Aircraft Manufacturing & Inventory Trends
COVID-19 Industry Brief
EFFECTS OF THE CORONAVIRUS ON THE Aircraft Manufacturing & Inventory INDUSTRY Updated April 24, 2020
- Commercial Air Travel Reductions: Commercial aviation will be hard hit by huge reductions in air travel brought on by the pandemic. Airlines are anticipating that the impact of the pandemic will be even worse than the 9/11 terrorist attacks, the 2003 SARS epidemic, and the 2008-2009 financial crisis. The four largest U.S. airlines have adjusted their spring schedules downward to attempt to right size demand. This has resulted in scheduling cuts of 40 percent at Southwest, 42 percent at United, 70 percent at Delta, and 80 percent at American. Air passenger miles flown declined by 84.7 percent in the second half of March 2020. The International Air Transport Association has forecasted that global passenger numbers will fall 55 percent this year compared with 2019.
- Commercial Market Sentiment: At current flight levels, and at the flight levels that will likely be achieved in the second half of 2020, there is significant excess commercial capacity in the marketplace. It is hard to project at what level air travel will return, but it may hit 2017 or 2018 levels, or lower, by the end of 2020. This will have a negative impact on the sector and has negative implications for inventory and related equipment values.
- Impact on Original Equipment Manufacturer (OEM) Production: Commercial flights dropped by 55 percent in the final week of March 2020 compared to 2019 levels, according to flight-tracking service Flightradar24. Because of the dramatic slowdown in air traffic due to the COVID-19 travel restrictions, Boeing suspended production at its South Carolina facility that produces the 787 Dreamliner on April 8, 2020. This followed the March 2020 closure of multiple facilities in the Pacific Northwest and Pennsylvania, which were extended indefinitely as of April 5, 2020. Boeing reported deliveries of 50 commercial aircraft in the first quarter of 2020, as well as 39 defense-related aircraft. The company also reported orders for an additional 49 planes (most of them defense related) and 196 cancellations for the same period. Airbus paused production at its facility in Mobile, Alabama, through April 29, 2020, as well as its facilities in Germany. Airbus also announced on April 8, 2020, that it was reducing its production rates for the A320 by 33 percent, the A330 by 66 percent, and the A350 by 40 percent. Airbus reported delivering 122 aircraft in the first quarter of 2020. For the same period, Airbus also booked orders for 356 aircraft and cancelled 66 orders.
- Boeing 737 MAX Issues: On April 14, 2020, Boeing announced the cancellation of 150 737 MAX aircraft and removed another 139 737 MAX aircraft from its backlog, as their order status was in doubt. While it seems likely based on Boeing guidance that the 737 MAX-recertification approval will come through in 2020, certification flights were recently pushed back from May to August 2020. This additional delay was due to the ongoing Federal Aviation Administration review of the new software fixes. In addition, the channel for these planes is fairly full, both for Boeing and its suppliers. Therefore, while the recertification approval will be good for Boeing in the long term, it likely does not mean that activity on that platform will pick up materially in the short term. Further cancellations are expected in the coming months given overall business conditions.
- Impact on Aftermarket Activity: For aftermarket demand, Gordon Brothers expects parts demand to falter substantially due to weakness in maintenance, repair, and overhaul (MRO) demand. A study released in late March 2020 by consulting firm Oliver Wyman estimated that “the total global impact of COVID-19 on MRO is estimated to be between $17B and $35B, a 19 to 39 percent reduction from our original $91B forecast for 2020.”
- Impact on Defense Related Aviation: Gordon Brothers does not expect there to be a material impact on defense spending in 2020, and have seen reports that defense spending has actually increased as the government attempts to push stimulus to the economy.
- Commercial Aviation Valuation Outlook: While it is difficult to gauge the impact of the coronavirus pandemic on appraisal values, Gordon Brothers expects it to be materially negative for both inventory and machinery and equipment. Gordon Brothers expects that on the OEM side of the business inventory values will decline due to reduced Tier I concentration and potential margin erosion, as well as commodity and general industrial weakness. On the machinery and equipment side, computer numerical control (CNC) dealers are comparing the current market to 2008-2009 for used equipment.
- Defense-Related Aviation Outlook: Gordon Brothers does not expect there to be a material impact on companies on the defense aviation side of the business, and accordingly feels values for inventory should be stable in this sector for 2020. Inventory valuation should be insulated as a result. For equipment, as much of it is sector-agnostic, weakness on the commercial side of the business and in other industrial sectors will bleed into this space, Gordon Brothers expects that values will decline.
Date June 2021
- The economic effects of the COVID-19 pandemic cost U.S. airlines $35 billion in 2020 and forced many to take on new debt obligations to survive the downturn.
- Setbacks continue for Boeing as the 737 MAX is once again under investigation by the Federal Aviation Administration.
- Airlines’ focus on modernizing their fleets with more efficient planes will support industry recovery in 2021.
- The national defense segment continues to provide strong foundational support to the industry amid the lingering pandemic.
Approximate net recovery on cost*
Setbacks continue for boeing: In 2020, Boeing had its worst year on record for net aircraft sales, as deliveries dropped by 60% between 2019 and 2020. Customers have canceled more than 600 orders in 2020, primarily due to fallout from the pandemic in addition to ongoing issues with the 737 MAX aircraft. Specifically, Boeing reported that airlines canceled 373 orders for the 737 MAX during the first five months of 2020 after electrical issues were discovered on the aircraft, which resulted in two devastating crashes in 2018 and 2019.
Although Boeing fixed its flawed automated system in 2020, the company is again under audit by the Federal Aviation Administration (FAA). The most recent audit was triggered when Boeing disclosed an electrical power system issue on April 7, 2021. This audit subsequently grounded 109 Boeing 737 MAX aircraft worldwide, including 71 in the United States.
On April 28, 2020, the FAA ordered Boeing to fix bonding issues in the electrical systems in some 737 MAX planes that could lead to engine ice protection loss and critical functions on the flight deck. The FAA noted the affected planes were manufactured after a design change in early 2019. Per FAA documents, Boeing must also repair more than 300 additional undelivered planes that have the same issue.
Despite these setbacks, February marked the first month since November 2019 where monthly sales outpaced scrapped orders, marking an important inflection point for the company. First-quarter 2021 commercial airplane deliveries totaled 77, compared to 50 in 2020. However, Boeing’s first-quarter revenue for 2021 still decreased 31% due to heavy discounts offered to buyers lacking liquidity.
As the pandemic continues around the world, the company’s 737 program is currently producing at a reduced rate, but it plans to increase production to 31 per month in early 2022. Boeing has not disclosed the current monthly production rate, but it is believed to be in the low double digits.
Continued setbacks related to the 737 MAX, combined with pandemic-related shutdowns, drove Boeing to deliver just 157 total aircraft in 2020, compared to the 566 aircraft delivered by major competitor Airbus. However, Boeing maintains a strong defense, space and security segment that has remained resilient throughout the pandemic.
Pandemic Impact Continues but Industry is rebounding: Since the start of the pandemic, there have been over 150 million COVID-19 cases around the world and three Centers for Disease Control and Prevention (CDC)-reported variants remain a global concern. U.S. passenger airline operating revenue decreased 62% from the first quarter of 2019 through the first quarter of 2021. Although airlines incurred more than $35 billion in net losses in 2020, the availability of COVID-19 vaccines has created expectations for recovery in the commercial airline industry.
Airlines are seeing an increase in vacation bookings through summer 2021, and Transportation Security Administration screenings are on the rise. Since March 11, 2021 over one million people have been screened each day; by May 28 this number was just under two million. This momentum is a result of growing consumer confidence in the safety of domestic air travel through rigorous on-board protocols, such as requiring face coverings, using HEPA filtration systems, disinfecting surfaces and offering touchless check-in. However, business travel, which is more profitable for airlines, remains down, resulting in a lagging financial recovery. A return to normal air travel abroad remains uncertain as many countries are still dealing with various levels of COVID-19 restrictions and vaccine implementation, particularly in Europe.
A concern for the foreseeable future is the increase in debt undertaken during the pandemic. Throughout 2020, industry participants were forced to take on billions in debt to survive the pandemic, partially offsetting the positive momentum from the vaccine rollout as companies are now forced to address significant debt load. American Airlines survived the pandemic by taking on $22 billion in new debt, raising its total debt obligations to $50 billion. Similarly, United Airlines’ long-term debt for the quarter ending March 31, 2021, totaled over $26 billion, representing a 92.3% increase year-over-year. Additional debt taken on by key industry airlines has diminished credit ratings, causing increased interest expenses. These sizeable expenses will hinder the airlines’ ability to rehire and innovate until their debt levels return to normal.
With the significant reduction in flights and the financial instability of airlines, ancillary companies that supply and support airlines have been negatively impacted. With fewer flights over the past year, the need for companies to repair and maintain current aircraft fleets has dropped significantly. However, airlines’ focus on updating older, less efficient aircraft models will likely drive the commercial segment in 2021. For example, German airline Lufthansa, which received a $9.8 billion bailout from the German government in May 2020, agreed to purchase five Airbus A350-900 and five Boeing 787-9 Dreamliner aircraft to modernize its fleet. In April 2021, Delta Airlines placed an order for 25 A321neo Airbus aircraft, which offer expanded seating capacity and optimized use of cabin space. A strong focus on fuel efficiency and aircraft optimization will play a vital role in industry growth throughout 2021 and beyond.
Industry Outlook: As more consumers get vaccinated and global vaccine deliveries continue to progress, the commercial aviation industry is seeing signs of recovery following a year of rapid decline. Prior to the pandemic, the industry was expanding as the economy grew and more people spent their disposable income on travel. As the economy rebounds and consumer income increases, combined with decreased unemployment rates and government stimulus programs, U.S. commercial air travel is forecast to return to pre-pandemic levels.
Prior to the pandemic, the FAA had projected the number of general aviation and air taxi aircraft would decline, leading to a younger fleet that would require fewer repairs and less maintenance, in turn negatively affecting the aircraft parts industry. Although airlines contracted their fleets and replaced older aircraft with newer, more fuel-efficient planes in 2020, airlines are expected to stimulate industry growth by expanding their fleets in 2021 and 2022 as travel demand returns. According to data from Avolon, an aircraft leasing company based in Dublin, Ireland, nearly 90 new airlines are set to debut before the end of 2021 as they endeavor to take advantage of heavily discounted aircraft sales, further accelerating the industry’s rebound in the latter half of the year.
Through 2025, aircraft engine and parts manufacturing industry revenue in the U.S. is forecast to increase at an annualized rate of 9.0% to over $260 billion, per IBISWorld. Much of this growth is the result of the low base created by the pandemic. Industry revenue, however, is not expected to return to pre-pandemic levels until 2023, as commercial airlines are currently focused on optimizing their fleets and coping with financial setbacks.
Defense Segments Provide Strong Foundational Support During Pandemic: Amid the decline in commercial air travel, the defense and aerospace segments supported the industry to some extent. Major players in the industry, including Boeing, Airbus and Lockheed Martin, experienced flat to increased growth in their defense divisions despite ongoing obstacles on the commercial side. Strong defense sales are expected to continue as heightened geopolitical tensions in the Middle East, Asia and Europe fuel increased military spending heading into summer 2021.
With a lagging commercial segment and mechanical issues with the 737 MAX aircraft, Boeing has managed to maintain market share through its defense, space and security segments. The company’s defense revenue increased 19% to $7.2 billion in the first quarter of 2021 compared to 2020 , driven primarily by increased orders for military aircraft. In addition, Boeing was awarded a contract for 11 P-8A Poseidon aircraft for the U.S. Navy and the Royal Australian Air Force as well as contracts for Bell Boeing V-22 Osprey rotorcraft for the U.S. Navy and the U.S. Air Force.
After cancellations, net commercial aircraft orders for Airbus were at negative 61 units for the first quarter of 2021 compared to 290 in 2020 . Although Airbus achieved positive commercial performance in the first quarter of 2021 due to a favorable mix and currency hedging, the economic effects of the pandemic remain a major threat. Conflicting policies on quarantines, lockdowns and testing have disrupted Europe’s aviation market. This lack of coordination is making it extremely difficult to manage travel in Europe, creating difficulties for Airbus in navigating one of its most essential commercial markets.
Although Airbus is facing prolonged pandemic-related issues in its commercial segment, the company has been successful in offsetting deficits with its defense and aerospace initiatives. The company succeeded in securing major contracts for space systems and recurring military aircraft orders, realizing a profit of €362 million ($439 million) during the first quarter of 2021, in contrast to a loss of €481 million ($522 million) in the same quarter of 2020.
Lockheed Martin, one of the world’s largest defense contractors, exceeded expectations in the first quarter of 2021 as the company reported a 4% increase in net sales to $16.3 billion, compared to $15.7 billion in the first quarter of 2020 . The increase was led by Sikorsky helicopter sales and the company’s missile division. Each of Lockheed Martin’s segments reported growth in sales from 2020 to 2021, further proving the resiliency of the defense segment during the pandemic.
The defense segment will continue to act as the industry’s backbone while companies rework their operating structures to accelerate recovery in other business segments.
Reduced Military Outlay Sparks M&A Activity:The most expensive and sophisticated products manufactured in the industry are made for military services; however, slowing U.S. defense spending caused the industry’s defense segment to contract in the five years to 2020. Although many top-priority programs were minimally impacted, U.S. military outlays are expected to have declined during the period, according to the federal 2020 budget.
As a result, merger and acquisition activity was prevalent among smaller defense companies looking to diversify through expansion into the commercial industry segment and other military-related divisions. Due to increased merger and acquisition activity, industry enterprise numbers decreased at an annualized rate of 0.5% to 1,324 during the five years to 2020, according to industry research firm IBISWorld.
Fewer large contracts paired with increased defense spending will encourage smaller defense manufacturers in the industry to consolidate and combine their product lines going forward. However, smaller operators are expected to enter the market to fill niche positions in the supply chain. As a result, IBISWorld forecasts the number of companies to increase at an annualized rate of 4.6% to 1,659 over the five years to 2025.
Long-Term Agreements Make Inventory More Valuable: To manage the cost of subcontracted parts, aircraft 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 parts, 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 that are manufacturing to forecasts face deeper discounts because they do not 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 current models typically retains more value than inventory for retired models. While planes remain in operation for many years after being discontinued, predicting the need for replacement parts becomes more challenging. 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.” With airlines seeking to cut energy costs and optimize their fleets, this practice will be especially important as major industry players, including Boeing and Airbus, replace older aircraft with newer, fuel-efficient models. 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 them 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 and titanium, among other alloys, should be procuring these materials subject to their existing orders or LTAs. If a company faced liquidation, these raw materials would likely retain a higher value, as the customer contracting the parts would be motivated to purchase in order to minimize disruption and production delays. In some cases, these metals are being purchased from the OEM or the agent of the OEM, increasing the likelihood they would buy them back in a liquidation.
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REFERENCE SOURCES: AIRBUS, BOEING, MSN MONEY, NASDAQ, BLOOMBERG, BUSINESS INSIDER, IBISWORLD, MACROTRENDS, NPR, THE WALL STREET JOURNAL, CENTERS FOR DISEASE CONTROL, US NEWS & WORLD REPORT, CNBC, AERONEWS GLOBAL, CNN, REUTERS, THE NEW YORK TIMES, INTERNATIONAL AIR TRANSPORT ASSOCIATION