GRAHAM WARWICK / WASHINGTON DC AND JUSTIN WASTNAGE / LONDON
Revenues may only have increased slightly, but the world's aerospace industry is more profitable than a year ago - and in better shape to weather the economic storm
Aerospace companies have traditionally suffered by their close association with airlines. Carriers are well known barometers of economic change, and the weather has been worsening since the beginning of the year. Airlines are awash in red ink and aircraft orders placed in boom times are at risk as the traditional cycle enters the bust zone. Will greater industry consolidation, cushioned by increased defence spending, soften the blow this time round?
The Aerospace Top 100, Flight International's survey of the industry's leading companies, produced in association with Roland Berger - Strategy Consultants, serves as an annual report for the industry and highlights key trends looking forward.
Our survey, based on year 2000 financial results, shows that the signs of the current downturn could already be seen a year ago. Overall industry revenue growth in 2000 was lower than in the previous three years - down to only 1% from 5% in 1999, 12% in 1998 and 17% in 1997. This is due to the emerging cyclical downturn in commercial aerospace, which is expected to worsen before bouncing back in 2003. Boeing's 11% fall in sales, on lower commercial aircraft deliveries, was a big factor - its $6 billion decline equates to 2% of total Top 100 revenues last year.
The effect of a strong dollar on non-US companies was also a factor in the low growth. "Exchange rates are a double-edged sword," says Neil Hampson, an associate partner at Roland Berger. "European manufacturers, for example, benefit from increased euro receipts, as the aircraft they sell in dollars are worth more in euros. However, as they buy parts, they have increased dollar expenditure."
EADS' third-place ranking in this year's Top 100 makes this anomaly more explicit: its revenues grew from €22.5 billion to €24.2 billion, an increase of 7.3%, but the weakness of the European single currency means its sales decreased in dollar terms by 7%. This prevented EADS overtaking second-placed Lockheed Martin, despite the US company's 2% decline in revenues - a situation the European company expects to rectify this year with a forecast 20% increase in sales.
The real success stories of 2000 are not to be found in either the Boeing or EADS figures, says Hampson, but in the results posted by regional jet manufacturers. Bombardier came in at number 10 with an 18% increase in aerospace revenues on higher regional and business aircraft deliveries.
Embraer saw revenues climb by over 32% on higher regional jets sales, and was only kept out of the number 20 slot by the inclusion of Alcatel's space business in this year's Top 100.
Regional jet manufacturers are expected to fare better than the large aircraft builders in the current economic downturn. While Boeing actually has increased planned deliveries, and therefore revenues, to 538 commercial aircraft this year compared with 489 last year, it has reduced its delivery forecast for 2003 to 510-520 aircraft. Airbus will increase deliveries this year to 400 aircraft, from 330 last year, but revised its 2003 delivery forecast downwards, from 450 aircraft to 400.
Soft market
Bombardier, meanwhile, will deliver more than 420 regional and business aircraft this financial year, up from 370 last year. The Canadian company is still forecasting growth for 2003, despite a softness in the market. On the other hand, that same softness has led its Brazilian rival, Embraer, to warn it will not meet its delivery forecast of 220 regional jets this year as airlines decline to exercise options for additional aircraft.
Embraer, however, continues to post profit margins that are the envy of the aerospace industry, achieving 15.6% last year against the overall industry margins of 9.7% (an improvement over 1999's 8.9%). On a dollar basis, aerospace and defence companies increased their profitability by 12% last year, compared with 10% in 1999, largely due to the benefits of consolidation and significant cost improvements achieved against staticrevenues.
The US industry not only continues to outperform its European counterpart in terms of the average operating profit margin as a percentage of turnover, but is widening the gap: European operating margin slipped last year by a tenth of a percentage point to 8%, while the USA saw its margin rise from 9.6% to 10.8%. European companies are starting to tackle difficult restructuring and labour issues, and could contribute to rather than detract from the global operating margin's steady progression towards investors' magic 10% threshold.
Among the industry's top prime contractors and system integrators, Boeing achieved the best operating margin last year at 7.2%, an improvement on 1999's 5.8%. The best-performing companies in the Top 100 - all suppliers and not primes - achieved two to three times the overall margin, due to a mixture of key technology positions and high after market margins, says Hampson. General Electric and Honeywell achieved operating margins above 20%, but were matched or beaten by the likes of Heico, Singapore Technologies, Meggitt and brake specialist K&F, which reported industry-leading margins above 30%.
While almost all the industry primes reported lower revenues last year, ranging from Boeing's substantial fall to Northrop Grumman's marginal slide, tier 1 suppliers almost all posted healthy increases in sales and/or profits. Among the leading lights were Rolls-Royce (sales up 19% on increased civil engine marketshare) and Mitsubishi Heavy Industries (aerospace revenues up 37% on higher aerostructures deliveries to Boeing and Bombardier). Eaton's fluid power sales shot up 366% as a result of acquisitions.
Business aircraft manufacturers also had a banner year in 2000, as reflected in the results of Bombardier, Dassault (Falcon) and Textron (Cessna). Raytheon's overall lower sales disguised a 19% increase in business and general aviation aircraft sales last year, but the company has been hard hit this year by market softness caused by the economic downturn. While strong backlogs for new products will carry most business jet manufacturers through this year, the order drought will make itself felt in 2002 and 2003.
Defence moves
Drawing firm conclusions from the revenue pattern among the major defence aerospace primes is difficult because of continuing portfolio adjustments following the most recent consolidation phase. Lockheed Martin sold businesses valued at almost $2.8 billion to BAE Systems in 2000, yet the UK firm's re-stated revenues fell 7% while the US company's slipped only 2%. BAE blamed its decline, in part, on lower than forecast export orders for the Hawk, while Lockheed Martin was able to point to a forecast reduction in F-16 sales, which are set to increase again in 2003.
BAE expects sales to remain flat this year before resuming growth next year, mainly as a result of its US acquisitions and the start of Eurofighter Typhoon production. Lockheed Martin's forecast for growth next year looks more secure following the US Department of Defense's decision to approve production of the F-22 Raptor fighter, but the company is banking heavily on defeating Boeing to win the Joint Strike Fighter (JSF) competition, expected to be decided in October.
While it is now considered likely that the winner will be directed to place significant workshare with the loser, securing the position of JSF prime contractor is vital to Lockheed Martin. "A significant proportion of Lockheed Martin's future revenues and, more importantly, its position as the leading military aircraft maker, is under threat if F-22 production is scaled back further or if it loses out on the prime contractor position on the JSF," says Hampson.
Boeing is also keen to win JSF. However, its forecast of revenues exceeding $62 billion next year, a 7% increase over the upward-revised projection for this year, is based largely on improved performance in its Space & Communications sector following last year's $3.8 billion acquisition of Hughes Electronics' satellite manufacturing business. Boeing, like Lockheed Martin and Raytheon, also expects to benefit generally from increased US defence spending, and specifically from increased funding for missile defence programmes.
Only 20% of EADS' sales are in the defence sector (Airbus alone accounting for 60% of total revenues), but this is set to increase when the company completes the delayed formation of a European military aircraft joint venture with Italy's Finmeccanica. The venture is now expected to become operational on 1 January 2002 - a year later than originally planned - and will control 67% of the Eurofighter programme (with BAE) and 46% of the rival Rafale (with Dassault).
France's Thales, the former Thomson-CSF renamed in December, saw revenues increase 8% last year on the integration of the UK's Racal and higher organic growth resulting from key programme wins. Defence sales increased substantially, and the company is forecasting further revenue growth this year.
North America continues to dominate the sector with 51 US and Canadian Top 100 companies accounting for 63% of global sales, while Europe has still seen its share of world production fall slightly to 30% with the rest of the world producing only 6%.
Breaking down Europe's figures has been made trickier this year by EADS' decision - partly political, partly fiscal - to headquarter itself in Amsterdam. French and German shares of aerospace production appear to have fallen in just one year from 11% and 4% respectively to 7% and 1%. Meanwhile, the Netherlands has become a global aerospace player with 8.1% of the business with only two companies in the Top 100 - EADS and $538 million Stork.
US growth
Back in the USA, Northrop Grumman expects to resume growth this year, following the April completion of its $5.2 billion merger with Litton Industries. The company is forecasting a 70% increase in revenues this year, to $13 billion, rising to $16 billion next year and $18 billion in 2003 - which puts it in the running to overtake fifth-place Raytheon.
Also rising rapidly up the Top 100 through acquisitions is General Dynamics, currently in a bidding war with Northrop Grumman for US aircraft carrier builder Newport News.
Despite the revenue falls, aerospace and defence did outperform other sectors of the stock market in 2000. Roland Berger points to the Standard & Poor 500 listing of top performing shares, where the average shareholder return fell by 9.3% last year, while that for aerospace companies grew by over 60%, albeit from a lower base. Roland Berger's aerospace consultant, Mark Hanrahan, says: "As investors have taken their money out of technology stocks, solid industrials, including airframers, have benefited. Aerospace has largely shaken off its credibility issue, as most forecasts point towards slow but steady long term growth of 2%."
Most aerospace companies are now firmly focused on delivering financial performance that will satisfy the stock market. That includes generating cash to pay down the huge debt loads accumulated during the recent consolidation phase, and to buy back shares. Cashflow has become the mantra of US firms in particular. Boeing generated $4.9 billion in cashflow last year, and is forecasting another $3.5-4.5 billion this year and over $5 billion next year. Lockheed Martin generated $1.8 billion in cashflow last year, and expects to produce another $1.8 billion over this year and the next.
Levels of debt
As a result, debt-to-capital ratios among the US giants are approaching more comfortable levels, but still nowhere near as low as in their European counterpartslike BAE. Those levels will rise, however, if European industry embarks on a consolidation round similar to that just completed in the USA.
Consolidation of the European missile industry is already under way around MBDA, while France is consolidating its tier 1 suppliers around Snecma.Hampson argues that, if European industry wants to keep up with its transatlantic peer, there must be further consolidation, as European companies are still considerably smaller than their US counterparts.
Size matters in the aerospace industry: the Top 20 companies still account for four-fifths of the market and those companies are getting even bigger as several former Top 100 entries have either merged or been absorbed into others in the table.
While there were fewer high profile mergers and acquisitions in 2000 than in previous years, the overall figures nevertheless indicate another record year for deals. Total value last year was over $70 billion, up from $55 billion in 1999.
This excludes the GE-Honeywell merger, whose combined aerospace revenues would have been close to $21 billion, overtaking fourth-placed BAE Systems, had the European Commission (EC) not blocked the deal.
Last year marked a shift in emphasis, with the impact of consolidation among suppliers challenging that among the major producers, in part because the latter have become so large.
Indeed, Snecma only moved up one place, from 15 to 14, following its acquisition of 38th-placed Labinal, while Thales remained at 13 despite its acquisition of Racal Electronics, which ranked at 61. But among suppliers, second tier operations can still leapfrog up the Top 100 as a result of consolidation, as with Eaton's jump from 60 to 23 following its acquisition of Aeroquip-Vickers.
Big deals between suppliers are likely to come up against anti-competition barriers and in the aftermath of the EC's rejection of the GE-Honeywell tie-up, several major merger possibilities could be put on ice. Nonetheless leading suppliers Honeywell, Rockwell Collins and United Technologies must decide where they will go next to scale up.
Despite the apparently relentless march towards creating ever bigger entities, niche players still have a role to play, and some new entrants have been created by larger companies hiving off divisions to concentrate on core activities.
Service oriented
Economic peaks and troughs tend to concern military divisions of aerospace companies less than their civil counterparts, but defence contractors have their own cycle, largely dependent on political decisions.
The good news here is that, after years of shrinking budgets, defence spending on both sides of the Atlantic is set to rise during the decade, as many air forces upgrade and invest in new programmes.
Additionally, European firms should increase their involvement in the defence services market this year, with maintenance and financing deals up for grabs. A major reason for Europe's relative weakness in service provision has been widespread bans on private sector companies subcontracting from the military.
Although the USA opened its maintenance contracts as long ago as 1966,some European governments have traditionally been reticent to allow private companies to work in potentially sensitive environments.
Various European governments led by the UK, and to a lesser extent, Germany, are now following the North American example and opening up their markets. This change, which European aerospace companies are hoping will come sooner rather than later, should open up lucrative non-operational contracts, such as training and maintenance.
Finally, although aerospace is a more attractive investment target than a year ago, with average margins tantalisingly close to double digits and stable growth, investors still appear reticent, having had their fingers burnt by high-tech stocks. The key stocks investors will be going for this time around will be those companies which are making the sustainable returns that portfolio managers need.
Regional jet manufacturers, specialist suppliers and niche players are all likely to perform well next year. But the likes of Boeing and Lockheed Martin have been around too long to let their arriviste colleagues steal the limelight for too long.
Source: Flight International
