Defense Feels Budget Squeeze, Fuel Savings Boost Civil Airframers

By Joseph C. Anselmo
Source: Aviation Week & Space Technology

Indeed, companies will have to make tough strategic decisions on how to manage the turmoil: Should they shed some operations, make selective acquisitions or diversify into new lines of business? But as they move outside their comfort zones in search of new growth, contractors run the risk of venturing into areas they don't fully understand and for which they are ill-prepared to compete—a mistake that was oft repeated during the massive aerospace consolidation of the 1990s. “They have a lot of money, they're panicked about their revenues declining and they're starting to look way outside their core,” says TPC adviser Harlan Irvine of Deloitte Consulting. “You can destroy value in a hurry if you don't think through how it is going to work.”

The companies that consistently rank high in the TPC rankings, such as Lockheed Martin, Rockwell Collins, Precision Castparts and FLIR Systems, are benefitting from years of carefully planned investments and strategic moves (see five-year graphs, page 52).

For the second consecutive year, Boeing topped the TPC rankings of publicly traded companies with revenues of more than $20 billion, beating out second-place Lockheed Martin. Boeing's score of 90 was the highest of any company in this year's study and the third-highest TPC score posted since 1998, bested only by Lockheed Martin in 2007 and General Dynamics in 1999. The Chicago-based airframer has endured a flood of negative publicity from the grounding of its 787 jet following meltdowns of the aircraft's advanced lithium-ion batteries. But TPC analysts predict the price tag of cleaning up the mess and getting the 787 back into service will not materially affect the balance sheet of a company with more than $82 billion in annual revenue.

Boeing's rival, Airbus parent EADS, came in with a significantly lower TPC score of 64, but its rising profit margins point to a brighter future. “I would not be surprised if they moved up in the rankings next year,” says adviser Antoine Gelain of Candesic. “It's still a relatively young company, and they are going in the right direction.” Ironically, EADS's failed bid to merge with BAE Systems may prove fortuitous in the near term as most of the company's sales remain on the booming commercial side of the aerospace industry. “Airbus is doing extremely well, and European defense is doing extremely poorly,” notes Thompson.

So why didn't EADS finish higher in this year's rankings? While the company's operational performance is heading in the right direction, it is short of the mark for best-in-class status. EADS's operating margin of 3.2% last year was less than half of Boeing's 7.4%. “Their new governance model will help, but they are still saddled with European social welfare policies,” notes Captain.

Northrop Grumman, once a laggard among large defense contractors, continued its climb in the TPC rankings, rising to third place with a score of 80. The company posted operating margins of 12.4% while Huntington Ingalls, the ship division that it spun off in 2011, had margins of just 5.1%. And while Raytheon's score was flat from last year, TPC advisers believe the company is uniquely positioned for the downturn, with a strong missile-defense business and roughly a quarter of its sales generated outside the U.S. “In this new affordability environment, existing equipment will be upgraded rather than replaced,” notes Thompson. “That's their sweet spot.”

United Technologies placed second-to-last in the large-company rankings, but TPC advisers say a key reason for that was the goodwill added to its balance sheet from last year's $18.4 billion acquisition of Goodrich. UTC's score is expected to rise in future years as the old Goodrich operations are integrated into the company and synergies kick in.

One of the most improved scores in this year's study went to Finmeccanica, but it was a dubious distinction. The Italian aerospace company's score of 36 was up from 15 last year, but that was only good enough to tie with Curtiss-Wright for the lowest score among the 58 companies ranked this year. Finmeccanica's high-profile acquisition of DRS Technologies in 2008 has proven difficult to integrate, and operations in its home market remain riddled with inefficiencies. TPC advisers speculate the company could seek a merger or—copying a strategy famously executed by General Dynamics in the early 1990s—sell off pieces to generate value for shareholders.

The top ranking among companies with revenue of $5-20 billion went to Dassault Aviation, which produces large business jets such as the Falcon 7X and Rafale fighters. Gelain believes the French company's score of 79 and its leap to the top from 12th place last year is no anomaly. “There is a misconception that Dassault relies on a monopoly in combat aircraft in France to generate most of its profits,” he says. “While it does have a monopoly position in military, that now accounts for only 25% of their business.”

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