Aerospace Top 100 Special Report 2007: Capacity crunch

Aerospace's top 100 revenue generators grew 12% in 2006, but almost all that growth came from the commercial market, with the defence business staying essentially flat. And, as the commercial sector approaches its capacity limits, the industry's revenue and profit growth are slowing.

This is the picture that emerges from Flight International's annual Aerospace Top 100 survey - compiled in association with PricewaterhouseCoopers and based on the 2006 financial year results of companies in the manufacturing sector.

Revenues of the Top 100 aerospace and defence companies totalled $483.4 billion in 2006, up 12% from $431.5 billion in 2005. Operating profits totalled $41.5 billion last year, up 8% from $38.3 billion a year earlier. In keeping with the traditional 80/20 rule, the Top 20 companies accounted for 80% of the industry's sales and earnings.

Conversion of the euro and sterling revenues of European companies to dollars for the Top 100 listing boosted the 2006 totals, and the underlying industry growth was closer to 10%, says Neil Hampson, a partner at PricewaterhouseCoopers. "The extra 2% is probably due to exchange rate effects," he says, as both the euro and sterling appreciated 10% against the dollar from 2005 to 2006.

With constraints on commercial aircraft capacity growth at Airbus and Boeing, and defence spending staying flat, the aerospace industry will be lucky to see similar revenue growth in 2007. "Ten percent would be ambitious," says Hampson.

"Growth in profits of 8% and revenues of 10-12% is pretty good. The industry has rapidly come out of a trough, but don't expect it to continue at the same pace," says Hampson. "Commercial has grown much faster than 12% and defence much less, but the level of commercial growth is constrained by Airbus and Boeing, which are pushing the upper limits of their capacity."

Profit growth is also coming under pressure. The 8% achieved in 2006 compares with 17% in 2005 and around 22% in 2004. "Profits have grown less than in previous years because of restatements and new accounting regulations, as well as acquisitions bringing new lower-margin companies into the Top 100," says Hampson.

But the average operating margin of the Top 100 companies continued to improve from its post-9/11 low of 6.9% in 2003, reaching 8.9% in 2006. While still below the recent peak of 9.7% in 2000, this was "a pretty good jump" over the 8.2% achieved in 2005, says Hampson, who expects the industry's average operating margin to approach 9.5% in 2007.

The average margin would have been higher had EADS not fared so badly in 2006, its operating profit dropping to barely $500 million from more than $3.5 billion a year earlier, but the margin achieved "is a pretty clear sign the industry is back to health," he says.

Top 10 newcomer

The upper ranks of the Top 100 are essentially unchanged from last year's survey, which was based on 2005 financial results. The exception is L-3 Communications, which makes its fifth consecutive move up the table to enter the Top 10 for the first time at number 10 on its now-familiar mix of organic growth and acquisitions. "L-3 is a case study in how to build a business," says Hampson.

Boeing's position at the top of the Top 100 looks unassailable, the US giant extending its lead over EADS in 2006 with a 15% increase in revenues on higher commercial aircraft deliveries. And while its European aerospace rival has warned of slightly lower revenues in 2007 because of A380 delivery delays, Boeing is forecasting revenue growth of almost 6% to $65 billion in 2007 and a further 9-10% in 2008, to $71-72 billion, on progressively higher commercial aircraft deliveries.

EADS saw its revenues increase 11% in 2006 on higher commercial aircraft deliveries, but entered 2007 mired in operating problems. Airbus deliveries will increase only slightly this year, allowing Boeing to draw level, and as well as one-off costs for its Power8 restructuring programme the company faces delays and penalties on key military programmes including the A400M transport and NH90 helicopter.

Top 10 companies dependent on the defence market reported much lower growth in 2006 on flat US procurement spending. Third-placed Lockheed Martin achieved 6% revenue growth as increases in space and government information technology sales offset a slight decrease in its aeronautics business. The company is projecting just 3.5-5.5% growth in 2007, to beyond $41 billion.

Fourth-ranked Northrop Grumman achieved almost no revenue increase in 2006 and is forecasting growth of less than 5% in 2007, to $31.5 million. BAE Systems (ranked 5) achieved 9% revenue growth in 2006, but most of that was from its 2005 acquisition of United Defense. Acquisitions boosted sixth-ranked General Dynamics to its 15% revenue growth, with higher sales of Gulfstream business jets also contributing.

Raytheon achieved 7% growth in 2006, but the sale of its aircraft business to investors in March means the company's revenues will actually reduce in 2007 to less than $22 billion. This could cost the company its seventh place in next year's Top 100 if eighth-ranked United Technologies achieves its expected revenue growth in 2007.

UTC's aerospace revenues grew 17% in 2006 on higher commercial sales of Pratt & Whitney engines and Hamilton Sundstrand systems, and increased civil and military helicopter deliveries at Sikorsky. UTC's lead over ninth-ranked General Electric, meanwhile, has been narrowed by GE's $4.8 billion acquisition in May of Smiths Group's aerospace business, which ranks 27th in this year's Top 100.

The Smiths acquisition plus strong growth in commercial engine sales will probably keep GE ahead of L-3 Communications in next year's Top 100. Although L-3's revenues grew 32% in 2006 to boost the company into the Top 10 for the first time, its pace of acquisitions has slowed as it focuses on consolidating operations to improve margins, and it is projecting just 5-6% higher revenues in 2007 at around $13.5 billion.

L-3's move up from 13th position in last year's survey pushed Finmeccanica out of the Top 10, the Italian giant relinquishing the 10th place achieved last year and dropping back to 14th position after its aerospace revenues declined slightly from their 2005 level. This leaves EADS and BAE Systems as the only non-US companies in the Top 10.

Underlining the industry's consolidation in recent years - as well as the growth in commercial aircraft and engine sales - the Top 10 companies accounted for more than 60% of total Top 100 revenues in 2006, up from 50% in 2005. But their share of the total profits declined slightly to just under 60% because of the difficulties at EADS.

Moving up

Outside the Top 10, the major movers include France's Safran, moving up two places to number 13 as its revenues rose 28% on higher sales of commercial engines and aircraft systems. In the first half on 2007, sales were up more than 15% at the Snecma propulsion division on higher CFM56 engine shipments. But Safran is one of many suppliers across the Top 100 affected by the Airbus A380 delivery delays, and revenues at its equipment division increased by just 5.5% in the first half - barely half the expected growth.

There is persisent speculation within France that Safran, the unlikely business combination of Snecma aero-engines and Sagem cellphones, could yet merge with electronics giant Thales. Such a move would create a new Top 10 aerospace and defence company to rival the likes of Raytheon.

After a series of acquisitions, US defence electronics and flow control company ITT moved up three places to 19 on 21% higher revenues in 2006, and is projecting another 9-11% growth this year despite the flat defence market. Diversified US manufacturer Eaton also moved up three places to number 22 on 23% higher revenues, largely from commercial aerospace growth and acquisitions.

Commercial aerostructures maker Spirit AeroSystems is making its first appearance in the Top 100, entering at number 26 with 2006 revenues of $3.2 billion. The company was formed in 2005 when Canadian investment firm Onex purchased Boeing's commercial aircraft operations in Wichita, Kansas and Tulsa, Oklahoma for $1.2 billion. The company is forecasting sales of at least $4 billion in 2007, which will boost it closer to the Top 20. "Spirit has benefited from the rebound in Boeing production," says Hampson, but is still looking for Airbus business to broaden its portfolio.

Hampson views Spirit, which builds Boeing 737 fuselages and is a major risk-sharing partner on the 787, "as the only Tier 1 aerostructures player" in the industry - although Vought Aircraft Industries (ranked 41) might quibble with that categorisation  as it also has a major stake in the 787 through its Global Aeronautica joint venture with Italy's Alenia Aeronautica.

But EADS's plan to sell Airbus plants in France, Germany and the UK could create additional Tier 1 aerostructures companies, Hampson says. The UK's GKN (ranked 45) is bidding for the Filton plant, while Latécoère (ranked 78) has its eyes on the Méaulte and St-Nazaire-Ville plants in France. The partnerships on offer include major risk-sharing roles in the new Airbus A350.

Companies moving up the Top 100 include US defence electronics firm DRS Technologies, which rose to 37 to 31 on a 62% increase in revenues from an L-3-like combination of organic growth and acquisitions. Organic growth pushed French safety systems, aircraft equipment and cabin interiors company Zodiac up the rankings, from 38 to 35, on a 35% increase in revenues.

Two non-US, non-European companies significantly improved their positions in the middle of the rankings. Hindustan Aeronautics moved up three places to number 40 on a 40% increase in revenues and is poised for further growth as India's commercial and defence markets expand. Israel's Elbit Systems moved up four places to 42 as revenues grew 42% on higher domestic and export defence electronics sales, and its strong performance has continued through the first half of 2007. "Elbit is growing in the US," says Hampson.

The UK's Meggitt moved up two places to 46 on organic growth and bolt-on acquisitions, and is poised to rise further up the Top 100 following its June acquisition of US aircraft braking specialist K&F Industries (ranked 84) for $1.8 billion . This is expected to boost the share of Meggitt's revenues that come from the aftermarket. "Results for the first half [of 2007] are ahead of expectations," says Hampson.

After a successful restructuring, Canadian training and simulation company CAE climbed three places up the rankings to number 47 on 13% higher revenues from equipment sales and training services. CAE has also made several acquisitions, including Indian simulator manufacturer Macmet and a number of modelling companies, that will boost growth beginning in 2007.

After a major rationalisation following the melt-down of the US airline market after 9/11, cabin interiors firm B/E Aerospace rose three places to 49 as revenues jumped 38% in 2006. Commercial aircraft deliveries, the 787 programme and airline fleet upgrades are expected to fuel further growth.

At the lower end of the table, French aerostructures and wiring specialist Latécoère moved up four places to 78 on higher Airbus and Boeing business, and Heico - a manufacturer of FAA-approved replacement parts entered the rankings at 86, having been just outside last year's Top 100. US forgings and casting specialist Ladish entered the Top 100 at 97 on higher sales of commercial engine components. UK investment firm Melrose also made the ranking for the first time, at number 99, but in March announced the sale of its McKechnie Aerospace business, acquired only in 2005.

Rounding out this year's rankings is GPS and avionics specialist Garmin, while waiting just outside the Top 100 are Canadian landing gear and structural components manufacturer Heroux-Devtek and Germany's Diehl. But South Africa's Denel tumbled out of the Top 100 this year as revenues slumped 18%, mostly due to a lack of sales to the South African government. A similar lack of success with its domestic customer caused Switzerland's RUAG to slip four places down the table to 53, he says, while the Netherlands' Stork slid five places to 67 largely because of the A380 delivery delays.

Airbus's troubles have reverberated through the supply chain, and underlined the industry's dependence on a healthy and growing commercial market. The European manufacturer held on to its lead in the commercial aircraft sector in 2006 (see table, P34), but its 10% revenue growth was dwarfed by the 33% achieved by Boeing Commercial Airplanes. The two companies are each expecting to deliver about the same number of aircraft in 2007 - 440-450 - but Boeing is likely to outstrip Airbus in shipments in 2008, forecasting shipments of 515-520 aircraft.

"The demand is there, but it is difficult to generate the capacity," says Hampson, pointing out that Airbus is increasing A320 output by only 5%. "The A320 is maxed out, the A330/A340 is steady and the A380 is the only thing that will move the needle this year," he says. "There is not the room for growth at Airbus that there is at Boeing."

Bombardier has slipped down the Top 100 is recent years, following the collapse of the 50-seat regional jet market. But the Canadian manufacturer remains the third largest commercial aircraft manufacturer and is benefiting from the surge in business jet sales as well as a recovery in the regional turboprop and 70/90-seat jet markets.

The business jet boom boosted Cessna and Gulfstream to fourth and fifth places in the commercial aircraft rankings and both companies have increased production rates for 2007 and 2008 as blacklogs reach record levels. Embraer slipped to sixth place despite a modest increase in revenues in 2006, but is poised for growth once it begins delivering its new light business jets in 2008.

A "new" name in the Top 100 is Hawker Beechcraft, the former Raytheon Aircraft business acquired in March by private equity firms Onex and Goldman Sachs. The company ranks seventh among commercial aircraft manufacturers. Dassault Aviation's business jet sales are growing strongly, and could boost the company ahead of Hawker Beechcraft in next year's Top 100 listing.

Rounding out the Top 10 commercial aircraft manufactures, EADS/Alenia company ATR continues to benefit from resurgence in regional turboprop orders.

There are few surprises in the defence aerospace rankings (see table, P34), although Boeing and Lockheed Martin trade places at the top of the table. Total revenues of the Top 15 companies increased barely 3% in 2006, to just under $160 billion, underlining the impact of flat defence procurement spending.

Near term, industry expects US operations in Afghanistan and Iraq to consume a major share funding, to be followed by significant spending on "resetting", or refurbishing, war-worn equipment, then some degree of "recapitalising", or replacing, lost or damaged equipment. But longer term, US defence spending is expected to decline from its current level. As a result, US defence companies are looking to diversify into government IT and homeland defence markets.

As most engine manufacturers play in both the commercial and defence markets, it is not surprising to see them grow significantly while retaining their relative rankings in the sector (see table, P34). GE Aviation held on to its pole position with more than 10% revenue growth in 2006, but Pratt & Whitney closed the gap with almost 20% growth - partly because of increased deliveries of small engines by Pratt & Whitney Canada. Rolls-Royce grew more slowly, in part because its installed base for aftermarket sales is not as large as GE's and P&W's.

The character of this sector is changing as the major players extend their reach beyond engines. United Technologies, Snecma/Safran and Honeywell have long combined engine and systems offerings, and GE is following the trend with its purchase of the Smiths aerospace business. This could lead to greater bundling of products and services.

The space sector saw only modest growth and no significant ranking changes in 2006 (see table, P34). But there was a substantial change in the structure of the industry with the December 2006 merger of the Boeing and Lockheed launch vehicle businesses to form United Launch Alliance, which is expected to have annual revenues of around $2 billion from Atlas and Delta rocket manufacturing and government launches.

Another change that will be reflected in the 2007 ranking was the creation in April of Thales Alenia Space. This will be accomplished by the transfer to Thales of Alcatel-Lucent's shareholdings in two space sector joint ventures with Finmeccanica. The French aerospace and defence company now owns 67% of satellite manufacturer Thales Alenia Space, with Finmeccanica holding the rest.

Overall, this year's Top 100 survey reveals an industry that is healthy and growing, but not all companies are benefiting equally. Prime contractors continue to be less profitable than their Tier 1 and Tier 2 suppliers, but there is less variability in their operating margins, which makes their financial performance more predictable and stable.

"The primes earn less, but have much tighter control of their businesses," says Hampson. The operating margin of the aerospace primes averaged 7.6% in 2006, up from 6.5% in 2005, and varied from 5% to 12% - a narrower range than the year before. Tier 1s averaged 11.6%, down from 12.1% in 2005, but their margins varied from -5.6% to 21.6%.

And the variability was even greater among Tier 2 suppliers, where the average was almost unchanged a 10.8%, but individual company operating margins ranged from a whopping 43.7% to a dismal -13.5% - much greater volatility than seen a year earlier. "Most Tier 2s have a mix of small A&D product businesses - some of which have very high margins," says Hampson.

The highest margins continued to be found among those companies with aftermarket-rich businesses such as brake supplier K&F Industries and countermeasures-to-pyrotechnics specialist Chemring, which improved on their already-impressive operating margins. GE Aviation, with its strong engine services business, continues to be the highest-margin Top 10 company. Others with industry-leading

operating margins are integrated avionics suppliers Garmin, Rockwell Collins and Honeywell. Lower-tier UK manufacturers also fared well in margin terms, with Meggitt, Melrose and Cobham joining Chemring at the upper end of the ranking.

Equity interest

Against a background of commercial growth, the higher margins and potential for consolidation among the industry's fragmented lower tiers continue to make aerospace attractive to private equity. Despite concerns that the recent global credit market turmoil could deter investors, "aerospace and defence is still fundamentally attractive," says Hampson.

Unlike many of the leveraged buyouts that have strained the financial markets, "most aerospace and defence deals are quite sensible, with sane levels of debt", he says. And, because of the health of the aerospace industry, "there could be a return to real businesses" by private equity.

There is also the promise of new sources of equity. Hampson believes Dubai Aerospace Enterprise and other Middle Eastern investors will soon move into the aerospace manufacturing sector. Abu Dhabi government investment arm Mubadala Development acquired 35% of Italian business aircraft manufacturuer Piaggio Aero in 2006. And DAE, established by the emirate in February 2006 and focusing initially in the aircraft leasing and maintenance markets, has the manufacturing sector -and supply-chain consolidation - as one of its top five targets for investment.

"India and China are also finding the sector interesting," Hampson says, adding: "There is an internationalisation of the supply chain under way, and if they want to be big players they have to go out and own a business."

China has political obstacles to overcome, but "India will become an investor", he says. With the rapid growth in the domestic Indian aviation market, private-sector powerhouses like Tata Group are looking to get into aerospace manufacturing. "I would not be surprised in five years time to see three or four [Indian-owned businesses] in the Top 100," says Hampson.

Source: Flight International