AeroSpace Market Analysis (2)

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Part
01

Aerospace Market Drivers

Below is a summary of the commercial and military aerospace industry growth drivers, including government-subsidized programs. Notably, underperforming aerospace segments lack these drivers.

Commercial Aerospace Drivers

  • The commercial aerospace industry's growth is being driven primarily by the increasing number of passengers, particularly in the APAC region, due in large part to the need for fast transportation to handle the demands of globalism, business, and tourism.
    • This increase in passengers is directly correlated to the growth of a thriving middle class with disposable income in many countries, again with special reference to the APAC region.
    • Consequently, Boeing estimates that there will be a global need for 44,000 new airplanes over the next 20 years. APAC will account for 40% of global demand for new aircraft, totaling an estimated "16,930 deliveries — this makes for a service market of $3,365 billion."
  • The industry rebounded quickly after the 2009 market crash, with the main drivers being "consolidation, revenue passenger kilometer and airline capacity discipline, along with low fuel prices, and more revenue sources."
    • Consolidation, in turn, is driven by the inability of smaller aerospace firms to "meet the rising financial, managerial, technical, risk-taking, and investment requirements needed to survive in a borderless world of growing competition."
  • In some regions, like the Russian Federation, with high foreign-born populations, the aerospace industry is bolstered further by VFR (visiting friends and relatives) air travel.
  • The increased demand for aircraft, in turn, drives the maintenance, repair, and overhaul (MRO) market, which is growing at a CAGR of 3.7% globally and 4.5% in the APAC region.
  • Airbus has indicated that the development of new technologies and materials is driving a trend towards outsourcing MRO, especially in the component and engine market.

Government Initiatives as Drivers

  • India's Ude Desh Ka Aam Nagrik Regional Connectivity scheme, or UDAN-RCS, "is a government initiative designed to make domestic flying more accessible to the Indian population, by making it more affordable and convenient," stimulating both India's air travel industry and the general economy.
  • China's Belt and Road Initiative (BRI), which launched in 2013, aims to connect Asia to the Middle East, Africa, and Europe via a vast transport and logistics network. As noted by Satair, "The initiative already appears to have had a positive impact on air travel to and from China for countries participating in the program."

Defense Aerospace Drivers

  • The defense side of the aerospace industry is driven "by rising geopolitical tensions, natural recapitalization cycles, greater high/low mix of assets, focus on aligning solutions to local requirements, and the increased demand for affordable, off-the-shelf equipment," all of which contribute to a general rise in military expenditures.
  • The race to develop hypersonic weapons illustrates how global competition to develop more advanced weapon and defense systems drives the defense segment of the aerospace industry: Washington is concerned that Beijing may have their first hypersonic weapons platform, the DF-ZF, online before any equivalent American system. The DF-ZF, in turn, was "largely catalyzed by concerns that US advanced missile defense systems ... are severely undermining if not abrogating China's strategic and conventional nuclear deterrent."

Underperforming Segments Lack Drivers

  • In 2018, the output of single-aisle jetliners rose 20% and combat aircraft rose 7.6%, but losses in regional aircraft, business aircraft, military transports, and larger military rotorcraft dragged overall output growth to just 1.9%.
  • As noted by Aerospace Manufacturing & Design, "Each of these underperforming segments lack identifiable growth drivers."
Part
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Part
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North American Geopolitical Risks and Challenges

Below are outlined the geopolitical risks and challenges faced by the North American aerospace industry. Note that Boeing is an American company and so the forced grounding of the 737 Max might be considered an additional challenge, but due to Boeing's global reach, we have detailed their woes in the global brief for this project.

Tariffs and Trade Wars

  • With China:
    • On April 3, 2018, the Trump administration "threatened a 25% tariff on $50 billion in Chinese electronics, aerospace, and machinery" with a demand that China cease subsidizing its industries to give them an unfair competitive advantage. In return, China issued tariffs on sorghum and Boeing airplanes, attempting to undermine states that supported Trump in the 2016 elections.
    • While agreements were reached by early 2019 and both sides dropped the tariffs, the brief trade war illustrated the interconnectedness of the two economies; e.g., it is common for US companies to ship raw materials to China to be manufactured into parts at a lower cost than producing them Stateside, then have the parts shipped back for final assembly into finished aircraft.
  • With Europe:
    • On March 8, 2018, the Trump administration placed a 25% tariff on imported steel and a 10% tariff on aluminum, stating that dependence on foreign metals threatened America's defense industry.
    • This tariff would particularly impact European imports, which was deliberate, as the EU had raised a 10% tariff on automobiles and the administration wanted a quota on EU steel exports.
    • The Aerospace Industry Council claimed that the tariffs would only serve to raise America's military's costs.
    • Similarly, on April 15, 2019, the Trump administration announced tariffs on $11 billion of European imports, demanding an end to the EU's subsidies to Airbus.

Skilled Labor Shortages

  • As noted in a recent journal paper, "Because of the highly specialized nature of the business, companies must hire and retain skilled and qualified personnel necessary to perform the business-critical processes."
  • The pool of workers with the requisite skills and clearances is small and subject to competition from "commercial technology companies outside the industry."
  • In the US, the demand for commercial MRO maintenance technicians is expected to spike starting in 2024 even as the supply slowly but steadily declines.


Canada's Decline in Aerospace

  • A 2019 Aerospace Industries Association of Canada (AIAC) report by industry expert Jean Charest states that Canada's aerospace industry is at risk of falling behind "foreign rivals if [the] government doesn’t treat it as an 'urgent priority' and work with the sector to staunch falling employment and GDP contributions."
  • Since 2012, aerospace GDP ($25.5 billion) and employment contributions (over 213,000 jobs) in Canada have declined 4-5%.
  • In addition, 40% of aerospace research and exports in Canada "is done by foreign companies like Pratt & Whitney and Bell Helicopter."
  • Charest states, "Global competition has never been tougher, and we’re at a turning point where Canada must step up, or risk being left behind."
  • The report calls on the government to commit to new funding and "Canada-first defense procurement" along with efforts to draw fresh talent to the industry.

The Hypersonic Arms Race

  • While the US, like other world powers, is developing hypersonic weapons as a part of its aerospace defense, China's DF-ZF hypersonic vehicle is seemingly closer to deployment.
  • At 4,000 to 7,000 mph, the DF-ZF is slower than proposed US platforms like the X-51 scramjet, but its advanced timeline has raised concerns in Washington.
  • The DF-ZF, in turn, was "largely catalyzed by concerns that US advanced missile defense systems ... are severely undermining if not abrogating China's strategic and conventional nuclear deterrent."

Shift in Growth Patterns

  • At the current rate, China's aviation market will surpass that of the US by 2022, a shift that moves power in the market from North America to the APAC region.
Part
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Part
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European Geopolitical Risks and Challenges

Below are outlined the geopolitical risks and challenges faced by the European aerospace industry.

Brexit

  • The combined turnover of UK-based aerospace companies rose 39% from 2012 to 2017 to £31.8 billion, "placing Britain behind only the US in the global league."
  • As a result, the European aerospace industry has been warning of possible chaos and losses should Britain leave the European Union without "a good Brexit deal."
  • In July 2019, officials of Airbus, Europe's largest aircraft manufacturer, issued a warning about rising tensions, with CEO Guillaume Faury saying, "It is now obvious that no deal is likely and we want all governments to be prepared for that, which was not the case by end of March."
  • Airbus has stockpiled parts as a hedge against supply chain disruptions and regulatory issues.

Tariffs and Trade Wars

  • Following World Trade Organization rulings against European aircraft regarding EU subsidies to Airbus, the US has threatened to impose sanctions — specifically, tariffs on $11 billion of European imports — on the European aircraft industry.
  • Previously, on March 8, 2018, the Trump administration had announced a 25% tariff on imported steel and a 10% tariff on aluminum, stating that dependence on foreign metals threatened America's defense industry.
    • This tariff would particularly impact European imports, which was deliberate, as the EU had raised a 10% tariff on automobiles and the US administration wanted a quota on EU steel exports.
  • The EU has threatened counter-tariffs following a similar WTO ruling against US subsidies to Boeing.
  • Faury has called for an end to the dispute.

Withdrawing Government Support

  • Due to the above WTO ruling, Airbus has expressed concerns in its annual report that it has no assurances that it will continue to receive "different types of government financing of product research and development."
  • The report goes on to warn that, since other forms of financing may not be as available due to market conditions, Airbus could become more limited in its ability to make capital expenditures.
  • As Airbus is the largest aircraft manufacturer in Europe, a disruption in its ability to obtain financing would have a similar deleterious effect on its extensive supply chain to Boeing's current woes.

A Mature, Consolidating Market

  • Europe's aerospace market is a mature, long-cycle market, with suppliers and buyers having long-established relationships that newcomers to the market find difficult to penetrate, requiring a long-term strategy.
  • The number of players is shrinking rather than growing due to a large volume of mergers and acquisitions: "All independent SMEs, with few exceptions, end up as part of a larger company in the same sector."
  • Simultaneously, major contractors are reducing the number of suppliers that they work with even as the number of aircraft in production or requiring maintenance grows at a rate of 5% per year. This will potentially cause suppliers to fall behind production needs.

Eurozone Debt

  • As a result of concerns about the ability of several European countries to reduce their budget deficits and repay their debts, "the European financial markets have undergone significant disruptions."

Part
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Part
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APAC Geopolitical Risks and Challenges

Below are outlined the geopolitical risks and challenges faced by the APAC aerospace industry. Due to China's prominence, our brief touches on multiple challenges faced by or poised by that nation, but this simply reflects the focus of the industry experts that we have cited.

Chinese Aviation Goals

  • China's "Made in China 2025" goals (unveiled in 2015) include moving its aerospace industry "up the value chain to reduce reliance on foreign technology," to capture 10% of the domestic market and 25% of the global market in the next five years.
    • This includes a 40% share of the global general-purpose plane market and 15% of the global helicopter market.
  • Generous government subsidies, which have been in effect for over a decade, "allow the Commercial Aircraft Corporation of China, known as Comac, to price its planes cheaper than Boeing or Airbus."
  • The Trump administration has directly attacked these government subsidies as "unfair government interference in China's economy, to the detriment of US exporters."
  • As a result of these subsidies, the C919 had already received over 800 orders by June 2018 although it is not expected to enter operation until 2021.

China's Credibility Challenge

  • The Civil Aviation Administration of China (CAAC), the Chinese equivalent to the FAA in the US, lacks credibility due to being "basically an arm of the government, with no political independence," having little in the way of experience or established procedures, and a tarnished track record.
  • China currently consumes 23% of the world's jetliner output and was hoping to reverse from a net importer to a net exporter with the launch of China's first production jetliner, the Comac ARJ-21 and the upcoming launch of the C919, which closely resembles the 737 Max. However, only ten of the ARJ-21 have been produced so far, all for a single Chinese airline.
  • The CAAC-approved Xi'an MA-60, China's "most exported civil transport aircraft," has seen half of the 60 or so planes exported "withdrawn from use, either through mishaps, fatal crashes, nonairworthiness, or because countries have a perfectly legitimate fear of an unsafe aircraft."
  • Some experts believe that China is trying to mitigate its commercial aircraft woes by having the CAAC be the first aircraft safety agency to ground Boeing's 737 following two lethal crashes in 2019.
  • Additionally, multinational aerospace firms, such as CFM International, have pulled out of deals with Chinese government-controlled firms due to China's reputation for intellectual property theft.

Market Slowdowns

  • China has reduced its GDP target growth, "indicating apprehensions of a slowdown of the world’s largest growing economy." China's total GDP growth rate is expected to decline over the next several years despite assurances of Beijing to the contrary.
  • The possibility of a slowdown is particularly troubling as the APAC region has surpassed North America as holding the most debt; 35% of global debt, to be specific.

Tariffs and Trade Wars

  • On April 3, 2018, the Trump administration "threatened a 25% tariff on $50 billion in Chinese electronics, aerospace, and machinery" with a demand that China cease subsidizing its industries to give them an unfair competitive advantage. In return, China issued tariffs on sorghum and Boeing airplanes, attempting to undermine states that supported Trump in the 2016 elections.
  • While agreements were reached by early 2019 and both sides dropped the tariffs, the brief trade war illustrated the interconnectedness of the two economies; e.g., it is common for US companies to ship raw materials to China to be manufactured into parts at a lower cost than producing them Stateside, then have the parts shipped back for final assembly into finished aircraft.
  • This means that an escalating trade war "threatens supply chains across APAC, and a trend toward protectionism could infiltrate the area's closely intertwined network of economies."

India's Shaky Position

  • The majority of Indian airlines carry heavy debts owed to Air India, the country's national carrier. Air India, however, has hemorrhaged nearly $1 billion a year since 2012, creating a precarious economic situation.
  • While access to modern technology is improving and the number of aerospace firms is growing, the former monopoly of the "state-owned aeronautical giant, HAL" has put India at a disadvantage in keeping pace with global aerospace technology and manufacturing.
  • As a result, China's aerospace industry, which began at roughly the same time, has far outpaced India's.

Part
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Part
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Rest of World Geopolitical Risks and Challenges

Below we have outlined the current geopolitical risks and challenges which affect the global aerospace industry. Additionally, while not fitting the criteria of this brief, we came across an excellent article from NC State University on the general risks faced by supply companies for the aerospace industry. We recommend perusing this article for context.

Contraction Concerns

  • A recent Accenture report states that "there have been warning signs that capacity growth has outstripped demand," and that key players are preparing for a market downturn.
  • In 2018, industry margins fell 20% "as favorable tailwinds driving better cost performance dissipated"; competition and capacity growth have kept pricing power out of any company's hands.
  • While many experts believe that a true industry-wide downturn is unlikely, "OEMs and suppliers have become accustomed to high growth rates in aircraft production and deliveries, and those rates will almost certainly slow in the years ahead." Given the high demands of aerospace companies by investors, any decrease in growth rates might be perceived as a contraction.

A Shift in the Market


Grounding the 737

  • Boeing's 737 Max aircraft has been grounded since March 2019, following two deadly crashes that killed 346 people.
  • This action has "wrought havoc for the aviation industry, with suppliers and airlines feeling the pinch" and the total number of global airline seats falling by 40 million at a time when Boeing and Airbus have a combined backlog of about 14,000 planes, representing eight years of production.
  • Moody's considers the 737's grounding to be "the most pressing risk for the sector," and if the aircraft does not return to service by early 2020, "will likely downgrade its outlook for the industry as a whole," as Boeing's woes would "trickle down" to its incredibly large supply chain.
  • While it is likely the aircraft will return to service in 2020, questions about how much Boeing will have to compensate its partner airlines, an SEC investigation into the company's financials, and a multi-departmental investigation into production practices don't bode well for Boeing or its supply chain.
  • Already, Boeing has announced that it will suspend production of the 737 in January 2020 and has told its suppliers to cease shipments in the middle of the month.
  • In the meantime, Airbus is trying to ramp up production of the A320, the direct competitor to the 737.

Risks of Global Operations


Risks of Crossover with the Defense Industry

  • Operating in countries with high levels of bribery and corruption creates a higher risk of fraud and corruption within a multinational company, exposing them to severe consequences in other countries, "such as the imposition of fines and penalties, termination of contracts, suspension or debarment from bidding on or being awarded government contracts, and civil or criminal investigations or proceedings." This is particularly a risk for aerospace firms that also work in the defense industry.
    • For example, India recently barred several overseas defense companies — Singapore Technologies Kinetics; Israel Military Industries; Rheinmetall Air Defense of Zurich, Switzerland; and Corporation Defense of Russia — from doing business in India until 2024.

Supply Chain Challenges

  • As noted in an S&P Global report, "The global aerospace supply chain remains strained, limiting the ability of Boeing and Airbus to increase production rates, especially for narrowbodies, much above current plans."
  • Over the next 18 months, 71% of aerospace supply chain executives expect their production capacity to increase; however, over 60% cite a lack of automation in their factories and current production capacity as among the top factors hindering them from meeting the necessary production rate levels over the next year.
  • The top reason cited for failure to meet short-term production needs is lacking an agile supply chain.
  • Over half of respondents saw "increasing costs across production labor, raw materials and sub-system or parts costs" in 2019, with nearly 60% expecting cost increases in the coming year.
  • Only 38% of aerospace executives believe that their investments in digital technologies (e.g., 3D printing, Digital Twin, IoT, AI) over the last three years are sufficient to allow their company to fully meet their production requirements.
  • Since smaller aerospace firms are less likely to be able to "meet the rising financial, managerial, technical, risk-taking, and investment requirements needed to survive in a borderless world of growing competition," they may be absorbed in "painful industry mergers" which cause further economic instability.

Underperforming Segments

  • In 2018, the output of single-aisle jetliners rose 20% and combat aircraft rose 7.6%, but losses in regional aircraft, business aircraft, military transports, and larger military rotorcraft dragged overall output growth to just 1.9%.
  • As noted by Aerospace Manufacturing & Design, "Each of these underperforming segments lack identifiable growth drivers."
Sources
Sources