Past the halfway point of 2021, the vast majority of Western commercial aerospace and defense OEMs, primes and suppliers have logged respectable midyear financial results. Despite this improvement, industry’s prospects still are not as good as expected a few months ago, and increasingly the depths of last year’s pandemic-related falloff are becoming clear.
The upshot: Aerospace and Defense’s (A&D) recovery from the worst downturn in the jet age remains a 2023-25 prospect, and expectations of a steep, straight-line, and up-and-to-the-right growth trajectory may not be reliable.
- Recovery in 2023-25 remains consensus, despite hopes for better
- A&D industry may reach breakeven this year, at best
For starters, a July report from consultants at AlixPartners warns that profits in the industry this year will likely just reach breakeven—at best.
According to the consultancy, challenges include increasing pricing pressures—with factors such as lessors weighing in against aircraft manufacturers’ traditional power more fiercely than ever—as well as a continued depressed widebody production backdrop. Other issues that remain are a weakened supply chain, higher commodity prices, uncertainties surrounding the steep upcoming narrowbody ramp-up and likely impairment charges for lessors this year, which were largely put off by many lessors last year.
“Uncertainty is still very high,” Eric Bernardini, co-leader of the global aerospace, defense and aviation practice at AlixPartners, told Aviation Week in May. “Pricing will be very intense. In the end, everyone is chasing the same customers.”
Bernardini believes that airlines will face the most pressure of all commercial aerospace sectors to transform their business models in coming years to become financially sustainable. In manufacturing, he anticipates that consolidation in the lower tiers will accelerate after summer in the Northern Hemisphere, when many government aid programs there will stop.
Such an outlook is not surprising considering the results of the latest annual report from PwC’s A&D practice, led by Scott Thompson, which shows how dramatic the 2020 downturn was for industry. A&D reported $697 billion in revenue, down 8% from 2019, and just $25 billion in operating profit, a drop of 61%.
“2020 was an unprecedented year,” Thompson said in May. “The shock to end markets devasted demand for new aircraft and maintenance, repair and overhaul services. Commercial aviation companies had to pivot from high levels of growth to a focus on employee safety, liquidity and preserving critical skills in the workforce for the eventual recovery.”
According to PwC’s review, Boeing’s performance weighed heavily on industrywide results in 2020: The airframer’s operating profit was down nearly $11 billion, accounting for more than a quarter of the total industry’s decline. Better only by comparison, Airbus reported a $2.1 billion profit decline, with revenue down $22 billion.
Spirit AeroSystems, an aerostructures leader and potential super Tier 1 supplier, saw revenue plunge by 57%. Indeed, the four largest Tier 1s to commercial manufacturers—Raytheon Technologies, General Electric’s GE Aviation division, Rolls-Royce and Safran—all reported an aggregate operating profit loss of $1.4 billion for a decline of $16.3 billion, PwC says.
Combined with the OEMs, these seven companies represented more than three-quarters of the overall industry profit decline last year.
In contrast, many defense primes announced stellar results. L3Harris Technologies reported revenue growth of 42%, albeit largely because 2020 was the first full year following the merger of Harris and L3 Technologies. Lockheed Martin reported revenue of $65 billion, up 9% over 2019, thereby becoming Western A&D’s largest company by revenue. The growth was driven largely by expansion of the F-35 program and, of course, sharp decreases at Airbus and Boeing.
But even in defense, expectations are moderating going forward. Lockheed, which caught Wall Street off-guard with a $225 million charge to second-quarter earnings due to issues with a classified aerospace program, this month suddenly lost its seasoned chief financial officer after an abrupt resignation for personal reasons.
What is more, Lockheed in the current third quarter will recognize a noncash, nonoperational settlement charge of $1.7 billion before taxes due to a recent deal to transfer pension obligations to a third party. While the move may increase its competitiveness long term, as other primes have ditched pensions and costs, it will trigger a $4.75 per share hit to earnings per share this year. An investor briefing on Aug. 5 left many financial analysts unsatisfied with the company’s new leadership regime’s grasp over a midterm plan.
“The event was suitably replete with Lockheed Martin buzzwords, such as 21st century warfare, 5G.mil and JADC2,” Vertical Research Partners analysts Rob Stallard and Karl Oehlschlaeger said the next day. “However, we think that investors have yet to be convinced that this intellectual construct can be converted into hard dollars, and yesterday’s event did little to change that situation. We think investors, like Congress, find it easier to get their arms around actual programs of record versus this thematic stuff, and hence the continued default to Lockheed Martin equals F-35.” That fighter’s production is expected to peak in a couple of years and concerns remain whether the U.S. military will procure the full forecast of jets in the long term.
Looking ahead, several consultants and executives say they continue to believe forecasts that a full recovery for industry is not expected until at least late 2023, starting with the prolonged return of commercial aviation prospects.
“We’ve shared previously—and consistent with IATA and other industry groups—[that] we expect passenger traffic to return to 2019 levels in 2023 to 2024 and then, a few years beyond, to return to long-term trend growth,” Boeing CEO and President David Calhoun affirmed on July 28.
Boeing still sees recovery in three phases: first, domestic; then, regional markets such as intra-Asia, intra-Europe and intra-Americas; and finally, long-haul international routes. “Therefore, we expect demand for narrowbody aircraft to recover faster—as evidenced by our year-to-date orders for 737 MAX airplanes—and demand for widebody aircraft to remain challenged for a longer period,” Calhoun says.
PwC says the Western defense market should remain robust, although admittedly longer-term outlooks are clouded. “Global defense budgets are plateauing but at healthy levels,” Thompson’s group says. “While escalating deficits pose a risk to defense spending, global threat levels remain elevated in some regions, including those undergoing military modernization programs.”
Industry is not standing still, both PwC and AlixPartners say, and companies are trying to adapt. PwC says the restructuring actions begun by commercial aerospace companies in 2020, combined with digital transformation and business process improvements, will boost competitiveness for “many” years and position A&D for a profitability boom as end markets recover.
But Bernardini warns that more hard work is ahead. “For the industry to achieve sustained levels of strong profitability will require structural cost reduction, not just emergency or one-off actions,” he says. “And that, in turn, is going to require a collaborative approach throughout the value chain to reduce aircraft unit costs, including a leveraging of win-win opportunities such as ‘redesign-to-cost’ parts redesign and greater levels of digital transformation.”
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