Aerospace Industry Flying Into Strong Turbulence Ahead, According to New AlixPartners Study

Business Wire, July 10, 2008

Key Findings Include:

* After Five Years of Strong Growth and Profitability, Order Books Are Full and Companies Are Scrambling To Meet Delivery Deadlines

* However, as Much as 30% of Backlogs Could Be At Risk, as Rising Jet-Fuel Prices and Falling Demand Cause Pain for Airlines; Plus Future U.S. Defense Spending Levels In Question

* Logistics-cost Increases Coupled with Other Cost Pressures Will Drive Production to 'Regional' Low-cost Countries Such as Mexico, Morocco and Tunisia

* Consolidation of Tier 2/3 Suppliers Likely to Accelerate, In Part Due to Boeing's and Airbus's Drive Toward Becoming Systems Integrators

NEW YORK -- After very strong financial performance over the past five years, the global aerospace industry is facing tougher times ahead. Order books are full, and the good times may continue through 2008--but storm clouds are on the horizon. The negative impact of sky-high fuel prices on airline customers, the weak U.S. dollar and uncertainty about future U.S. defense spending will create turbulence for this high-flying industry in the year ahead, or at least bring it back down to earth. That's according to a new study released today by AlixPartners LLP, the global business-advisory firm.

Supply Chain Already "Scrambling"

Driven by past growth in commercial-airline demand and by strong U.S. defense spending, the study finds that the global aerospace industry presently has unprecedented order backlogs--not only the commercial segment, with Airbus and Boeing fully booked until 2012, but also defense products, helicopters and business jets--with revenues in the industry up 95% from 2001 to 2007. Even revenues of the bottom ten performers have grown by average of 22% over that period, according to the study, the 2008 AlixPartners Aerospace & Defense Review(SM).

However, to deliver this huge backlog, "The whole industry supply chain is scrambling to increase capacity to deal with very stiff ramp-up demands," said Philip Toy, a managing director of AlixPartners and co-lead of the firm's global aerospace practice. "On top of this, the industry is also getting additional pressure from skyrocketing raw-material costs and a dramatically weakened U.S. dollar."

On the raw-materials front, the demand for lightweight materials so often used in aerospace has increased much faster than supply, says the study, rendering the 2008 materials forecasts of many aerospace companies worthless. The study finds that over the past three years the industry's cost of aluminum has jumped 90% while carbon fiber is up as much as 60% and titanium is up 30%. It also finds that this trend is likely to accelerate throughout at least the rest of 2008.

The study also finds that, in an industry in which revenues are usually denominated in U.S. dollars but costs are in local currency, the weakened dollar has also been a bitter pill for many companies to swallow. This issue is especially significant for European-based aerospace companies, as the euro has appreciated 20% versus the dollar in the past 12 months.

"The combination of the spike in raw materials cost, the drop in the U.S. dollar and the difficulties faced by aircraft OEMs and suppliers to deliver their huge backlogs could be a wind shear awaiting the aerospace industry globally," said Toy. "In the past, aerospace suppliers often passed on cost increases to the aircraft OEMs, who either absorbed them or passed them to their own customers. However, given the magnitude of today's cost increases aerospace companies need to find new ways to navigate through this difficult environment."

Companies Have to Redefine Their Business Models

Facing this strong demand for new programs and products, wildly fluctuating currencies and increasingly scarce capital due to the ongoing global credit crunch, aerospace manufacturers such as Airbus, Boeing, Bombardier and Dassault have in recent years explored ways to share risk with their entire supply chain. Companies such as these have retained the roles of design, testing and system integration, while asking Tier 1 suppliers (companies like Spirit AeroSystems, Honeywell Aerospace, Thales Group, the Messier-Dowty division of the SAFRAN Group and Goodrich Aerostructures Group) to assemble major sub-systems--which, in turn, rely on Tier 2 suppliers to perform the majority of manufacturing tasks. Both Boeing and Airbus are streamlining their supply chains and re-focusing their role as system-integrating "aircraft architects," said AlixPartners, and both companies are also divesting non-core aerostructures assets. According to AlixPartners, this new model has allowed the aircraft OEMs to share the development costs of new programs with their supply chain, but also has created major difficulties when Tier 1 capabilities were not quite up to the task.

On top of this value-chain consolidation, the demand for aircraft in emerging countries, a steep increase of logistics costs and the ongoing pressure to reduce costs is forcing many aerospace companies to relocate their production to what AlixPartners calls the "regional" low-cost countries. For instance, the study finds that apart from places like China and India, Morocco or Tunisia might deliver a better trade-off in terms of labor versus logistics costs for many European airframe companies and suppliers. Likewise, for North American companies Mexico (whose peso is closely linked to the U.S. dollar) and even the southern United States often offers the better total economic alternative, the firm says.