The aftermarket supply chain will look much different in the wake of the brutal COVID-19 shakeout, Aerodynamic Advisory Managing Director Kevin Michaels told attendees at IATA’s ongoing Maintenance Cost Conference.
Aviation manufacturing that is less integrated at the top, but more consolidated below the top seems to be the most likely outcome. And that could have big implications for airlines and MROs depending on OEM support in the aftermarket.
First, after years of vertical integration, OEMs are pulling out of non-core activities. As evidence of this much-discussed trend, Michaels cites Airbus’ decision not to vertically integrate on the nacelle of the A320neo’s GTF engine, Bombardier’s sale of Short Brothers to Spirit AeroSystems, and Rolls-Royce’s plans to sell assets, including ITP Aero, to raise at least $2.6 billion. “All eyes are on Boeing now,” Michaels says, arguing Boeing would be better off conserving limited capital for a new airplane.
Michaels predicts that Tier 1 suppliers will restructure, right-size their operations and engage in mergers and acquisitions. “Like OEMs, Tier 1s will purge under-performing or non-core assets,” he argues.
Among Tier 1 suppliers, avionics and systems suppliers are the least vulnerable to drastic change, given their market diversification and strength in the aftermarket. “They do a lot of work for the military and business aviation,” Michaels notes. But aerostructures and interiors suppliers are experiencing financial difficulties and will have to right-size their capacity, according to Michaels. “If you are an aerostructures company, you really don’t have access to aftermarket revenues,” he says.
Financially strong Tier 1 suppliers and holding companies as well as private equity companies will be active in acquisitions, Michaels predicts, adding: “Parker’s bid for Meggitt is the big news here.” Many of these acquisitions may actually be necessary to rescue critical aviation suppliers headed for failure. Above all, Michaels stresses, “The blind pursuit of scale without synergies will ebb.”
Below Tier 1, the outlook for reorganization varies considerably. For Tier 2 suppliers of components and sub-assemblies, Michaels foresees some attrition, particularly in aerostructures and interiors, and targeted acquisitions by Tier 1s and private equity.
Tier 3 suppliers of build-to-print parts will suffer the most turmoil. “These are machine shops; they don’t have the design IP,” Michaels notes. “There are thousands of these firms across the world…they have burned down their working capital.” He expects significant attrition and restructuring, especially in aerostructures and general machining. Tier 3s with defense, general and business aviation and non-aerospace customers are best positioned to survive intact, and government aid programs in each home country will help determine the fate of the others.
Tier 4 suppliers that mill, process, forge or cast raw materials are now suffering from the whipsaw of destocking and reduced volumes. But Michaels does not expect much attrition here, as these companies are usually large and diversified, and raw material prices are highly resilient.
When will all of this happen and which companies will be hit? The Michaels says one set of pressures to watch is the working capital and human resource requirements of production recovery, which could lead to more failures. Working capital of many small suppliers is now depleted, and some companies only survived through government funding and sales of work in progress.
“Supporting a ramp-up will require non-existing working capital,” Michaels observes. “Can they bring back skilled employees after deep cut-backs?” For example, he points out, Precision Cast Parts laid off 50% of its workforce during the crisis. That could matter significantly when orders recover, says Michaels, adding “Will the supply chain be ready?”
