The global aerospace and defence industry will grow three per cent this year, driven mainly by the commercial aerospace sector, according to a new report, which notes the defence sector is still sluggish.
While the rate of growth for the overall industry has been slowing over the last two years as a result of declines in defence sector spending, the commercial aerospace sector is likely to enjoy close to an 8 per cent growth rate, according to the Deloitte Touche Tohmatsu Limited (Deloitte Global) Manufacturing Industry group 2015 global aerospace and defence industry outlook report.
“The commercial aerospace sector is expected to set new records for aircraft production in 2015. The accelerated replacement cycle of obsolete aircraft with next generation fuel-efficient aircraft, and growing passenger travel demand, especially in the Middle East and the Asia-Pacific region are key drivers behind this trend,” said Tom Captain, Deloitte Global Aerospace and Defence Sector Leader.
“Recent lower oil prices will not likely have a dramatic lasting impact on production rate increases for commercial aircraft, given the nine-year backlog the industry enjoys,” explained Captain. “Supply chain capacity and capability remain the critical risks that need to be managed in order to maintain production commitments.”
Global revenues in the defence sector will likely continue to decrease in 2015 at an estimated 1.3 per cent, Deloitte forecast. The global reduction in defence spending is mainly due to reduced armed conflict in Iraq and Afghanistan and affordability concerns in many traditional militarily active governments. However, Deloitte noted that defence spending is increasing in several areas of the globe, especially in the UAE, Saudi Arabia, India, South Korea, Japan, China, Russia, and other nations that have sufficient funding and border or regional security threats.
“However, these opportunities for sector growth are likely to be diminished with the overall downward trend in global revenues for the top tier defence companies, which declined 0.9 per cent in 2013 and 1.3 per cent in 2012,” Deloitte said. Because the United States accounts for 39 per cent of total global defence spending, any reduction in the U.S. defence budget will have a disproportionally higher impact on the global spend. Total global defence spending in 2013 amounted to $1.731 trillion.
Deloitte said the global defence industry in 2015 and beyond will be challenged by how to grow profitably in a declining market and deciding which actions are necessary to cut costs to maintain acceptable financial performance.
“With declining budgets, there likely will not be sufficient work to sustain current levels of revenues and earnings, requiring global defence companies to find other sources of revenue. Governments are expected to continue to spend on programmes of significant value, such as the next generation intelligence, surveillance, and reconnaissance (ISR) technologies…The ability to process mega- billions of data bits provided by high-resolution optics, communication sensing, and other multispectral sensors, is key to differentiating friend from foe, or tactical threat versus benign events for example. The use of advanced data analytics to sift through the data and make sense of it will be another strategic advantage in armed conflict. Innovations in these areas represent a source of potential growth for defence companies,” Deloitte said.
Its report stated that defence companies will increasingly be required to invest their own funds in potential growth areas, including next generation ISR. Other areas of growth that may help fill the revenue gap are foreign military sales to countries that are spending more on defence. Other promising areas of growth are in cyber-security, adjacent markets, and application of military technology for civilian markets. Lastly, growth is expected to come from inorganic sources via acquisitions. Acquisitions into new markets or consolidation of weaker companies to create economies of scale are expected to accelerate in 2015.
“Secondly, in order to maintain margins in a declining revenue environment, costs need to decrease. Successful defence companies have already been anticipating defence budget cuts and have been reducing staff, cutting overhead costs, and getting lean. They are accelerating the substitution of process automation over more expensive labour, resulting in higher operating earnings per employee. Digital product development and computer aided design have been a game changer by creating significant efficiencies in the product development process. Lean manufacturing and six sigma initiatives have significantly cut waste and inefficiency in the production process. It is expected these initiatives and programmes will accelerate in 2015 as companies manage their margins and profitability in a declining revenue environment.”
Deloitte pointed out that the global defence industry could receive a boost from regional conflicts. “Despotic leaders can still create dangerous disruptions, demonstrated for example with the recent invasion and takeover of the Crimea and continuing troubles in the Ukraine, the ISIS and Syrian conflict, the continued sabre rattling by the North Korean leadership, and high tensions over the disputed ownership of islands in the East and South China Sea. Each regional danger zone has its own unique military characteristics: Iran and North Korea with its threat of nuclear strike capability and China with its claims in the East and South China Sea using long-range fighter and sea power, for example.”
“As demonstrated over the last 50 years, armed conflict occurs on average every two and a half years, an increase from every four and a half years since the fall of the Berlin Wall. Should this trend continue, expect that defence spending will increase globally in the next two to three years, although this is highly dependent on the global defence environment, and how these potential threats described above unfold,” Deloitte said.
In terms of financial performance, Deloitte research revealed that during the first nine months of 2014, the top 20 global aerospace and defence (A&D) companies outperformed the top 20 US aerospace and defence companies both in terms of revenue and operating income growth. During the trailing nine months ending September 2014, the top 20 global A&D companies accounted for 52.3 per cent of the industry revenues of US$709.4 billion reported in 2013.
The top 20 global A&D companies reported combined revenues of US$370.7 billion during the first nine months ending September 2014, which represents a year-over-year increase of 2.7 per cent. In contrast, the top 20 U.S. based A&D companies’ revenues grew by 2.3 per cent to US$272.2 billion during the same period.