Aerospace & Defense

Present tense, future imperfect for commercial aviation

As the U.S. economy plunged into a recession in 2008, the aviation industry, dominated by Boeing and Airbus, was only expected to suffer a slowdown, sooner or later. This started with commercial airline manufacturers facing poor order book position and mass deferrals or cancellation of orders, mainly from China and India.

According to the Director General of International Air Transport Association (IATA), Giovanni Bisignani, 2009 will prove to be the toughest year ever for the aviation industry, as revenue from passenger and cargo businesses is expected to fall by as much as 12%. Also, a full recovery is not expected until 2011. The only bright spot was the decline in fuel prices since late 2008, which reduced the share of fuel costs in total operating costs to 25% from 32% a year ago. However, with crude prices more than doubling in the past few months, this relief is also petering out. Overall, the global airline industry is forecasted to incur a huge loss of approximately $9 billion in 2009, according to IATA. In the short term, airline companies worldwide would continue to struggle with the global economic recession, fuel price fluctuations, and difficulty in raising ticket prices, which might have an impact on airplane and engine purchase orders in 2010.

Considering the huge losses incurred in the first three months of 2009, the major U.S. carrier, American Airlines, announced plans to cut its U.S. schedules by 9% this year. The decision came as the company saw a sharp decline in air traffic, and a 2.5% drop in bookings. February traffic for American Airlines fell 13.5% from a year earlier. The situation perhaps is no less gloomy for other major U.S. carriers, most of which have reported similar drops in traffic as well as sharp declines in yields. However, the drop in financial performance is more concentrated in the cargo segment, as the passenger airlines in the U.S. had aggressively reduced capacity on domestic routes as early as summer 2008.

U.S. industry data shows that many A&D companies still have healthy cash reserves built up during the period of boom (2001-2007). Also, some of these players have strong order backlogs that may provide a cushion. At the same time, risks of order cancellation and postponement loom large amid the severe economic downturn all over the globe. There is also the risk of governments diverting defense allotments to other social programs such as health, education and infrastructure. Liquidity risks, competition from counterparts in China and Russia, and unavailability of experienced professionals also pose significant risks for many. All these factors point towards that any inordinate delay in recovery would make things further worse for this segment.

According to a new Deloitte research report titled “Midyear outlook for the global aerospace and defense industry,” financial performance of the top 20 global aerospace and defense companies has weakened in the first quarter of 2009 compared to 2008. Despite a nominal increase in sales, revenue growth declined substantially (down from 10% to 1.7%), operating profits plunged 12%, and operating margins fell by 13.9%. The commercial aircraft sector suffered a dramatic fall in orders, while business jet manufacturers experienced financial stress, and military equipment spending, led by the U.S. Department of Defense, showed a decline.

The sharp falls in both passenger and cargo traffic over the last three months have hit current results hard but expectations for the year ahead are for more stability - IATA Economics Briefing April 2009

“U.S. industry data shows that many A&D companies still have healthy cash reserves built up during the period of boom (2001-2007). Also, some of these players have strong order backlogs that may provide a cushion. At the same time, risks of order cancellation and postponement loom large amid the severe economic downturn all over the globe.”