First-quarter earnings season in the global aerospace and defense sector is drawing to a close, and comments from aerospace suppliers have continued to highlight revenue-growth issues in the aftermarket. We have been noting the relative lack of growth in the aerospace aftermarket for a while now, with many suppliers seeing mid-single-digit revenue growth in spares and repairs despite very strong airline traffic growth, record airline profits and a slowdown in the retirement rate of older aircraft. Our aftermarket revenue tracker shows average aftermarket growth for the suppliers of 4.8% in 2015, and our preliminary data for the first quarter of 2016 shows that has not moved much (7% growth on average). Mid-single-digit growth may not sound bad—but it is roughly half the growth rate that suppliers enjoyed in the last aerospace up-cycle.
As we dug into this matter, we identified a number of structural headwinds that appear to be holding back the aerospace aftermarket:
1. A more modern aircraft fleet. Although retirement rates have recently eased, the proportion of older aircraft in the fleet is dramatically lower than it was in 1999. Back then, 23% of the fleet was more than 20 years old, with 9% over 30 years old. Roll forward to 2014, and only 15% of the fleet was more than 20 years old, while 3% was 30 years or older. As anyone can imagine, after 30 years of compound price inflation, the spares on these old aircraft are the most profitable for aerospace suppliers—and that ultra-high margin category has shrunk.
2. More reliable equipment. At the other end of the spectrum, the new aircraft being produced by the OEMs are much more efficient and reliable than prior-generation aircraft. As a result, they require less maintenance and spares, which is great for the airlines but not good for suppliers. An example of this trend can be seen in C checks for the Airbus A320. Following entry into service, the first A320s would be coming in for a C check after 15 months. By 2014, that C check interval had stretched out to 20 months.
3. General improvement in airline MRO practices. The global airline industry has been adopting and adapting best practices for aircraft maintenance, repair and overhaul (MRO), and this has also had a negative impact. Carriers are now making broader use of recycled spares from parted-out aircraft-—while pooling some spares with other airlines—and requiring fewer initial spares when they take delivery of new aircraft such as the A350. Spares inventories have not been restocked to historic levels, as airlines realize that they can still operate efficiently with lower levels of buffer spares.
Consultants Roland Berger had independently reached similar conclusions, and their work also highlighted the increased use of long-term service contracts by the engine OEMs, which now motivates them to do less maintenance on their installed base of engines. The consequence of lower spares demand flows down to their parts suppliers. Comments from aerospace suppliers this quarter suggest that management is increasingly accepting that these aftermarket issues are real and not going away. At the same time, we see continued evidence of price pressure from the airframers on the supply chain, with some high-margin structures aftermarket work even being brought back in-house. So with less high-margin aftermarket growth than hoped for in this aerospace up-cycle, and continued negative pressures from OEM pricing and R&D costs, aerospace suppliers—and their margins—are potentially caught in the middle. And this is still an aerospace up-cycle—imagine how things could look in a down-cycle. At this stage, we have not really moved to the next chapter of this story, which is: What do suppliers do about these issues? We have seen more focus on tackling the surplus parts market (“if you can’t beat 'em, join 'em”) but nothing major at this point. However, if suppliers do nothing, then we could see operating margins come down due to these structural hurdles in the aerospace aftermarket.
Intelligence. Analysis. Insight.
This story is a selection from the May 16, 2016 issue of Aviation Week & Space Technology. New content posted daily online.
Robert Stallard is a managing director of RBC Capital Markets in London.
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