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Post-Downturn MRO Rebound Projected By Many May Not Happen At All

Is the wait for a bigger MRO rebound being supplanted by a new normal growth rate?

Those poised for commercial aftermarket growth rates matching the low-double-digit figures reached in previous industry recoveries may have to curb their enthusiasm and embrace a new normal of tempered maintenance spending by ever-more-prudent airlines.

Sustained low oil prices, solid airline industry fundamentals, and historical data had many observers predicting annual MRO growth rates closer to 10%. But the latest round of earnings are in, and many analysts believe the current annual aftermarket revenue growth range of about 5% may be closer to the top of the market’s summit than a stop on a rapid climb back.

“While expectations may have been overly heightened coming out of 2014 with lower fuel prices, better airline profits, strong traffic, and an expectation that airlines would increase the use of older aircraft . . . we believe the year-to-date commercial aftermarket numbers are running below levels even normal traffic would justify,” write Canaccord Genuity analysts. 

Several factors—some temporary, and others that could be more fundamental shifts—are working together to keep MRO spending down.

“We think there are a few culprits, including a more consolidated airlines sector with better overall efficiency, aircraft that require less overall maintenance [especially early on] and a younger global fleet since deliveries have essentially been going up indefinitely for years,” RBC Capital Markets notes in a recent analysis. 

RBC’s calculations show that annual aftermarket growth averaged about 12% during the last sustained airline up-cycle, from 2003-07. Such spikes are typical for a segment that grows about 3% per year, but rises and falls as airlines go through boom and bust periods.

Following the most recent downturn in 2008-09, the aftermarket is entering its sixth year of recovery and has posted year-over-year growth in 19 straight quarters. But absent a double-digit spike in 2011 that helped offset even greater declines at the downturn’s depths, quarterly aggregate commercial aftermarket sales have shown a growth rate hovering around 5-7%.

This figure is in line with airline traffic growth—the traditional barometer for MRO spending. But the knock-on effect of downturn-related maintenance deferrals had many projecting that near-term MRO sales growth would easily out-pace traffic, as it did a decade ago, when annual aftermarket expansion flirted with 15% for several years. Instead, increasing uncertainty in some key regions combined with a relentless focus on cost containment have created headwinds for MRO providers.

IATA’s traffic figures for the first six months of the year showed year-over-year traffic growth at a healthy 6.3%. Leisure traffic is strong, stimulated by low oil prices that are keeping fares down. But high-yielding premium traffic growth has been sluggish, at 3.3%.

Add it all up, and fares are down 13% year-over-year, and yields are falling. Lower fuel prices augmented in many cases by aggressive cost-cutting mean most airlines are maintaining strong balance sheets. But the revenue trends have many airline CFOs fretting.

“IATA’s most recent confidence survey suggests airlines are less bullish on the profitability and yield outlook for the next 12 months” RBC notes. “We think there is probably some causal relationship here, as airlines’ view of the future may cause them to pull back on aftermarket spending, including running leaner, destocking, using less expensive part/service alternatives, etc.”

The deceptively shaky airline traffic outlook has many carriers keeping a tight hold on discretionary MRO spending. Pushing off heavy checks and engine shop visits is hard, but specifying workscopes that minimize nice-to-have tasks, like service bulletins or 100%-new parts installed, is becoming commonplace.

“Even with record profitability, it is clear that airlines are maintaining a very tight control on MRO spending,” Canaccord Geunity reported in its most recent aftermarket survey. Respondents, including more than 50 MRO providers, listed deferred maintenance as the primary reason that MRO market growth has not been stronger.

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Deferrals can create a domino effect that puts more drag on aftermarket revenue. Less work in shops means more capacity, which drives prices down. “The excess MRO capacity is a headwind, enabling airlines more options to push harder on labor rates and terms, and to more aggressively shop around the business,” Canaccord notes.

The increasing role of used serviceable material (USM) also is eating away at spare parts revenue. ICF International calculates that USM’s share of the $40 billion annual airline material market is approaching 10%. Respondents in Canaccord’s survey said they sourced 23% of their material from the used market in the second quarter, up from 10% in the first quarter. USM’s prevalence is unlikely to go away. 

One factor keeping MRO revenue down that will change with time is the global fleet age. High profits, cheap capital, and record OEM production rates have airlines taking deliveries and retiring aircraft at record rates. In the decade ending in 2009, annual retirements averaged about 400, ICF’s figures show. For the last two years, it has been 600-700; while lower fuel prices have slowed the wave, projections see 1,000 per year by the early 2020s.

An attractive environment for buying new, more fuel-efficient equipment combined with a delivery bubble starting in the late 1980s are generally seen as the main drivers behind the retirement boom. RBC calculates that 69% of the current fleet is older than five years, compared to 75% a decade ago.

Regardless of why older aircraft are being parked, MROs feel the pinch. Newer models have both a natural maintenance honeymoon and in some cases lower projected lifetime maintenance costs. Boeing’s baseline maintenance cost estimates for leasing calculate that a 767-300ER’s monthly airframe expense is $84/flight hour based on 4,800 hr. per year. A 787-9 flying the same amount is projected to set the lessee back just $58/flight hour.

As the aftermarket’s macro performance continues to confound, company-level analysis provides little clarity. GE Aviation reported a 30% jump in year-over-year engine spare parts for the first half of 2015, while Safran logged a 27% increase in civil aftermarket business. As partners in CFM, both benefited from an increase in CFM56 shop-visit volume of 6-7%. Safran’s CFM aftermarket revenue was up 38% year-over-year at 2015’s halfway point.

Meanwhile, Rolls-Royce’s civil aftermarket grew at a more leisurely 7% in the first half of the year. Pratt & Whitney saw 1-2% gains, one reason parent United Technologies Corp. revised full-year aftermarket growth guidance from high single-digit gain to “down slightly.”

Despite sluggish growth, some still see at least a temporary spike in MRO spending, as lower oil prices keep some older aircraft flying and airlines exhaust options to defer must-do maintenance.

“We believe we will see improvement” in the second half of 2015, Canaccord says. “But according to this survey, a stronger rebound is not expected until early 2016.” 

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