftermarket sales increase, in 2003. Spares and support services, driven by increasing commercial-aircraft utilisation, are leading a recovery in 2004. The only significant changes in this sector involved ownership, the sixth-ranked MTU now owned by US private-equity firm Kohlberg Kravis Roberts; and eighth-ranked Avio (formerly FiatAvio) now owned 70% by US private-equity firm Carlyle and 30% by Finmeccanica.
Private-equity firms are interested in companies like Avio and MTU "because they see good cashflows in mid-size businesses that have long-term programmes and good aftermarket potential", says Hampson. "Aerospace is also a sector that has fallen out of favour with the public market since the technology boom. It has long product life-cycles and requires a lot of upfront investment."
Bolt-on acquisitions
Buying in at the bottom of the cycle, private-equity firms can take companies off the public market, restructure them, make bolt-on acquisitions and then cash out in five years at the top of the market, says Hampson. The Avio and MTU deals were notable in a year with historically low merger and acquisition activity. "A lot of the easy things have been done. What's left is at a transatlantic or a supplier level."
The space sector saw something of a recovery in revenues in 2003, but margins continued to suffer from the weakness in the commercial satellite and launch markets. Although the US military space market is growing strongly, the commercial market is forecast to remain depressed for several years.
Rationalisation is taking place, with EADS buying out BAE's 25% stake in satellite manufacturer Astrium in 2003. In June of this year, Alcatel and Finmeccanica signed a memorandum of understanding to merge their space activities. Two companies will be formed: satellite manufacturer Alcatel Alenia Space (67% owned by Alcatel and 33% by Finmeccanica), with estimated 2004 revenues approaching $2.2 billion; and a satellite services company (67% Finmeccanica, 33% Alcatel) with expected sales of exceeding $400 million.
Profit margins in the Aerospace Top 100 have taken a beating in the downturn, falling from a respectable - by aerospace industry standards - 9.7% in 2000 to a low of 6.9% in 2003. The main reasons are flat sales, restructuring costs and falling prices in the commercial market. US industry profitability fell relative to 2002, while Europe was broadly flat, a phenomenon Hampson blames on the "Boeing anomaly" - profits in its commercial aircraft business dropped dramatically in 2003.
It is still possible to make good money in aerospace, however, as the margin table illustrates (see P33). "It is a fact that a smart Tier 2 supplier can make more than a Tier 1 company and a Tier 1 supplier can make more than a prime," says Hampson. Margins are highest in niche suppliers with proprietary technology, such as GPS specialist Garmin, or companies with a strong aftermarket business, such as engine maker General Electric.
"GE is the best when it comes to owning the aftermarket business," says Hampson. "Boeing and EADS are looking at it, but the primes are not good at managing the aftermarket. They do not have the business model to make money from spares and services." As a result, as margins recover, the best the primes can probably hope for is about 10%, he says.
There were promising signs for the future in 2003, with research and development spending increasing in percentage terms. This was driven largely by higher US government spending on defence programmes such as the Joint Strike Fighter and Future Combat Systems, but company-funded R&D was also up on programmes like the A380 and 7E7 as product development moved into higher gear in anticipation of a recovery.
Hampson anticipates a largely jobless recovery because of the leaning-out of the industry over the past few years. While Airbus and Boeing will add people as production rates increase, "the Tier 1s will not", he says. He also expects greater outsourcing this time round, with companies moving work to eastern Europe, China and India rather than adding people as demand increases. In the long term, that could change the shape of the lower reaches of the Aerospace Top 100.
GRAHAM WARWICK / WASHINGTON DC
Source: Flight International