2014 Global aerospace and defense sector financial performance study Growth slowing; strong commercial aerospace; continued contraction in defense

2014 Global aerospace and defense sector financial performance study Growth slowing; strong commercial aerospace; continued contraction in defense

Warning: foreach() argument must be of type array|object, bool given in /home/mexiconow/public_html/sites/mexiconow/wp-content/themes/mexiconowwpnew/single.php on line 254
By Tom Captain
Global Aerospace & Defense Sector Leader
Deloitte Touche Tohmatsu Limited


Executive summary


The Deloitte Touche Tohmatsu Limited’s (DTTL) Global Manufacturing Industry group analyzed the 2013 financial performance of 100 major global aerospace and defense (A&D) companies using information from public company filings and press releases. The key financial indicators studied include sales revenue, operating earnings, and operating margin. The results presented in this study reveal important observations about the overall global A&D industry.

Global aerospace and defense sector growth slowed down in 2013. The global A&D sector revenue growth rate from 2012 to 2013 declined, from 5.9 percent to 3.1 percent. Despite the slowdown, the industry still added US$21.4 billion in revenues, which is the second largest annual increase over the last five years. Total global industry revenues exceeded US$700 billion, an overall record with improved operating efficiencies, higher profits, and higher margins. This is the second year in a row that sector growth was above global GDP growth, which in 2013 was 2.4 percent. Rate increases for commercial aerospace, new product introductions, and a flattening of government defense spending rates in the United States (U.S.) and Europe over the next few years are expected. Therefore, it is likely that above average revenue growth will continue, if not accelerate slightly in 2014, driven largely from anticipated growth in the commercial aerospace sector.

U.S defense subsector slowdown is a key contributor. The decline in total revenue of the U.S. defense subsector significantly contributed to decreased global revenue growth. The revenues of the top 20 U.S. defense contractors’ declined by US$5.8 billion, or 2.5 percent. This decrease was attributed to a continued decline in funding outlays by the U.S. Department of Defense, the largest subsector customer, whose budget decreased by 4.4 percent in 2013. Of the top 20, only three U.S. defense contractors experienced revenue growth. However, with escalation of tensions in the Middle East and other global conflict areas, several countries outside of the U.S. are expected to increase defense spending. The U.S. is likely to start increasing defense spending by 2017, barring unexpected global security events and military actions, which might lead to increases.

Commercial aerospace growth slowed from “ultra-fast” to merely “very fast”. The global commercial aerospace subsector grew by 9.8 percent, with 85 more large commercial aircraft delivered in 2013. This compares to an unprecedented 16.1 percent subsector growth in 2012, when 178 additional aircraft were delivered, compared to 2011. The Boeing Company and Airbus Group alone added US$11 billion in additional revenue in 2013, down from US$20.5 billion of incremental growth in 2012. It is estimated that 100 more aircraft will likely be delivered in 2014, with an expected return to higher revenue growth rates, albeit lower than in 2012. Key questions raised are whether the lower number of deliveries in 2013 is the beginning of a longer-term slowdown, and, is the often-cited order backlog “bubble” bursting? We believe long-term increases in demand for travel, especially in China, India and the Middle East, as well as the need for more fuel-efficient aircraft, appear to support the view that aircraft sales demand and production volume will likely continue to grow. Additionally, should there be future increases in oil prices, fuel-efficient aircraft sales demand may increase.

Top 10 global A&D company rankings have changed from 2012, reflecting commercial aerospace growth. In terms of sales revenues, United Technologies Corporation has moved up the list to the fourth spot with General Dynamics, now in fifth position. Rolls-Royce has also moved up in ranking to the eighth spot ahead of Raytheon, which is now ninth. Finmeccanica S.p.A has dropped off the top 10 list, while GE Aerospace remains in the tenth position. These ranking movements reflect the rising fortunes of commercial aerospace including significant revenue increases in the supplier base, which has resulted from commercial aircraft production increases. Additionally, it reflects declining growth in global defense spending experienced over the last few years. Indeed, faster growth in commercial aerospace is driving this subsector towards a larger share within the overall sector. At the current rate of growth, it is expected that the commercial aerospace subsector will likely reach parity with the defense subsector in terms of contribution to total A&D sector revenues for the first time by 2016, barring the unexpected.

Although U.S. companies continue to dominate, the A&D sector is becoming more global. U.S.-based sector companies comprise 59 percent of revenues for the global A&D industry. European headquartered companies represent 34.2 percent of total revenues, while the balance is shared by companies headquartered in Japan, Canada, Brazil, and other countries. Although this geographic makeup has been relatively constant for the past few years, over the longer term U.S. dominance has declined as the growth of non-U.S.-based A&D companies continues. With globalization increasing across the sector, many companies are designing, manufacturing, and selling some of their products in non-domestic markets. Thus, the comparison of revenues based on a company’s headquarter location will likely become less important, as compared to where revenues are generated. Many U.S. and European companies today have invested in manufacturing operations in China, Poland, Mexico, and North Africa, as well as other geographies. This is significant because in those countries, no major publically held A&D companies are headquartered, yet tens of thousands of workers are employed in the sector. Many European companies are generating increased revenues in the U.S., Middle East, and other geographies. Similarly, U.S. companies are generating increased revenues in Australia, India, Saudi Arabia, United Arab Emirates (UAE), Japan, South Korea, and other non-domestic markets.

Europe is gaining momentum in revenue growth, but losing some ground in profitability. The European A&D sector revenue growth rate of 5.4 percent exceeded the U.S revenue growth rate of 1.3 percent. This was partly attributable to negative revenue performance of the U.S. defense subsector as cited above, as well as the heavy weighting of Airbus Group, whose revenues grew by 4.9 percent. However, despite higher revenue growth rates, European companies lagged U.S. companies in profitability with a 3.6 percent decline in earnings in 2013, as compared to an 11.6 percent increase in operating profits for U.S. companies. This shortfall resulted partly from certain European companies reporting most of the sector impairment charges, which was close to 70 percent of the global nonrecurring A&D write-offs in 2013, plus continued below average core operating performance.







Profitability is improving across the global A&D industry. A&D sector earnings, a key financial performance indicator, outpaced revenue growth globally. The sector added US$5.1 billion in global profits, reaching a record US$62.6 billion. Commercial aerospace grew earnings by 15.7 percent, because of more aircraft delivered at lower costs. Defense companies grew earnings by 3.6 percent despite the revenue decline cited above, which was mostly the result of anticipatory cost cuts. In addition, profitability was not uniform across the different segment and supplier tiers. Original equipment manufacturers (OEMs) and platform companies generally experienced significantly lower margins than their suppliers. For example, top performing engine and avionics tier one suppliers can routinely earn close to 20 percent operating profit margins. Conversely, the services segment and tier three suppliers typically lag A&D sector averages in profitability. Global earnings would likely have been much higher, but for one-time charges – see below.

Impairment charges have returned. One-time earnings charges have increased for the second year in a row, with approximately US$5.6 billion in one-time charges in 2013. The two most significant one-time charges occurred at BAE Systems plc (minus US$1.388 billion charge) and Finmeccanica S.p.A (minus US$1.085 billion charge). One-time write-offs mostly resulted from a variety of factors, including difficult conditions caused by the U.S. defense slowdown, the complexity of new product development, challenged program execution, and asset impairment. It is expected the environment of complex product development and uncertain market dynamics could likely result in a certain level of impairments and onetime charges in the future, however those levels are difficult to forecast. Program performance continues to be a key management challenge of the global A&D industry.

Europe still lags the U.S. in profit margin performance. There are still large differences between the U.S. and Europe in operating margins, with the U.S. at 11.0 percent in 2013 and 10.0 percent in 2012. This is compared to Europe at 5.6 percent in 2013 and 6.2 percent in 2012 in operating margin performance. Airbus Group, with operating margins of 3.4 percent in 2013, is the largest A&D company in Europe, while The Boeing Company, with margins of 7.6 percent in 2013, is the largest U.S. A&D company. This difference serves as a reasonable proxy for gaps between U.S and European profit margin performance, which has existed for several years. It brings into focus the efficiency of the cost and asset base and the comparative ability of the European A&D sector to rationalize assets and reduce operating expenses. In the European A&D sector, country specific defense budgets supporting the individual country industrial base may not be large enough to achieve competitive efficiencies. Thus, the European A&D sector may benefit from a certain level of regional consolidation in order to gain scale economies, should that coincide with national employment and defense policies.

A&D sector share prices outpaced global equity indices. In 2013, despite the fall in defense subsector revenues and the slowing pace of growth in commercial aerospace, A&D sector share prices continued to advance at a significantly greater rate than most of the global averages. U.S.-based A&D sector companies outpaced the Dow Jones Industrials and Standard & Poor’s 500 averages at 39.4 percent versus. 28.1 percent and 31.8 percent respectively. European A&D companies outpaced the STOXX 600 index, 41.4 percent to 17.3 percent. Likely contributors to share price increases for commercial aerospace include the continued increased demand for commercial air travel, increased demand for fuel efficient aircraft, greater subsector profit margins, increased generation of free cash flow, and an expectation of continued above average growth prospects for the subsector.

Bottom line: Still a tale of two subsectors with better than average growth performance and outlook. For the commercial aerospace subsector, as The Boeing Company and Airbus Group goes because of their relative weighting, so does the A&D sector. For the defense subsector, U.S. defense contractors are driving the overall global performance because of their relative weighting. Overall, financial performance is heavily influenced by the concentrated nature of the sector where the top 20 global A&D companies make up 74.0 percent of the total global A&D sector revenues. Defense continues to be impacted by lower sales volume, while commercial aerospace continues to grow due to increased travel and demand for more fuel-efficient aircraft. The overall A&D sector slowed down in 2013 but still had revenue growth of 3.1 percent, which was above global GDP growth at 2.4 percent. The Global A&D industry in 2013 has improved operating efficiencies, resulting in higher profits and margins. A slightly higher growth rate is anticipated for 2014 likely due to increased commercial aerospace revenues, and a slowdown in the rate of decline for the defense subsector. Figure 1 represents a summary of the key drivers of A&D sector revenue and earnings performance.


×