Top 100: big guns keep firing

Last year EADS supplanted Boeing as the largest aerospace manufacturer, aided by the machinists' strike that crippled its US rival's production line for almost two months, a record year of commercial aircraft deliveries for the European company and a relative strengthening of its defence aerospace business.

Overall, the world's 100 largest manufacturers managed to grow revenues by 7.1% and profits by 7.8% despite the financial crisis and worldwide recession. That is according to the latest Flight International annual Top 100 survey compiled in association with PricewaterhouseCoopers and based on company returns for the previous financial year.

The survey also found stability in the average operating margin, which edged up from 9% to 9.1%, the highest level since 2001 (see chart). Margins among the top 20 averaged 9.3%, and there was lower variability in prime contractors' margins than in those of tier-two and tier-three suppliers.

While positive, the overall rates of growth in revenue and profit are, unsurprisingly, below those enjoyed in 2007, when revenues rose 13% and profits by a staggering 26%. In 2006, the comparable figures were 12% and 8% respectively.

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EADS's climb to the summit was aided by a 7% strengthening of the euro against the dollar, while last year's other significant currency shifts included sterling's 8% depreciation against the dollar and the Canadian dollar's 9% fall in value versus its US counterpart.

The impacts of such shifts were nuanced, however. While averages have been used to translate year-end figures, there was unusually dramatic fluctuation in exchange rates across the year, with the result that a contract's particular timing could bring either a windfall or a shrunken yield.

Furthermore, there is often a limited correlation between the local currency of an aerospace group's domicile and the currency in which the bulk of that group's contracts is denominated.

At most, a currency shift could explain a growth or decline of a few percentage points, so other factors came into play to lift EADS above its major rival for the first time.

Airbus's owner achieved the highest absolute growth in revenue, of $9.8 billion, while Boeing suffered the greatest drop, of $5.5 billion. The 57-day strike by Boeing's machinists is reckoned to have hit the airframer's revenues to the tune of $4.3 billion. Overall, its revenues declined 8.3%.

Drilling down to business-unit level, there were starkly contrasting fortunes for the two giants' respective commercial aircraft divisions. While Airbus's sales rose 18.9% (or 11.2% in euro terms), Boeing Commercial Airplanes suffered a 15.3% sales drop. Constrained by the strike, Boeing delivered 375 commercial aircraft in 2008, while Airbus enjoyed a record year of deliveries, achieving a total of 483.

A further contributor to the reversal of positions was the strong growth of EADS's defence aerospace businesses, which grew 47.2%, in dollar terms, to $17.8 billion. In euro terms EADS's military transport aircraft division almost trebled its revenues, boosted by research and development funding committed to the A400M military transport, while its defence and security unit grew 15% and Eurocopter 11% (same basis). Boeing's defence business, meanwhile, remained stagnant, with revenues remaining flat.

WINNERS AND LOSERS

Elsewhere in the top 10, the picture is largely stagnant, although Finmeccanica succeeds in penetrating the elite following its $5.6 billion acquisition of New Jersey-based defence electronics company DRS Technologies, not only the aerospace and defence sector's biggest mergers and acquisitions deal of 2008, but its third biggest of the decade.

Finmeccanica's move from 11th to ninth in the rankings pushes GE Aviation out of the top 10.

There has been more jockeying for position within the second half of the top 20. Benefiting from its relationship with compatriot Messier-Dowty, French engine systems manufacturer Safran has overtaken L-3 Communications to take twelfth place. Meanwhile, sales growth of 19% has allowed Textron - owner of Cessna and Bell Helicopter - to leapfrog Bombardier Aerospace, which suffered the negative impact of contraction in the regional sector.

The ongoing struggle to find export customers for the Rafale fighter jet was a factor in Dassault Aviation exiting the top 20. While Dassault drops from nineteenth to 21st, the same journey in reverse is completed by ITT. In September 2007, ITT grew its defence electronics business with the $1.7 billion acquisition of EDO, a manufacturer of electronic-warfare systems, weapon launchers, antennas and composite structures. Aerospace sales jumped 48.6% in 2008.

DIVERGENT PERFORMANCES

The divergent performances of Airbus and Boeing, combined with the relative buoyancy of defence compared with the commercial sector, appear to drive much of the movement elsewhere in the Top 100.

Among the companies to have slipped down the ranking by three places or more are suppliers to the delay-hit Boeing 787 programme, including composite structures specialists Spirit AeroSystems (down to 29 from 25), Kawasaki Heavy Industries (42 from 39) and Fuji Heavy Industries (65 from 61).

"If you are a structures maker, you are very much driven by the output of the primes," notes Neil Hampson, global head of aerospace and defence at PwC. "They are manufacturing original equipment, rather than relying on the installed base, which you might have if you're an engine or avionics manufacturer."

Elsewhere, the Boeing strike is likely to have contributed, to some extent, to the revenue slide at Curtiss-Wright, a New Jersey-based provider of motion-control and heat-treatment systems to the 737 and 787. It falls 25 places to number 89.

There are few companies on the list that supply Airbus solely, and few Boeing suppliers that do not also serve Airbus, but it is notable that certain suppliers with high levels of Airbus exposure fare well in the rankings. Zodiac Aerospace, which manufactures escape slides and interior components for various Airbus types, climbs three places to 33. Latécoère, another French Airbus supplier (see profile), rises from 71 to 60. New York-based Moog, which provides motion control systems to the A350 XWB as well as earlier Airbus aircraft, jumps five spots to 62.

Defence seemed a more lucrative business, to judge from the performances of two defence electronics companies: Florida-based Harris boosted aerospace sales by a quarter to reach number 26 (from 34 last year) and Israel's Elbit Systemsgrew its sales by a third to ascend five places to number 36. Yet analysis of the performance of defence aerospace's top 10 yields a more complicated picture.

SECTORAL SPLIT

EADS's bumper year in defence aerospace led it to eclipse Finmeccanica as that sector's sixth largest player (see table), despite the Italian giant growing its own revenues by 15.4% to $14.2 million.

Overall, the defence aerospace industry maintained its momentum, with the top 15 companies or divisions growing 6%, against a comparable figure of 7% for 2007. However, behind this headline figure PwC detects the impacts of "flatter defence procurement spending, a focus on land systems and network warfare and less procurement of air systems": Boeing's Integrated Defence Systems unit failed to grow and Lockheed Martin's aeronautics and electronics business shrank 1.5%. Northrop Grumman, meanwhile, managed only modest growth, of 2.4%, in its defence aerospace business.

From the regional sector, meanwhile, the tidings are bleak, reflecting a continuing reliance on the US airline industry. While Bombardier Aerospace achieved modest growth of 2.6%, Embraer saw its regional sales fall by close to a third (see table). In business aviation, the financial crash of September 2008 came too late to turn the full-year figures negative: Dassault Aviation recorded sales growth of 31.4% in its Falcon executive jet business, while sales at Gulfstream and Cessna were up 14.2% and 13.2% respectively.

However, there seems little prospect of business aviation enjoying such a strong year again, in the near future at least. "It's a very highly geared sector," notes Hampson. "It's very highly geared to the state of the economy and the perception of the state of the economy. The majority of users of business jets are corporates, but much of the recent growth has been predicated on new markets in Asia and the Middle East. There has also been a change of sentiment on business jets in traditional corporate markets impacted by the recession." He cites the notorious case of the automotive industry executives who used corporate jets when they travelled to Washington DC to ask Congress for emergency funding.

The combined sales of the Top 100 totalled $585 billion, of which North American companies accounted for $350 billion, or 60%. The average operating margin among the 51 North American companies in the Top 100 was 10%, compared with 8.1% for the 37 European companies in the Top 100, which accounted for 35% of total sales. Hence, the rest of the world's aerospace companies have combined sales of only $29 billion (or 5% of the total).

Yet it should be stressed that work undertaken by a manufacturer's offshore subsidiaries is not separated out within the listing. Additionally, Russian and Chinese manufacturers have, as usual, been excluded from the Top 100 on the grounds that they employ very different accounting methods from those that prevail elsewhere. Hampson estimates that the "rest of world" contribution to Top 100 sales could reach 15-20%, in terms of value added, over the next five years.

As is traditional, rich pickings were to be had in the aftermarket business in 2008. TransDigm, newly arrived in the Top 100 at number 85, managed an operating margin of 42%, while Chemring and Precision Castparts were in the 20-25% range of profitability, reflecting the benefits that arise from prescribed replacement cycles. Electronics proved a similarly lucrative field, as shown by the margins of FLIR Systems (26%: see profile), Garmin (25%) and Rockwell Collins (20%). Plainly, the "black-box" nature of modern aircraft electronics can allow for a premium to be extracted.

Some consistency is discernible in the profit performance of major manufacturers, with five of the top 10 in situ since 2005, and as usual, Pareto's principle applies to the Top 100: the top 20 account for roughly 80% of revenues and profits or, to be more precise, 79% of the former and 81% of the latter.

Merger and acquisition activity in the global aerospace and defence sector declined by more than 50% in 2008, with total deal value declining from $32.9 billion to $14.3 billion. However, European bids for North American targets totalled $7.3 billion, their highest level this decade, an outcome explained not just by dollar weakness, but also by a US defence budget that tops $500 billion.

Finmeccanica's landmark acquisition of DRS was the year's biggest deal. Other major ones included General Dynamics' $2.2 billion takeover of business aviation services company Jet Aviation; BAE Systems' purchase of Australian parts manufacturer Tenix Defence ($683 million); and Cobham's move for missile defence company Sparta ($416 million).

The contraction of merger and acquisition activity over the full course of 2009 is expected to be "severe", although there may be bargains available to those with funds to invest.

DANGER AHEAD?

In appraising future prospects, PwC warns that there is evidence to suggest that the ongoing down-cycle differs from others in aviation history - for better or worse.

"The impact of the recession on the banking sector has made it very difficult for airlines to finance new aircraft orders, with many orders from 2010 onwards as yet unfinanced," says the consultancy. The shortage of financing is considered a short-term differentiator. It is exacerbated by the travails of mega-lessor International Lease Finance (which fell into the US government's hands after the bailout of AIG and is earmarked for divestment), and by the limited coffers of airframers and governments, which might otherwise ride to the rescue with financing support.

Another differentiating factor is that airline growth is now strongest in Asia and the Middle East. Potentially a long-term trend, this helps to shield manufacturers from downturns in the US airline industry, which have traditionally had devastating impacts. Equally, the sheer size of the airframers' orderbooks provides what Hampson terms "a cushioning effect".

SUPPLY CHAIN TRANSFORMED

Meanwhile, the aerospace supply chain has been transformed as Airbus and Boeing look to streamline their supplier bases and reduce exposure through risk- and revenue-sharing partnerships.

Assuming the market outlook remains poor, 2010 and 2011 will bring cuts in production at Airbus and Boeing, by PwC's forecast. "A strong backlog is underwriting current production and therefore production rates have not declined as far as airline demand would predict," says the consultancy. Tier-two and tier-three suppliers will need to ready to react rapidly to any such cuts to ensure their long-term health, given the leanness of modern supply chains.

Nevertheless, 2009's full-year figures are likely to reveal limited evidence of the downturn's impact on financial performance across the supply chain, with civil aircraft production peaking across 2008 and 2009. "Revenues and profitability are going to hang on the civil cycle," says Hampson. "It has to come off its peak, in terms of deliveries, irrespective of what happens to the orderbook. The orderbook is not the basis from which you derive your revenues."

Orders for large civil, regional and business jets are likely to fall considerably from 2007-8. For the first quarter of 2009, the total net orders achieved by Airbus and Boeing combined stood at just four aircraft, compared with 683 in the same period of 2008. Airbus achieved eight net sales after adjustment for 14 cancellations, while Boeing's net order tally was minus four, after 28 new sales were offset by 32 787 cancellations.

However, the airframers' fight for market share has diminished in importance as attention switches to protecting profits and cash.

"Airbus and Boeing both have very significant cash requirements from development programmes, but the amount of money contributed to that requirement by orders isn't very much," says Hampson. "Down payments don't really move the needle much, compared with the amount of money that you have to spend developing a new aircraft."

A possible reduction in output and revenues is foreseen for 2010, driven by a likely $10-20 billion shortfall in the funding needed to support 950-1,000 Airbus and Boeing deliveries this year.

Elsewhere, uncertainty surrounds the future of defence budgets on both sides of the Atlantic, with the Obama administration's intentions a source of much speculation and a general election due in the UK in 2010. Accordingly, PwC's outlook for defence aerospace is cautious. It anticipates "no likely substantive or noticeable increase in defence procurement - especially in air systems".

Ultimately, however, the distinctive nature of the ongoing down-cycle means that manufacturers are perhaps less vulnerable than they have been in the past. "There are some things that are going to change in 2009, but I have not seen any signs that it's going to fall off a cliff in the way it did in 2002 and 2003," says Hampson.

As to the likelihood that EADS will again top the table next year, much hinges on the number of commercial aircraft deliveries and the outcome of negotiations with customers for the indefinitely delayed A400M.

Source: Flight International