Defense Feels Budget Squeeze, Fuel Savings Boost Civil Airframers

By Joseph C. Anselmo
Source: Aviation Week & Space Technology
May 27, 2013

With all the gloom and doom about the future of the aerospace and defense (A&D) industry, a dose of perspective is in order. Unprecedented demand for new fuel-efficient aircraft boosted Boeing's revenues by nearly $13 billion last year, while sales of commercial Airbus jets were up by $7.5 billion. That means that in a single year the world's two largest airframers generated enough new sales to create a company that would be bigger than GE Aviation or Rolls-Royce.

And many of those added billions flowed into the vast aerospace supply chain, from advanced component manufacturers down to mom-and-pop machine shops.

“Commercial is taking off,” says Deloitte's Tom Captain, one of nine industry experts who helped analyze the results of Aviation Week's 2013 Top-Performing Companies (TPC) study. “As Boeing and Airbus go, so goes the industry.”

That is good news for contractors and suppliers, which are starting to feel the first squeeze from what will likely be a prolonged downturn in the defense market. Sales at BAE Systems, Finmeccanica, General Dynamics, Northrop Grumman and Raytheon declined by a collective $6.4 billion last year, and the onset of deep automatic budget cuts in the U.S.—known as “sequestration”—signals tough times ahead. “Uncertainty is the new normal, and it has created a wait-and-see mode,” says TPC adviser Scott Thompson of PwC. “Last year was devoid of any big strategic acquisitions.” That uncertainty has only grown in 2013, inducing a state of paralysis in an industry coming off a run of prosperity that lasted more than a decade.

Paradoxically, that has led to higher profits in the near term: The TPC scores of most large defense contractors went up in this year's study, and the performance of the industry's largest companies matches the Dow Jones Industrial 30 (see chart, above). That is the payoff from moves by companies such as Lockheed Martin to get ahead of the downturn by cutting costs, shedding excess capacity and trimming workforces.

Deloitte calculates that U.S. defense contractors have handed out more than 40,000 pink slips. Yet TPC advisers caution that hunkering down is not a viable long-term strategy. “There's a limit to how long companies can squeeze efficiencies out of existing programs,” says James Schwendinger. “You turn that wrench a couple of times and it gets pretty tight.”

The consensus among the TPC advisory team is that incremental efficiency gains will not be sufficient to guide defense companies through what is likely to be a protracted downturn as governments in the U.S., Europe and Japan rein in unsustainable spending. Skeptics note the sky did not fall when sequestration took effect on March 1, but that is only because of the drawn-out nature of weapons programs. It could be another year before the full force of budget cuts hits the Pentagon's procurement and research, development, test and evaluation accounts. “I think this continues to be the calm before the storm,” says TPC adviser Jacob Markish of Renaissance Strategic Advisors. “Focusing on operational excellence and hunkering down may be dangerous, because the storm is not passing.”


Comments On Articles