November 2009- Cutting back is in vogue lately due to the still-struggling economy. Many consumers can’t afford airfares, aircraft companies are finding fuel costs challenging and the government is pulling back on a variety of defense programs. As a result, the industry that looked so promising just a short time ago is facing an uphill battle to stay cost competitive.
According to Nathan K. Smith, industry analyst, aerospace and defense, for Frost & Sullivan, a research and consulting firm that covers 10 industries and 31 markets, "For commercial and business aerospace, the global economic crisis is slowing travel and consumer demand whilst constricting industry revenues and profit margins. In response, many companies are shrinking their operations, reducing aircraft production and capacity, as well as staff. These moves are reducing cost, but the industry cannot shrink itself into profitability."
"The civil and military sectors are heading in different directions," says Richard Aboulafia, vice president, analysis, Teal Group Corp., Fairfax, Va. "The civil side has already been hit by a brutal business jet market downturn. Civil helicopters are following, but jetliners, the biggest part of the aerospace industry, are the ultimate lagging indicator. The numbers will head downward in 2010 and 2011, and we don’t forecast any kind of meaningful recovery until after 2012. Right now, it’s kind of extraordinary, however. All meaningful market indicators have been seriously depressed for more than 15 months, yet jetliner production rates are at record highs. That can’t last."
The future of defense
Past forecasts for defense have been strongly optimistic. However, the future outlook is decidedly flat. "The key to the defense sector is affordability," says Smith. "Can the country afford the requested or desired aircraft and systems, and how much will be budgeted to meet these desires and requests? The outlook is not a significant increase in the number of aircraft but the modernization of existing fleets."
Smith says plans to modernize the fleet include purchasing new aircraft, removing aging aircraft and the refurbishment of existing aircraft. "However, the overall size of the military fleet isn’t expected to grow, thus the production of metal products is expected to hold steady."
"Looking at defense, this market continues to hold up great, with particular strength in the military rotorcraft segment," says Aboulafia. "Given the state of the fleet and the popularity of high defense spending, little will change this. On the other hand, the good old days of 2001 through 2009, when the industry enjoyed strong growth rates, are over. We’re moving to a post-growth era, when program execution will be paramount and export contracts ever more crucial."
However, Jeff Kirchner, sales and marketing manager, High Performance Alloys, Tipton, Ind., sees a dismal market for defense products in 2010. "There will be some contracts left for the F-35, but they appear to be later in 2010 and are for a much smaller quantity than built so far in 2007 and 2008." Nevertheless, he sees "promise on the horizon with F-35 contracts increasing through 2016. Current Naval projects have picked up, as more Monel materials indicate that older designs are still being built. There’s little indication of a ramp up on a new design utilizing Inconel 686 as a replacement for K-500."
And Kirchner sees a minor slowdown in 2010 for the commercial side of the industry. "We’ve seen no projected growth for this sector; in fact, most projections are lackluster," he says. "There are several new designs coming through, but it’s still all development work with many approvals required before production. It may be years before airlines and private jets are ready for new purchases."
Connie Mayhill, president of Altemp Alloys Inc., Orange, Calif., says, "Altemp Alloys has been in this industry for more than 30 years and hasn’t seen a market crash like this one in a long time. Widespread demand deterioration presents a problem for all distributors and U.S. mills. It seems a lot of companies are now desperate. Mills are aggressively competing among each other and are now even competing with their own distributors. Everyone is trying to move higher-priced inventory, taking losses to just get rid of the product, which has caused panic. Extending credit and getting paid in a timely manner is also a factor."
Keeping the budget balanced
Reducing costs has been a necessity for the large commercial carriers, and they will continue to make cuts in an effort to increase profits.
Smith says, "The industry accomplished those things necessary to reduce cost in 2008 and continued the effort in 2009. The landscape isn’t expected to differ much in 2010 because the necessary steps to reduce cost and return to profitability have been taken."
Going forward, staying on top of fuel costs is crucial. "Fuel and labor are an airline’s largest cost, and the cost of fuel will continue to have an effect on the industry," Smith continues. "Jet fuel costs continue to fluctuate, putting consistent pressure on airlines to maintain positive cash flows. Historically, airlines have hedged future fuel purchases. While the costs are hedgable, there isn’t a perfect hedge available in either over-the-counter or exchange-traded derivatives markets. The industry paid a heavy price in 2008 and 2009 as major airlines posted millions of dollars in one-time losses as falling oil prices diminished the value of their hedge portfolios." He notes that many global airlines had reduced fuel hedging, but "a 64 percent increase in the price of crude oil this year has led to a renewed interest in fuel hedging."
"Fuel prices remain impossible to predict, resulting in notable hedging losses at several carriers," says Aboulafia. "But assuming we’re looking at a fuel landscape that’s in the $70-per-barrel range, that’s kind of a sweet spot. That price isn’t devastating to carriers’ finances, but it does provide a strong incentive to replace older planes with new ones.
"The problem is we’re running out of older jets to replace," he continues. "You’re starting to see the premature obsolescence of some good equipment because governments and manufacturers are aggressive about keeping new jet output high."
The composites concern
High-tech industries rely on the development of new ideas, and these future concepts will push the aerospace industry forward. "Innovation will continue to drive the industry; the leading drivers are electronic technology and advancements in composites," according to Smith. "Composites have considerable potential in the commercial aviation sectors, with the largest end-users in this segment being business, light and very-light aircraft. The cost- and weight-saving objectives of aircraft and engine original equipment manufacturers will drive the application of composites in the aerospace industry."
Aboulafia notes, however, that "innovation in materials is happening at a much slower-than-expected pace. The 787 has been a difficult experience for the industry. The A350 XWB might be a bit easier as a more conservative design. If it succeeds, there’s a good chance that Boeing will respond with a composite 777 replacement. But that’s hypothetical now.
"Even more hypothetical is the creation of smaller jetliners," he continues. "We don’t know about manufacturing costs versus actual benefits. It’s pretty clear that composites have no place on regional jets yet, as evidenced by Mitsubishi’s switch to metals. And business jets are highly uncertain. The most prominent experiences so far, Hawker’s 4000 and Premier 1, have been as troublesome as the 787, with a smaller pot of gold at the end of a long rainbow. The most ambitious, expensive and popular new business jet now on the drawing board, Gulfstream’s G650, is a metal design. In short, the material’s revolution is looking like a slow evolution, or perhaps even an ongoing battle that’s far from decided."
Smith says, however, that "in the short term, there isn’t expected to be a huge negative effect on metals producers," in regard to composites.
"Most of our materials aren’t used in what composites are replacing," says Kirchner. "There may be some small, niche business left from years past on nose cones or underbellies, but most have already been replaced where they could be. Many times, a composite cannot have the required properties that a solid metal can provide."
He points out, "There’s always something eating away at the metals markets, whether it’s coatings on lower grades, cathodic protection or changing to plastics. It’s nothing new, just a different portion of the market suffering this time--titanium and aluminum."
Taking care of business
To keep up with a constantly changing market, suppliers have adjusted their strategies. Kirchner says, "Our approach to the market has traditionally been to do what the customer wants. With all the escalated volumes, we have tended to put materials on contract--many with firm, fixed prices. It’s a steady business, but someone has to pay the inventory charges, which are usually passed on with a minor increase for interest rates to hold material for a specific requirement. It allows our customers a good, plentiful source for material by keeping at least a quarter’s worth of stock at any given time. In the last few years, our sales of cut-to-length items have really increased as people watch scrap rates and keep a closer eye on inventory."
Kirchner notes that High Performance Alloys’ "largest increase has been in the sale of more technical products, which require time to match materials to specific needs. In most cases, we talk directly to the engineers and specifiers of projects."
As a result, the company has specifically designated a portion of its sales force for specialized needs. "We don’t specify alloys. Rather, we help point [customers] in the right direction, even if it isn’t an alloy we carry. It sounds like we would lose business, but we get call after call looking for help. We help some, and others we pass on--we cannot do it all. It’s not the typical sales jockey you get when you call a big steel house or some other master distributor."
Mayhill says Altemp Alloys’ diverse business has kept the company strong. "We’re striving to stay lean, continuing to diversify to meet the changing demands of the market and all our customers, new and old. Altemp Alloys is remaining optimistic for the new year, but we do feel any increase in demand won’t be felt until possibly the second quarter of 2010." MM