Despite 2011 being the best year ever for the global aerospace industry, experts warn the financial sector may be unwilling to supply cash to pay for new aircraft
The fundamentals, as we are repeatedly reminded, are sound: Airbus-Boeing order backlog at record levels, global air travel demand growing strongly, airlines in urgent fleet renewal drive to exploit latest fuel-saving technologies.
To underscore the positive story, the global aerospace industry posted its best year ever in 2011, despite pressure on European and US defence spending: record revenue ($677 billion), record operating profit ($60 billion), record deliveries (1,000-plus from Airbus and Boeing), record mergers and acquisitions volume (341 deals worth nearly $44 billion).
Speaking in his capacity as vice-president of the aerospace section at the UK's ADS industry group, GKN Aerospace chief Marcus Bryson said in the run-up to Farnborough air show: "It's a great time, particularly on the civil side." But he adds a warning: "If you've been in this industry a long time you know not to get carried away by the euphoria." Three decades in the business tell him to take the full orderbooks with a pinch of salt. Airline profitability is weak and the 2008-2009 financial crisis hangs over an economic landscape suffering as US recovery is called into question. Meanwhile, Europe struggles with a currency and debt crisis and even China shows worrying signs of slowdown. So, Bryson notes, it would be unwise to dismiss warnings that the financial sector may not be eager or able to supply enough money to pay for all those aircraft scheduled to roll off the assembly lines.
Caveats aside, he is confident market strengths outweigh weaknesses so that, whatever happens, we're "not going off a cliff". But ultimately, he observes: "This thing can only defy gravity for so long." In an increasingly global aerospace market it is difficult to tease apart the impact of each region's particular economic challenges. But it is equally difficult to conclude that the greatest danger lies anywhere other than in Europe. Evidence of a deterioration of confidence comes from Bank of America Merrill Lynch (BAML). Its latest monthly survey of investment fund managers, carried out in the first week of June, reveals new worries over global economic slowing and falling corporate profits, particularly focused on Europe.
WEAKEST READING
A net 11% of those surveyed by BAML expect the global economy to deteriorate in the coming 12 months - the survey's weakest reading since December 2011 and down from 15% with positive expectations when surveyed in May. A net 19% expect corporate profits will fall in the next 12 months, compared with a net 1% that expected growth back in May.
Underscoring concerns over corporate profits, these investors are shying away from financial risk by increasingly holding cash rather than shares or bonds, even though they regard shares as undervalued - which in a normal economic environment would be a strong "buy" signal. Europe is seen as the most undervalued region of all - by the biggest margin in the survey's history and sharply more undervalued than in May. One example of how these investors' fears may be impacting the aerospace industry can be seen at GKN. The British engineering company earns the lion's share of its revenue and profit from its automotive systems business, but has grown dramatically in aerospace to become a significant top-tier supplier and one of Airbus's most important partners.
GKN now owns the Airbus wing factory at Broughton, and has invested heavily to develop the composite technology it is using to make the wing spars for the A350 and A400M, a position that leaves it in pole position to lead development of carbon wings for next-generation airliners. GKN is also working closely with Rolls-Royce on composite technologies for engine fan blades. In what looks another great example of the company's knack of acquiring its way into new, growth niches, GKN has been linked to Volvo Aero since March. On the face of it, buying Volvo Aero looks an obvious way to leverage its Rolls-Royce alliance into a manufacturing footprint in aero engines which, like structures, is a sector hungry for weight- and fuel-saving technology.
FINANCING CONCERNS
But since peaking for the year to-date in late February, GKN shares have been on a steady slide. The absence of a bid bounce may be down to short-term concerns over financing the reputed £700 million ($1.1 billion) price tag, but one industry watcher admits it may also be an indicator that for all the underlying strengths, investors may not be as enthusiastic about the aerospace industry as industry insiders.
Whatever the feeling among investors and financiers, industry people are concerned the combination of economic uncertainty and bursting airliner orderbooks is starting to lever open some alarming cracks in the very foundation of the aerospace industry: its supply chain. Consultancy PwC has studied this issue and reached the conclusion that more than a fifth of suppliers are not financially ready to support the ramp ups in major-programme production rates being planned in the next five to ten years, either for civil programmes such as Airbus and Boeing narrowbody airliners or for military programmes like the Lockheed Martin F-35.
A new PwC study - Soaring or stalling: can aircraft manufacturers prevent rate ramp-up problems? - notes that many observers believe major aircraft makers have underinvested in new capacity and technology, which could lead to capacity constraints as, say, Airbus and Boeing attempt to push monthly production of A320 and 737 aircraft beyond 40 units a month. There is also concern about shortages at the bottom of the supply chain of key inputs such as titanium or carbonfibre. Neil Hampson, PwC global aerospace and defence leader, stresses that many companies in the supply chain are reluctant to invest in increased capacity. "They've heard this story [about rate increases] before and it's gone wrong." The fear, he says, is capital investment based on the size of orderbooks will be transformed into financial difficulties by programme delays and eventual rate decreases. And, he adds, while suppliers are "slightly reluctant" to believe high production rates will reliably follow large order backlogs, banks are reluctant to fund the ramp-up.
Critically, notes Hampson, not only US or European banks are shying away from aerospace industry finance or demanding increasingly-onerous terms for lending; banks all over the world are cooling off. Some of this financial wariness may become evident in a shortage of funds to buy aircraft fresh off the assembly lines. Hampson is concerned "second or third-tier airlines" may struggle.
All in all, he says, there is evidence that Airbus and Boeing may have had even greater rate ambitions but scaled back plans to what are still "challenging" levels for their supply chains. Evidence of strain in the supply chain is not hard to find. Hampson notes the high-profile examples of Boeing's partial acquisition of key 787 supplier Vought in 2009 and Airbus parent EADS's purchase in September 2011 of a majority stake in Germany's PFW Aerospace, which faced a liquidity crisis. Both deals were necessary to prevent a key supplier's difficulties from disrupting production at the top of the chain.
Such vertical acquisitions may not be typical, but consolidation within the supply chain may prove necessary to maintain production rates. Here, Hampson sees three trends. One is acquisitions aimed at buying specific technology, a driver in deals such as United Technologies' $16.5 billion purchase of Goodrich, expected to close later this year. A second trend is for mergers or acquisitions designed to cut costs. Here, says Hampson, we may see partners in defence supply chains join forces.
RISK-REWARD
However, a third trend is for companies which are not pure aerospace players to decide to consolidate their own businesses around non-aerospace activities. Many such companies are simply deciding the risk-reward profile of aerospace is not as attractive as in their other businesses, so they will look to divest. Watch for this trend in companies which have interests in industries such as power generation or automotive.
If PwC is right and the aerospace industry does indeed face a serious challenge in achieving its desired production rate ramp-ups, then Airbus and Boeing face a particularly challenging period of being forced to step in where banks are unwilling to go. That means they will increasingly have to play a role in funding their suppliers and also their customers, as well as, of course, funding their own rate ramp-ups.
Meanwhile, Hampson adds, they are also having to supply engineering assistance to their suppliers while their own technical resources are under strain from new programmes and production-rate increases. Companies as large as Airbus and Boeing may well prove able to hold all these forces together but, notes Hampson: "We're observing that it's a system under pressure from both ends."
Source: Flight International
