Higher defence spending is one of the factors that is expected to return growth to the global aerospace and defence sectors this year, with the industry expected to grow at 2%.
This is according to Deloitte’s 2017 Global aerospace and defence sector outlook. The company notes that after multi-year declines in revenues, the defence sub-sector is expected to grow at 3.2 percent in 2017.
On the defence side, resurgence of global security threats, expected increases in US defence budgets, as well as higher defence spending from other major regional powers such as Japan and India will likely promote global defence sub-sector revenue growth in the near future. “In particular, we see an upside for US defence expenditure, given the outcome of the recently concluded US elections. In addition to boosting the number of troops, the US military will likely add more aircraft and ships, which will drive revenue growth at large defence primes over the next few years,” Deloitte said.
With rising global tensions, international demand for defence and military products is increasing in the Middle East, Eastern Europe, North Korea, and the East and South China Seas. This is in turn resulting in increased defence spending globally, especially, in the United Arab Emirates (UAE), Saudi Arabia, India, South Korea, Japan, India, and China – many of these countries have already started to increase purchases of next generation military equipment.
Regarding global spending, Deloitte noted that the US remained the largest defence spending nation, representing 34 percent of the total global military spend of $1 760 billion in 2015. Many Middle Eastern and African countries spend a greater percentage of their GDP on military expenditures, with Oman, South Sudan, and Saudi Arabia being the top three. With $85.4 billion in military expenditure in 2015, Saudi Arabia was also the fourth largest defence spender globally.
On the commercial aviation side, Deloitte noted that the commercial aircraft backlog is at an all-time high of around 13 500 aircraft units, representing more than nine and a half years of current annual production rate. Commercial aircraft production will likely increase, driven by stable global gross domestic product (GDP), strong airline passenger traffic, and continued airline profitability, supported by lower fuel costs. However, despite an expected increase of 96 additional large commercial aircraft being produced in 2017, continued pricing pressure and product mix changes by airline operators will likely result in only a marginal increase of 0.3 percent in commercial aerospace sub-sector revenues.
Looking forward, Deloitte noted that after persistent global tensions in 2016, many affected countries are planning for and taking actions to recapitalize and improve their defence posture. “Threats continue to evolve from traditional land based force on force, to maritime disputes, hybrid warfare, island building, high seas piracy, urban insurgency, lone-wolf civil attacks, cyber-attacks, to anti-access, area denial. Moreover, the new US administration has indicated that the US Air Force and Navy investment account spending, force structure and operational assets are to increase significantly.”
The US and allies in the South China sea region are expected to pursue more aggressive intelligence, surveillance and reconnaissance operations and might even carry out joint patrols with Japan. Also, the conflict between Saudi Arabia and Yemen carried on in 2016, where the US government continued to provide military support and aid to Saudi Arabia. In addition, Russia and Ukraine continue to be at odds related to Russia’s takeover of Crimea and their military actions in eastern Ukraine. North Korea continues to threaten its neighbours with its nuclear ambitions and aggressive rocket launches. The Islamic State (ISIS) continues to be a major threat in Syria, Iraq, and Afghanistan and is also carrying out terror strikes in Europe, Africa, and elsewhere. With the bombings and terror attacks in Brussels, Turkey, Nice, Paris, Beirut, Mali, the Sinai Peninsula, as well as other places, countries across the globe have joined the fight against terrorism.
Several governments have already started increasing their defence budgets to address security threats and to battle against terrorism. For instance, China, Russia, Saudi Arabia, and South Korea’s 2015 military expenditure rose by 7.4 percent, 7.5 percent, 5.7 percent, and 3.6 percent year-on-year, respectively.
“For defence contractors, this represents an opportunity to place more equipment and military weapons systems with these countries. Key defence products which are likely to experience increased interest from buyers, include armoured ground vehicles, ground attack munitions, light air support aircraft, intelligence, surveillance and reconnaissance electronic sensors, cyber protections, maritime patrol ships and aircraft, as well as provision for equipment maintenance and sustainment, as the military operations tempo continues to increase,” Deloitte said in its report.
With US defence spending experiencing a slowdown in the last few years, US defence firms increased focus on seeking growth opportunities via foreign military sales (FMS), mainly in markets such as, India and the Middle East. In fact, US FMS increased from $21.36 billion in FY2010 to a record $46.6 billion in FY2015. FY2017 is expected to be another record year for US FMS. This will be largely driven by the helicopter, missile, and other military sales to the Middle East, which have already been cleared by the State department.
According to the Defence Security Cooperation Agency (DSCA), the latest approvals of US arms sales overseas led to the total US FMS notifications to $41.8 billion for FY2017.
Also, given the increasing defence spending by India and the Middle East, foreign military sales are anticipated to remain strong in 2017 and 2018. In addition, Europe recently announced a major increase in defence spending after the US president called for NATO members to dedicate 2 percent of their GDP to military expenditure. The proposed increase in spending is approximately $5.8 billion annually. This will primarily be utilized for buying more hardware and increase R&D spending to $500 million a year, Deloitte noted.
Another avenue for growth will be acquisitions and joint ventures. Joint ventures in the sub-sector have gained traction as it is often used by global defence businesses to access new markets, reduce competition, as well as to share risks and costs. Joint ventures helped defence players to strengthen long-term relationships and also enable these companies to enter certain foreign markets that have high entry barriers. Some of the key joint ventures announced in the past twelve months include Boeing and Tata Advanced Systems (December 2015) for manufacturing fuselages of Apache helicopters in India and Raytheon (March 2016) for the development of unmanned surface vessel in the UAE.
Deloitte identified several key growth regions for military expenditure, including the Middle East and Asia and Oceania. The share of military expenditure from the Asia and Oceania region rose from 20.1 percent in 2010 to 25.6 percent in 2015, whereas, Americas’ contribution to the global military spending declined from 47.8 percent in 2010 to 39.1 percent in 2015. Hence, global defence companies dependent on the US and Europe are increasing their focus on regions such as India, China, the Middle East, and Russia.