The next big idea

Kevin O'Toole/LONDON

Stock markets may not always be right, but they are also very hard to ignore. So when Wall Street began to discount aerospace stock earlier this year it was a brave executive who turned a blind eye.

Perhaps most troublesome is the timing of the slump. It comes at a point in the cycle when, by most reckonings, international aerospace markets are in fine shape. Civil sales are setting new records and even the defence sector can see a glint of blue sky ahead after years of savage spending cuts.

Anyone doubting the extent of the boom need only look at this year's Aerospace Top 100 - a ranking of the world's largest aerospace groups compiled by Flight International and Booz Allen & Hamilton, a leading international management and technology consultancy. The usual health warnings apply about some notoriously variable international accounting standards and the impact of currency fluctuations, but there is no disguising this is a boom.

On the strength of the top 100 figures it seems that industry sales leapt by more than 17% last year - dramatic growth by any measure and the strongest performance since the industry began to wade its way out of recession nearly five years ago. Profit margins, too, kept pace at just over 7% - an industry-wide performance that would not embarrass most engineering sectors.

	THE EMERGING AEROSPACE RANKING - MID-1998
			Aerospace	Relevant acquisition/
	Group	Country	Sales ($m)	merger information
1	Boeing	USA	55,000	Civil production rate increases
2	Lockheed Martin	USA	25,500	Disposals complete and Northrop merger abandoned
3	Raytheon	USA	17,500	Full year of Hughes Aircraft acquisition
4	Aerospatiale*	France	15,000	Pending merger with Lagardère*
5	British Aerospace	UK	15,000	Siemens Plessey acquisition, etc
6	United Technologies	USA	10,700
7	Daimler-Benz Aerospace	Germany	10,400	Siemens Plessey acquisition
8	General Electric	USA	8,500	Full year of Greenwich/UNC acquisition
9	Northrop Grumman	USA	8,300	Minor acquisitions in train but B-2 work winding down
10	GEC	UK	8,100	Tracor acquisition and Alenia defence deals
11	Thomson-CSF	France	8,000	Merger with Alcatel/Dassault Electronique
12	AlliedSignal	USA	7,300

 

NOTES Ranking is based on likely annualised aerospace sales at mid-1998 if deals were completed, assuming constant exchange rates and current growth trends. *Aerospatiale merger with Dassault still not formalised, but would add another $1.8 billion

 

Yet there are at least a couple of reasons why Wall Street enthusiasm has been on the wane. Most obvious comes in the shape of the problems besetting the mighty Boeing. Its difficulties in ramping up airliner production at Seattle have left it with some embarrassing apologies to make to shareholders, and a hefty bill.

Even before the massive provisions set aside to cover losses on the New Generation 737 line, Boeing had seen production in inefficiencies cut group margins to a mere 2%, where they are expected to stay for this year.

As Boeing struggles to stay in profit, it is now the equipment suppliers rather than the platform manufacturers that they serve, which are turning in the prime double-digit margins - a trend that holds true on both sides of the Atlantic. In short, suppliers reap the rewards of increased volume in the good times, having been squeezed for more efficiency during the bad. In automotive, the likes of General Motors equally found its supply chain unwilling or unable to meet a surge in production.

	TOP 20 AEROSPACE BUSINESS BY MARGIN*
	Parent group	Country	Margin
1	Sundstrand	USA	20.90%
2	Aeroquip-Vickers	USA	18.40%
3	Cobham	UK	17.20%
4	Singapore Tech Aero	Singapore	16.90%
5	Meggit	UK	16.50%
6	Parker-Hannifin	USA	16.00%
7	Coltec	USA	15.70%
8	Dassault Aviation	France	15.40%
9	Rockwell Collins	USA	15.00%
10	Smiths Industries	UK	14.30%
11	Fairchild Dornier	USA	13.80%
12	AlliedSignal	USA	13.60%
13	GE Aircraft Engines	USA	13.50%
14	Lagardère	France	13.20%
15	Raytheon	USA	13.10%
16	Honeywell	USA	13.10%
17	BE Aerospace	USA	13.00%
18	TI Group	UK	12.90%
19	Figgie International	USA	12.70%
20	Precision Castparts	USA	12.50%
	TOTAL RANKING		7.30%

 

Further fuelling the pessimism are all the warning signs that airliner demand may be close to the peak in this latest cycle. Boeing is already riding with its hands on the brake, with some cuts in widebody numbers pencilled in for next year as the crisis in Asia feeds through onto production lines. It seems that 1999 will now be the year of peak output for airliner production for Boeing and Airbus alike. Boeing's airliner woes aside, Booz Allen believes that there may be some more fundamental reasons for the US aerospace/defence sector to take a look at where it goes next. Not least is how to follow a frenetic five years of consolidation. That has produced the potential for massive earnings improvements despite the overall decline in military spending. That process, which was drawing to a close anyway, finally came to an abrupt halt earlier this year as the US authorities, which had done so much to encourage defence rationalisation, finally forced Lockheed Martin to quit its bid for Northrop Grumman.

"After the earnings growth that's come out of the dramatic regroupings, there are the first signs that the USA is at the end of this wave of restructuring," warns Booz Allen.

True, there are still some further gains to come out of the existing restructuring as the new giants continue to prune cost out of their acquisitions. Both Raytheon and Boeing announced major plant closures and consolidation programmes earlier this year and Lockheed Martin has led the way with the promise of annual savings of some $2.6 billion.

There should also be room for some further rationalisation among second tier US players, with Northrop Grumman among them. But, with the top two positions in the aerospace league now settled, the days of the truly dramatic defence merger seem to be over. Without another big idea to take its place, the industry runs the risk that earnings will stagnate or even decline, warns Booz Allen. In turn that means lower value passed onto shareholders. Over the past five years of restructuring, aerospace stocks have soared above the overall market index, but that gap, once running at 60% or more, has since narrowed. The industry's performance has looked distinctly less glittering so far this year, underperforming the market as a whole.

The worst of the cuts may be over for Western defence budgets. Analysts expect the pending US budget announcement to show the first real increase in procurement spending for some 14 years and in Europe, too, the market should stabilise as deliveries of new platforms come on line. But the opportunities for overall growth in Western defence budgets looks modest indeed.

	INDUSTRY SECTOR RANKINGS
	COMMERCIAL AIRCRAFT
	All civil fixed-wing aircraft production
	Group	Division/type	Sales ($m)
1	Boeing	Commercial aircraft	26,900
2	Airbus Industrie	Aircraft deliveries	11,600
3	BombardierAerospace	Aerospace (inc Learjet)	3,300
4	RaytheonAircraft	Aircraft (inc Beech)	2,450
5	Textron	Aircraft/Cessna	2,200
6	Gulfstream		1,900
7	Dassault Aviation	Civil aviation (Falcon)	1,400
8	ATR	Aerospatiale/Alenia	800
9	British Aerospace	Regional aircraft	750
10	Embraer	Civil sales	650
11	Fairchild Dornier		500
12	Saab	Regional aircraft	400
	Figures are estimates for current annualised sales for fixed-wing civil aircraft production.
	ENGINES
	Civil and military engines
1	General Electric	Aircraft Engines	8,500
2	United Technologies	Pratt & Whitney	7,400
3	Rolls-Royce	Aerospace	5,030
4	Snecma	CFM/Hispano/SEP	2,450
5	Daimler-Benz Aerospace	Aero engines/MTU	1,700
	DEFENCE
	Military aircraft, defence electronics and missiles*
1	Lockheed Martin	Aeronautics/IT/electronics	18,000
2	Boeing	Aircraft/missiles/IT and systems	15,000
3	Raytheon	Electronics (inc Hughes Aircraft)	14,800
4	British Aerospace	Defence	10,800
5	Northrop Grummant	Electronics/aircraft	7,700
6	GEC	Marconi+Alenia Difesa jv+Tracor	6,500
7	Thomson-CSF	Alcatel+Dassault Electronique	6,100
8	TRW	Systems integration	2,800
9	LittonAdvanced electronics		2,700
10	Daimler-Benz Aerospace	Military aircraft/defence systems	2,600
	Figures are estimates based on current sales and announced merger/acquisition activity.
	Divisions include some marine defence systems, but other civil work removed. *Lagardère is linking with
	Aerospatiale/Dassault, which could give $5bn defence sales.
	SPACE
	Satellites, launchers and systems
1	Lockheed Martin	Space/launchers	6,700
2	Boeing	Space transportation	3,600
3	Hughes	Satellite manufacturing	2,500
4	TRW	Space and systems	2,200
5	SCS*	Thomson+Alcatel+Aerospatiale	1,800
6	Daimler-Benz Aero	Space sys/satellites	1,500
7	Matra-Marconi Space*	Lagardére+GEC	1,450
8	Loral	Space & communications	1,300
9	Arianespace	Launchers and services	1,120
10	Orbital Sciences	Satellites/launch services	600
	Figures are estimates based on current sales and announced merger/acquisition activity. *
	Lagardère due to link with Aerospatiale and Dasa due to join MMS, but details not firm.

 

INTERNATIONAL SUPPLY CHAIN

While civil transport may continue on its upward curve, there are fewer platforms and potentially fewer customers as airlines group into alliances. Long-term forecasts suggest demand for new airliners running at around the $50 billion a year mark over the next decade. It is sobering to note that this represents two companies of about the current size of Boeing. With Airbus fighting hard to be on equal terms, there appears little room for manoeuvre.

Booz Allen believes that, to keep profits moving, the aerospace groups will have to look further afield. "The next opportunity for earnings growth has to come from internationalisation," it says, arguing that to date industry consolidation has been largely regional, confined to North America and Europe. The next step is to make progress towards a truly global industry.

Platform manufacturers have the clear advantage of gaining access to new markets, feeding sales through to the top line.A second goal may be to develop a truly global supply chain. "Internationalisation of the supplier base has a logic in itself," says Booz Allen, citing wasteful duplications inherent in maintaining a series of unique regional suppliers with separate development and marketing overheads.

The automotive industry has already been here, too, shopping around the world for capable international suppliers. The likes of AlliedSignal and Lucas Varity are among these emerging global automotive suppliers. Perhaps unsurprisingly they are now among those taking the lead in developing transatlantic businesses in aerospace. A look down the top 100 rankings shows a growing band of second-tier companies now rising fast above the $1 billion sales mark. AlliedSignal is already in the big league with sales on course for around $7 billion this year, with BFGoodrich not far behind, following its acquisition of Rohr.

As the global game steps up a gear, the smaller national players are already beginning to disappear from the map, says Booz Allen. Last year it was the turn of Dutch national champion Fokker to bow out of the rankings. This year it is Sweden's turn, with Saab announcing the pending closure of its regional aircraft lines and the sale of a 35% stake to British Aerospace. Italy's Finmeccanica has been seeking deals for virtually all of its Alenia units, including the $1 billion defence joint venture struck with GEC-Marconi, while BAe has been eying up a stake in Spain's CASA if and when the company comes up for privatisation.

	TOP 20 AEROSPACE BUSINESS BY MARGIN*
	Parent group	Country	Margin
1	Sundstrand	USA	20.90%
2	Aeroquip-Vickers	USA	18.40%
3	Cobham	UK	17.20%
4	Singapore Tech Aero	Singapore	16.90%
5	Meggit	UK	16.50%
6	Parker-Hannifin	USA	16.00%
7	Coltec	USA	15.70%
8	Dassault Aviation	France	15.40%
9	Rockwell Collins	USA	15.00%
10	Smiths Industries	UK	14.30%
11	Fairchild Dornier	USA	13.80%
12	AlliedSignal	USA	13.60%
13	GE Aircraft Engines	USA	13.50%
14	Lagardère	France	13.20%
15	Raytheon	USA	13.10%
16	Honeywell	USA	13.10%
17	BE Aerospace	USA	13.00%
18	TI Group	UK	12.90%
19	Figgie International	USA	12.70%
20	Precision Castparts	USA	12.50%
	TOTAL RANKING		7.30%
	Notes* Operating margins for aerospace businesses within the relevant groups.
	Fairchild Dornier unaudited net margin.

 

While the theory in Europe remains the creation of a single overarching aerospace enterprise to challenge the US giants, the jury is still out on how and when that will happen. Progress has been made on the reorganisation of Airbus Industrie into a standalone company and the French regrouping around Thomson-CSF/ Alcatel and Aerospatiale/Lagardère. However, it remains to be seen how smoothly these will translate into Europe's much discussed single aerospace grouping.

Not least, there remains the issue of gaps in financial performance between the major European nations, as illustrated in the top 100 ranking. Like its close cousins in the USA, the UK's aerospace industry is trading at profit margins above the 8% mark, with BAe, GEC and others achieving world class levels of efficiency. Continental Europe has been making gradual but consistent productivity gains, with regular reductions in headcount at companies such as Aerospatiale beginning to show through in a steadily rising industry margin. "Continental Europe still has some basic operational efficiencies to make and then it's an issue of having to scale up volume," says Booz Allen.

Despite the advances, especially in France, there is still a perceptible gap with the UK and some risk that companies there may look across the Atlantic, rather than the English Channel, to achieve scale. GEC has already broken ranks with its acquisition of Tracor.

Booz Allen believes that another trend to watch on both sides of the Atlantic is the shift by the aerospace companies into the market for military telecommunications, satellite communications and information technology. Traditionally, the sector has been in the ownership of the major telecommunications and ITcorporations, but, with the level of growth and a frenzy of merger activity in their own core markets, aerospace/defence divisions have taken a back seat. Some have already stripped out unwanted defence units, eagerly snapped up by the aerospace majors, while further units could spill off as the global telecommunications mergers continue.

Raytheon and Lockheed Martin are forging ahead in the USA, while Alcatel, itself a major telecommunications players, has linked with Thomson-CSF to put the merged group ahead in Europe. GEC and others may yet follow.

There is one note of caution in this brave new world, however. If the world's telecommunications giants ever do run out of growth in their core markets, then aerospace may find itself a bit part in someone else's grand strategy.

Source: Flight International