Industry Market Trends
2012 U.S. Aerospace and Defense Outlook
April 24, 2012
Aerospace and defense industry insiders indicate optimism for the U.S. commercial aircraft sector, but are cautious about defense because of expected Department of Defense budget cuts. The aerospace and defense (A&D) industry is the United States' largest net exporter and one of the largest contributors to the nation's gross exports at $89.6 billion. The industry's contribution to the nation's gross domestic product (GDP) is approximately 2.23 percent, according to a recent Deloitte report. Yet financial performance among the top 20 U.S. A&D companies remained sluggish in 2011, posting revenues of $339.2 billion - a nominal 2 percent increase over 2010 - and operating earnings of $37 billion - a 3.2 percent increase over the prior year, Deloitte reports in a separate study. Four U.S. companies generated incremental revenues in excess of $1 billion last year: The Boeing Co., United Technologies, GE Aviation and Goodrich. Weakness in the defense sector, driven by slower spending on the part of the U.S. Department of Defense (DOD), was partially offset by record-setting production in the commercial aircraft sector. Many defense contractors have started to reduce overhead costs and personnel. A&D firms' marginal growth was largely due to companies' cost cutting and efficiency initiatives in anticipation of expected DOD budget reductions starting in 2013. Operating margin growth was flat at 10.9 percent in 2011, compared to 10.8 percent in 2010. "In 2011, the defense sector remained flat due to decreasing military budgets along with the drawdown of U.S. combat forces in Iraq and Afghanistan. Many defense contractors experienced nominal revenue growth for the year compared to peers, but remained profitable due to favorable government contracts and cost cutting in anticipation of the expected decrease in defense spending starting in 2013," Deloitte explains. "Few new programs of record were started in 2011, which impacted revenue growth; however, since programs are of long duration, many companies may not experience the impact of budget reduction for a few more years." In light of ongoing uncertainty over defense budget cuts, the outlook for the sector remains largely cautious. Earlier this year, the Pentagon released a 2013 budget plan that proposed cutting $487 billion in spending over the next decade. Moreover, the challenge of an additional $500 billion in defense cuts resulting from a budget sequester will likely add to the uncertainty experienced by defense contractors. The recently announced defense strategy review calls for a shift in strategic focus to smaller, more agile armed forces and a "pivot" to air-sea power. "The reduction in programs, less total defense spending along with the strategic military shift should bring new challenges and increased competition to top U.S. defense contractors," Deloitte states. Moving forward, these continued global economic challenges coupled with revenue gaps and cost pressures may result in margin contraction for global defense players. As a result, Deloitte says, the defense sector is "likely to undergo more streamlining of its cost structure, divestiture of non-core assets and additions of gap filling, as well as transformation acquisitions." "Expect to see more aggressive competition for the fewer large defense programs of record, as well as growth in defense sales to India, Brazil, the United Arab Emirates, the Kingdom of Saudi Arabia, Brazil, Japan and South Korea - countries with emerging wealth and a need to strengthen their defense capabilities," Tom Captain, Global Aerospace and Defense sector leader at Deloitte Touche Tohmatsu Limited, said in a statement. "The most significant trend affecting the aerospace and defence industry is the contrast in civil and military outlooks," according to PricewaterhouseCoopers' 2011 annual and fourth-quarter review. "The former is benefiting from fleet expansion in Asia, as well as fuel cost pressure that is supporting replacement demand in western nations." In 2011, the commercial aircraft sector generally trended upwards, building on production momentum started in 2004. Boeing and Airbus SAS delivered more than 1,000 aircraft last year, the highest production level ever reached in commercial aircraft history. "This increase in production is driving parallel production activity increases in the commercial aircraft supply chain, from engines, to avionics, to wiring harnesses, passenger seats and wheels and brakes for example. Reported sales orders for the year rose to over 2,200 aircraft, second highest in history behind 2007," Deloitte said in its 2011 A&D industry performance wrap-up. "This rise in sales orders was largely in response to airlines seeking new fuel-efficient aircraft. In 2011, new orders growth was led by Airbus... ." In the first quarter of 2012, Boeing registered 412 net orders, far more than its European rival Airbus, which booked 90 net orders in the first three months of the year. The commercial aircraft sector is likely to enter a prolonged "up cycle" in production this year, driven primarily by the continued production and development of next-generation aircraft programs that aim to address increasing fuel costs, according to a third report by Deloitte's global manufacturing industry group this year. Through 2015, commercial aircraft is expected to remain in an "up" business cycle resulting in strong order and delivery growth. Given the economic growth in emerging markets, commercial aircraft demand is forecast to expand over the next 20 years. Fluctuating oil prices are expected to push demand for fuel-efficient planes and engine technologies. Boeing forecasts 33,500 new aircraft will be produced from 2011 through 2030.