While defence rode to the rescue of the largest aerospace companies in 2002, those that rely largely on civil aviation still face difficult times

Aerospace felt the full force of the post-11 September crisis last year, the industry's first full year of operation after the terror attacks. But despite the deep slump in civil aviation and continuing poor demand for commercial satellites, the world's largest aerospace companies saw their profits maintained or even improved, according to Flight International's Aerospace Top 100 survey.

"Overall profitability is more or less unchanged despite the recession," says Neil Hampson of Roland Berger Strategy Consultants, which prepared the survey in association with Flight International. "It has been boosted by the beginnings of the higher defence spending in the USA," he says.

Hampson expects the growth in US defence spending to continue for at least another presidential term, even if George Bush loses the 2004 election. "I can't see it dropping," he says. And although operations in Iraq and elsewhere will consume a significant share of the US defence budget, Hampson expects procurement to account for a substantial slice of spending. "They need to do the Joint Strike Fighter, and a lot of it will go into network-centric warfare and other new technologies It will still end up with the major primes," he says.

The prognosis is less encouraging for the commercial aircraft sector, which is in a slump that began before 11 September as a normal cyclical downturn, but has been prolonged by the terror attacks, the Iraq war and the SARS virus. And while Boeing predicts a recovery in airliner deliveries in 2005, aircraft lessor and engine supplier General Electric does not foresee a rebound until the later half of 2006, or possibly 2007.

Slowly does it

While an early recovery would be good news for Airbus and Boeing, GE is among those which believe a slower rebound would be healthier for the industry, as it would give airlines more time, and incentive, to complete a radical and overdue restructuring of their business models.

The differing dynamics of the civil and military sectors are reflected in the performance and positions of the top-ranking companies in this year's survey, which is based on fiscal year 2002 results. While the positions are largely unchanged from last year, the gaps between the companies have closed, those with substantial civil businesses losing ground to those with predominantly defence portfolios.

Boeing stayed at number one, its revenues still almost twice those of second-placed EADS, despite a 7% decline in sales due to lower commercial aircraft deliveries. EADS's revenues slipped 3% on lower Airbus deliveries, while third-ranked Lockheed Martin saw sales surge 11%. BAE Systems was the only defence-dominated top ranker to lose ground in 2002, revenues dropping 8% on lower civil and military aircraft deliveries.

But this is the last year the UK's BAE will hold on to its number four slot in the survey. Northrop Grumman rose from seventh to fifth place (having moved from nine to seven last year) following its 2002 merger with TRW, and its projected 2003 revenues of $25-26 billion will boost it into fourth place, ahead of BAE and not far behind Lockheed Martin. "Northrop Grumman has finally appeared as a fourth major player," says Hampson.

Northrop Grumman's rise pushed Raytheon down a slot to sixth place despite a 5% rise in revenues due to higher defence sales. United Technologies (UTC) also moved one place down the table, to seventh place, for the same reason.

Less fortunate

While UTC was able to offset a decrease in civil sales at Pratt &Whitney and Hamilton Sundstrand with an increase in defence business at Sikorsky, eighth-placed GE was less fortunate, Aircraft Engines seeing a 2% drop in revenues.

Honeywell held on to ninth place, despite a 6% fall in revenues on lower commercial business. France's Thales entered the Top 10 for the first time, boosted by an 8% increase in revenues due to strong defence growth. Thales "is the real European winner", says Hampson. "Contrast that with BAE Systems. The question is how BAE is going to maintain its position [in the Top 10]."

Thales replaced Bombardier in the Top 10 after a dramatic decline in business jet deliveries caused the Canadian company's aerospace sales to drop 6% in 2002. Bombardier is likely to slip further down the rankings in 2003 to be displaced by fast-growing General Dynamics, which moved from 15th to 12th place this year on the back of a 15% increase in revenues due to acquisitions and higher defence sales. L-3 Communications was another fast mover, acquisitions boosting the US company from 25th into 18th place.

Boeing held on to its lead in commercial aircraft in 2002 (see table P44), despite sales dropping 20% to $28.4 billion on lower deliveries. Boeing Commercial Airplanes remained profitable last year, but faces the near-certainty it will be outstripped in deliveries for the first time this year by rival Airbus. The European manufacturer is projecting deliveries of 300 aircraft this year (compared with 303 in 2001), while Boeing expects to deliver 280 (down from 381).

Reduced forecast

The US manufacturer has cut its forecast for commercial aircraft deliveries in 2004 to a range of 275-290, down from 275-300, while Airbus is holding to its projection of 300 deliveries in each of the next two years. The European manufacturer, which is not listed in the Top 100 as it is jointly owned by EADS (80%) and BAE (20%), saw revenues slip 5% to €19.5 billion ($20.7 billion) in 2002, which would rank the company third (after adjusting EADS's revenues) in the overall listing.

Other civil manufacturers were affected mainly by the dramatic downturn in business aircraft deliveries, tied to the slowdown in the US economy. Bombardier took the drastic step of halting its business jet production lines for at least a month and delivered just 77 aircraft in its 2002-3 fiscal year, down from 162 a year earlier.

The business aviation slump steepened in the first half of this year, with manufacturers revising delivery forecasts further downwards, and order backlogs for 2004 are worryingly low. But with the US economy showing signs of a rebound there are hopes of a recovery beginning later this year. This is unlikely to have much of an impact of deliveries before 2005.

Mixed picture

The regional jet picture is mixed. While Bombardier increased deliveries in 2002 to 191 aircraft, and expects to deliver around the same number this year, Embraer's shipments fell to 131 aircraft with another drop, to 110 aircraft, forecast for this year. But Bombardier's delivery projection this year is under pressure due to upheavals in the US regional airliner sector, while Embraer's deliveries will pick up again next year.

Boeing merged its Military Aircraft & Missile Systems and Space & Communications businesses in July 2003, creating Integrated Defense Systems (IDS). In 2002, IDS accounted for 46% of the US company's revenues, thanks to a 9% increase in defence sales. This year the proportions will be reversed, with defence accounting for more than half Boeing's albeit-reduced revenues for the first time.

The Top 10 ranking of military aircraft manufacturers remains largely unchanged this year, although Dassault replaces Saab in 10th place. Not surprisingly, the US manufacturers saw significant gains in sales. BAE Systems is the only one of the 10 to see a reduction in military aircraft revenues. The UK company was forced to take a £500 million ($800 million) charge against its 2002 accounts to cover cost overruns on its Nimrod MRA4 programme, but the health of its military aircraft business has been boosted by the UK's decision to order new Hawk trainers.

BAE, EADS and Finmeccanica (Alenia) will all benefit from production deliveries of the Eurofighter, which was formally accepted into service in July. Lockheed Martin F-16 production will increase this year, and again in 2004, and Boeing is putting the F-15 back into production for South Korea. The long-awaited signing of the Airbus Military A400M airlifter contract is unlikely to have substantial financial impact at any of the European participants, led byEADS, for several years.

Offsetting decline

It is clear from the engines sector that the growth in US defence spending is only partially offsetting the decline in civil sales. While the manufacturers' rankings remain unchanged from last year, all but one - FiatAvio - saw sales fall or remain flat in 2002. Strong military orders did not stop revenues at GE Aircraft Engines falling 2%, but did allow Pratt &Whitney to hold sales essentially flat despite a slump in business engine deliveries at Pratt & Whitney Canada. In the first six months of this year, sales are down at both GE and P&W.

As engine supplier for the Lockheed Martin/Boeing F/A-22 and Lockheed Martin F-35 Joint Strike Fighter, P&W's military propulsion business looks secure, but questions remain about the future of its commercial engine business. Orders for Airbus A320 family aircraft powered by the International Aero Engines V2500, in which the company has a 32.5% stake, are about the only bright spot. "The question is whether Pratt & Whitney will drop out; they have seen their engines business declining over the last few years," says Hampson.

Key will be Boeing's decision later this year on engines for the planned 7E7 airliner. The manufacturer has said it will pick one or two powerplant suppliers, so at least one of the big three stands to lose out. Having joined forces with GE to compete against R-R to power the Airbus A380, P&W is the only one of the three proposing an all-new engine for the 7E7.

Elsewhere, interest is focused on Europe's smaller engine makers, following the takeover of FiatAvio (now just Avio) by the Carlyle Group and Finmeccanica. The US investment firm has now set its sights on DaimlerChrysler's MTU subsidiary, with the goal of consolidating the smaller European firms. Together, Avio and MTU would approach France's Snecma in sales. Add in Sweden's Volvo Aero and a new fifth-placed player could be created.

There was some movement in the rankings in the electronics sector, with defence-dominated companies showing healthy increases in sales. Raytheon performed particularly strongly to hold on to its top ranking, with defence electronics revenues growing by 10%, compared with 7% for Lockheed Martin's Systems Integration business. Thales was another strong performer, defence sales growing by 17%. Northrop Grumman and L-3 Communications were both boosted substantially by acquisitions. In contrast, commercial-dominated Honeywell and Rockwell Collins saw their sales slip.

With the major consolidations compete, the US defence electronics giants are increasingly turning to the government information technology sector for growth, with the emerging homeland security market an obvious target. Where Europe's BAE Systems and Thales will look for growth remains to be seen, but both have the North American market firmly in their sights.

Space grounded

The space sector is in trouble on both sides of the Atlantic, with depressed demand for commercial satellites exacerbated by the December failure of Europe's Ariane 5 ECA launch vehicle. Most of the major space manufacturers saw revenues flat or rising in 2002, their rankings remaining unchanged, probably because 2001 was an even worse year for the space industry.

And 2003 is not going well, although the February loss of the Space Shuttle Columbia has had little financial impact on the industry. The prolonged downturn is forcing some overdue consolidation, with EADS buying out BAE's stake in European satellite manufacturer Astrium earlier this year. More difficult obstacles remain to be overcome before the much-needed merger of Astrium with France's Alcatel Space and Italy's Alenia Spazio can become a reality.

US satellite manufacturers appear to have dodged the consolidation bullet for now, mainly because of the buoyant domestic military market. Its takeover of TRW means that Northrop Grumman joins the list of US satellite prime contractors alongside Boeing, Lockheed Martin and Loral, while Orbital Sciences and Spectrum Astro have the capability to produce smaller satellites. Some consolidation seems inevitable, however.

While Boeing's aggressive diversification strategy has succeeded in balancing the company's civil/military business base, it has increased the company's exposure to the downturn in commercial space. So far this year, the company has taken $2.3 billion in charges, a large part related to write-downs in the space sector, including its acquisition of Hughes Space & Communications and its investment in development of the Delta IV launch vehicle.

Fewer mergers

During 2002, mergers and acquisitions began to take a back seat to efforts to strengthen balance sheets, reduce debt, increase cashflow and shape portfolios. Northrop Grumman called a halt to further acquisitions after completing the merger with TRW. Annual revenues have risen from $7.6 billion in 2000 to $17.2 billion in 2002 on successive major acquisitions, and are scheduled to reach $30-32 billion by 2005, and the company has now embarked on a bid to reduce the substantial debt burden accrued during its shopping spree.

L-3 Communications has also seen significant growth, with its sales rising to $4 billion from $2.3 billion in 2001 on a series of small acquisitions. "They have a way of finding synergies in all their takeovers," Hampson says, adding that the result makes L-3 "a major player in defence electronics". The company's acquisition trail has continued into 2003, with the company most recently buying the military aircraft services arm of Bombardier, which is divesting non-core businesses as it seeks to strengthen its balance sheet.

General Dynamics has also been active, making several smaller acquisitions, mainly in government information technology, a sector where Lockheed Martin is also seeking to bolster its presence. But apart from these companies there has been little recent acquisition action. "Who has the appetite? No other majors want to grow through takeover. They are all talking about stabilising their business," Hampson says.

Three areas are most likely to see major acquisition activity in the near future. The first is transatlantic: BAE Systems chief executive Mike Turner's long-standing ambition of merging with a US company may come to fruition soon, Hampson believes, although "it now looks as if it won't be a merger so much as a takeover".

With BAE's share price still depressed after the spate of bad news on UK defence contracts late last year, the company will have difficulty meeting a major US player on equal terms. But political problems, including barriers to sharing technology, are likely to stand in the way of transatlantic mergers that do not involve US and UK companies, Hampson says.

Divesting and investing

Further down the list, "one to watch next year will be Smiths, which is divesting a lot of its businesses to focus on aerospace", Hampson says. Further small-scale acquisitions will mean that L-3 will continue to move up the rankings.

Thirdly, the last few years have seen increasing numbers of private equity companies move into the aerospace business. The most prominent is the Carlyle Group, which earlier this year announced the merger of Vought and Aerostructures, both of which it owns, and which has bought into Italian engine maker FiatAvio. Of the Top 100 aerospace companies, FiatAvio (34 in the Top 100), Vought (40), Dunlop Standard (51), Fairchild (55), Britax (76), Aerostructures (77) Doncasters (92) and RUAG (93) have been among those receiving investment from private equity groups.

Capital availability is behind this wave of investment. During the venture capital boom of the late 1990s, private equity funds raised huge sums only to see the collapse of the technology companies in which they had hoped to invest. This surplus capital is now finding a home in aerospace. "In the last two years a lot of private equity people have come in. Arguably, they did it at the wrong time, as the market was falling after 11 September, but it is a good market for them," Hampson says.

"[The industry] isn't well understood by the markets, because it relies on long-term contracts and needs long-term investment. Probably now it is most attractive [to invest] because we are at the bottom of the cycle."

But aerospace manufacturers in difficulties are unlikely to be rescued by equity investors. "The investors will need an exit route, and they won't go into businesses that need a lot of new capital investment. They will buy into ones with a decent portfolio, in the bottom 50 of the rankings. We could see a lot of them being chased by private equity companies."

Source: Flight International