Aircraft, Engines, & Parts Manufacturing
Date May 2018
Approximate net recovery on cost
- Global airline revenue was up 6.3% for 2017 and is forecasted to be up 9.4% in 2018
- After two years of declines, total airline expenses for 2017 increased 7.3% driven in part by increases in crude oil and jet kerosene prices
- Worldwide airline passenger traffic is expected to increase by 3.6% annually over the next 20 years, indicating an ongoing growth market
Long-term agreements make inventory more valuable: To manage the cost of subcontracted parts, original equipment manufacturers (OEMs) utilize long-term agreements (LTAs) as a way of securing the supply chain and controlling costs. Typical factors considered when entertaining LTAs include the size of the supplier pool for the part, the time it takes to bring suppliers on board, regulatory requirements, and the reputation of the supplier. The LTA obligates the aircraft manufacturer to purchase finished goods produced under the contract. Thus, aircraft parts suppliers’ inventory that is subject to LTAs typically carries higher liquidation values. In contrast, suppliers who are manufacturing to forecasts face deeper discounts because they don’t benefit from a guaranteed exit strategy.
Inventory intended for active platforms: Like automobiles, aircraft manufacturers are continually phasing models in and out of production. Inventory manufactured or warehoused for active platforms or current models typically retains more value than inventory servicing retired models. While planes certainly remain in operation for many years after they are discontinued, predicting the need for replacement parts becomes more of a challenge. Due to the specialized nature of products and the economics of order size efficiencies, manufacturers often produce more parts than are ordered and keep the extra quantity on hand as “spares.” Inactive spares typically retain minimal value in a liquidation scenario.
Raw material lead times impact value: Some aircraft components require the use of specialty metals in proprietary forms to meet performance requirements. These alloys may be lighter or have different chemical properties that enable materials to wear longer and withstand greater stress. But the lead times for these raw materials can be lengthy – six or more months in some cases. Manufacturers producing these types of products including castings, forgings, various nickel alloys, and aviation grade aluminum, titanium, and other alloys should be procuring these materials subject to existing orders or LTAs. If a company faced liquidation, those raw materials would likely retain a higher value, as the customer contracting the parts would be motivated to purchase in order to move to a new supplier, minimizing disruption and production delays. In some case, these metals are being purchased from the OEM and/or the agent of the OEM, increasing the likelihood that they would want to buy them back in a liquidation.
Industry outlook: Demand for commercial aircraft, especially large commercial aircraft, is expected to drive industry growth over the next five years. In the United States and other developed nations, airlines will look to continue replacing older planes with newer and more fuel-efficient ones. This will be in part to keep up with demand as U.S. air travel is expected to continue to grow with a strengthening economy boosting consumer spending. Based on information from the International Air Transport Association (IATA) global commercial airline revenue was up 6.3 percent for 2017 and is forecasted to be up 9.4 percent for 2018 as passenger numbers continue to grow. Similarly, the number of domestic and international trips by U.S. residents is forecasted to increase at annualized rates of 1.9 percent and 3.7 percent, respectively, over the next five years based on information sourced from research firm IBISWorld. Overall U.S. industry revenue is forecasted to increase at an annualized rate of 0.8 percent through 2022, and worldwide airline passenger traffic is expected to increase by 3.6 percent annually over the next 20 years based on the latest IATA passenger forecast.