Going into the second half of 2022 and beyond, aerospace suppliers continue to be buffeted by labor costs, workforce shortages, raw material inflation and other challenges. But despite the economic trauma of recent years, the industrial base is moving forward.
The upshot: Aerospace and defense supply chains will remain the leading hindrances to ramping up monthly production rates of large commercial aircraft and fighter jets compared with the eye-popping forecasts pushed by leading OEMs—but that is due to regrowth pains rather than financial stress in the supplier base.
- Separate surveys of A&D supplier base find strain but few cracks
- Challenges seen abating in 2023 as stability, growing production helps
“We all continue to hear anecdotal data [of individual companies], but I wouldn’t say financially that they are in a worse spot now than they were before,” RBC Capital Markets analyst Ken Herbert tells Aviation Week. “They have been able to largely manage what have been fairly mild increases on production runs mostly out of Boeing and Airbus. I would say they are managing through the disruptions pretty well.”
Herbert’s team in June published its 2022 first-half supplier survey, the latest regular market survey Herbert has done for years (see first graph). Concurrently, Jefferies analysts led by Sheila Kahyaoglu issued their second annual aerospace and defense raw materials survey, which includes a significant focus on supplier issues (see second and third graphs).
The surveys were conducted in May and early June, respectively, before increased recessionary concerns emerged later in June, pushing stock markets into bear territory. Both polls found labor, raw materials and rising costs to be foremost in the minds of industry executives.
Still, the leaders deemed these issues manageable, with conditions expected to ease by 2023 with relief from macroeconomic pressures and steadily rising airliner production rates. Contract cost escalation clauses and other management tools also will help mitigate costs in the meantime.
The survey results are backed by executive commentary elsewhere. “We had a solid start to the year, I’d say, despite the persistence of omicron and supply chain constraints,” Raytheon Technologies Chief Financial Officer Neil Mitchill, Jr., told a UBS investor conference June 8. The Super Tier 1 has 13,000 product-based suppliers, with around 1,900 seen as critical for complex components. Of those, roughly 400 have some performance risk, particularly in castings, rocket motors and microelectronics. But Raytheon is deploying some 300 of its own staff to help.
“All in all, I’d say we are actively engaged in managing the supply chain,” Mitchill said. “This problem won’t be resolved this year, but I think we’ve got a lot of resources focused on it.”
What is more, the surveys underscored the whole sector’s ongoing desire for predictability more than two years after the worst downturn in commercial aviation history, as well as a new geopolitical era marked by the Russian invasion of Ukraine in February. “They are asking for some sort of stability,” Herbert says of suppliers. “That’s the best thing right now.”
The industry certainly is still reeling in the aftermath of the COVID-19 outbreak. According to Jefferies, 95% of respondents said they are facing cost and/or supply chain headwinds related to the effects of the pandemic and subsequent recovery. Of those, 80% cited labor shortages as a significant headwind, given a lack of skilled applicants and the difficulty and cost of training and retaining talent.
Seventy percent reported facing high raw material costs related to limited availability and price gouging. More than half said they see supply chain problems related to finished goods, including extended lead times, while 45% of respondents are facing difficulties related to the limited supply of semiconductors. Almost one-third are experiencing pressures in each of the four categories.
With labor costs constituting around one-third of most companies’ cost base, worker issues led the lists. Jefferies respondents believe their labor costs will rise 8.8% in 2023 from 2022, due to more competitive wages being demanded generally, as well as benefits and salaries to attract, train and retain skilled laborers.
“Labor for skilled workers, including for the engineering involved in aerospace and defense manufacturing, is in short supply following the pandemic,” Kahyaoglu’s Jefferies team wrote. “Workers are quitting their jobs at faster rates than at any time in history, as the move for higher wages and greater workplace flexibility creates a disconnect between job openings and applicants.”
One-fifth of their respondents said they expect their workforce to grow 3-5% this year, while separate 15% factions said they expect 5-10% or 1-3% growth. But 30% see the workforce flattening in 2022, while 15% believe the workforce will shrink.
For 2023, their hiring expectations grow, with 50% of respondents indicating employment ranks could rise 3-5%, compared with just 5% expecting a flat workforce level and just 10% expecting the workforce to shrink.
As raw materials comprise almost as much of most companies’ cost base, they present the next hurdle to surmount after labor. However, it is not the classic metals that lead the laments, according to polled executives. Forty percent of Jefferies respondents said they are having trouble sourcing semiconductors or electronics parts, mirroring wider national and international business concerns. One-fifth identified steel sourcing as a top concern, followed by 15% each for composites and titanium and 10% for aluminum.
Nevertheless, as aluminum was reported as the highest proportion of the cost base on average, it is a relatively positive material for limiting cost inflation, according to Jefferies.
At the same time, prestocking is a popular response to raw material shortages. Jefferies survey respondents were carrying an additional 4.3 months of inventory on average through prebuying activity. Only 5% said they carried nine months or more of inventory, while another 5% are not carrying any extra inventory.
Survey respondents generally predict raw material prices will be about 12% higher in 2022 compared with last year. For next year, the Jefferies survey implies that unit raw material costs will be 9% higher on a weighted average basis. That is consistent with expectations for supply chain pressures to alleviate by mid-2023, given the deceleration of cost inflation, but still above prior expectations of just a 2% increase for 2023.
Overall, according to the RBC survey, the cumulative effect on 2022 first-half sales from supply chain disruptions, labor shortages and other challenges for suppliers is about an 8% hit. Looking into the second half, suppliers expect hiring and labor shortages to be another 5% of the effect, with most of that, 4%, tied to sourcing labor.
In the RBC survey, suppliers said they believe aerospace will see strengthening—albeit lower—work volume growth throughout the year. Suppliers are expecting about 8% growth in the first half, down from their expectation of 12% when RBC last ran the survey at the end of last year. However, suppliers remain optimistic about the sector’s recovery prospects and are anticipating roughly 11% growth for the second half.
One reason the effects could be ameliorated is because larger suppliers enjoy price protection. “A number of our companies have spoken to passing through inflation to the customer through higher prices, although flexibility varies by contract structure and end-market (e.g., aftermarket versus OEM),” the Jefferies report states. Suppliers have reclaimed 6.4% of gross price this year, with 65% of respondents pricing in line with or above the consumer price index (CPI), which was running above 8%. Almost one-third of respondents were even able to raise prices beyond 10%.
By comparison, the first-ever Jefferies survey found that in a typical year, annual net price increases (ex-CPI) were only 0.6%, as 45% stated they were able to push through 0-5% price increases, and 30% said prices remained flat on average.
Lower-tier suppliers do not traditionally receive price escalation-clause protections in their contracts with top-tier customers, however. And if inflation spikes dramatically beyond anything seen in modern history, even top-tier companies will find little refuge in the contract tools.
But coming off the commercial passenger traffic lows of the pandemic, airlines and OEMs are reporting that improving outlooks—and higher volumes of products or services will help partially alleviate higher input prices. For the time being, do not expect outright inflationary panic when it comes to aerospace manufacturing quarterly earnings.
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