The North American Aerospace & Defense industry realized substantial growth over the past several years. This growth was fueled by a variety of factors including the conflicts in the Middle East, upgrades in the need for advanced surveillance and security capabilities, counter terrorism measures, protection for our troops on the ground, renewed concern regarding the need for advanced tactical aircraft, and a surging demand for commercial aircraft in all sizes simultaneously. While some have predicted a reversal offortune for the industry starting in 2008, many believe that while the rate of growth in spending for A&D may slow, this is after several years of robust expenditure levels. This belief is based on a scenario in which the United States may be entering a period of sustained high spending in the sector driven by a set of factors for which the foundation is firmly in place.
While the U.S. is entering an election year with lots of rhetoric and posturing, it is doubtful, irrespective of which political party or leaders are in office, that a dramatic shift in the budget/spending will follow. This is driven by the harsh reality that once the political arm waving is over, we will still need to move forward and many of the fundamental priorities cannot be ignored.
WHEELS AND DEALS
In 2007, the commercial aerospace sub sector will likely end with record volumes of orders for new aircraft. The unusual aspect is that there is strong simultaneous growth in wide body aircraft, mid-size single aisle models and even the small business jets. Much of the global demand has been driven by a combination of needs. First, is that the high cost of aviation fuel is driving airlines to shift their fleets to more efficient aircraft to gain control of the energy cost component of operations. Airplanes such as the B-787, which leverages composite technology leading to lower weight and new engine designs, creates an imperative for airlines where fuel cost is a major lever in achieving competitive advantage. In addition, air passenger miles, a key metric for the commercial airline industry, is growing in the Middle East as well as the emerging economies of India, China and that region. This, in turn, creates accelerated demand for new aircraft.
The excitement in small business jets that can provide point to point service operating under a wide range of business models has resulted in a boom of new orders for several of the manufacturers. While it may prove difficult to match the record setting pace of new order bookings for the commercial aircraft industry in 2008, all of the premier manufacturers currently have very large backlogs and will be operating at full capacity for the next several years. An interesting story to follow on a longer term basis is the recent announcements by China, India and Russia to expand their efforts to establish a world class OEM aircraft manufacturing capability in country to serve the expected growth in their home markets. This could pose a threat to the existing established companies.
On the merger & acquisition front it is not expected that 2008 will include the types of mega deals we saw in the early 1990s. The expectation is for the large U.S. based OEMs to make portfolio shaping type moves shifting from non-core business areas to investments in new growth areas that support services type business and international growth. Most of these transactions will be modest in size representing transactions under $1B. Recent high valuations of U.S. based A&D companies has put a damper on the pace on inbound deals by European A&D firms, several of which have strategies to build U.S. beachheads from which to gain access and grow penetration of the large and profitable N. American defense market. We would expect to see a continuation of interest from those Euro-based firms but the pace will likely slow from the past two years or until valuations become more reasonable in their view.
Jim Schwendinger is the Vice Chairman for Aerospace & Defense and has 24 years of experience serving and commenting on issues and trends impacting the industry. Deloitte & Touche USA provides consulting, financial advisory, tax and audit services to the Aerospace & Defense industry and has done so for the past 50 years. Deloitte is one of the few firms that have a dedicated practice which focuses exclusively on the A&D industry.