Positive predictions for 2011

According to the “Aerospace Economic Report and Outlook 2010,” recently published by Embry-Riddle Aeronautical University (Barr et. al.), major OEMs and primes like Boeing, Lockheed Martin, EADS, and others forecast the near and long term future of aerospace manufacturing on the growth of Gross Domestic Product (GDP). The underlying principal is that the economy changes first, either up or down, and then the industry simply follows suit. Tracking the GDP, one clearly sees the trend of the economy. In 2000, the GDP was slightly more than $10 trillion and peaked at about $14.5 trillion in 2008, a tremendous 45% increase or about 18% in real terms (after inflation). Then, came the fall of half a trillion dollars just one year later, but a much smaller dip than the news media would have us believe.

In the third quarter of 2010, we were back above the 2008 peak at $14.75 trillion, that is an economy more than 47% larger than 10 years ago in nominal terms. No discussion – we had a V-shaped recovery. Matter of fact, from Q3 2009 to Q3 2010, the overall GDP was up 4.5%. However, problems like limited investment capital and other issues discussed later persist.

In our new post-recession world, trends change. Aerospace manufacturing no longer follows GDP. While GDP fell from its peak to its bottom by only 3.5%, aerospace manufacturing fell by more than 20%. At the same time, the overall GDP is now higher than before the start of the recession, aerospace manufacturing is not.

From its peak in December 2007 to October 2010, aerospace industrial production is still off approximately 13%. In our new world, aerospace manufacturing is a leading indicator of future economic growth rather than a lagging result. In other words, the downturn in aerospace manufacturing lead the fall in the overall economy, and the slow recovery of aerospace manufacturing helped stall a more sustained recovery.

IMPLICATION: Aerospace manufacturers should plan for sales and production to rise before the economy expands in 2011.

Key Aerospace Manufacturing Indicators

Indicator #1: Aerospace Industrial Production
The aerospace manufacturing sector is more volatile than overall U.S. manufacturing. The recovery was V-shaped. However, following the recovery in 2009, the level of aerospace industrial production has been slowly declining. This decline represents consolidations, increases in efficiency, and a global narrowing of both commercial and defense-based aerospace markets and very tight capital markets. The smaller firms with assets under $25 million experienced most of the decline.

IMPLICATION: Small and medium sized aerospace manufacturers took a greater hit from the recent recession than larger firms but, as in the past, will be even quicker to recover.

Indicator #2: Aerospace Capacity Utilization
Aerospace capacity utilization, or the percent of total available manufacturing capacity used, fell from its peak in late 2007 of 88% to about 71% in October 2010, up from a near record recession low of about 66%. Obviously, aerospace manufacturers have tremendous idle capacity.

IMPLICATION: Due to the increase of air travel and cargo traffic, idle aerospace manufacturing capacity, when utilized, will quickly spark growth in 2011.

Indicator #3: Capital to Fund Aerospace Growth
With all the talk about how difficult it is for business, especially small- and medium-sized firms to secure investment capital, little is said about the reason why. While large OEMs and primes have easier access to capital from the issue of stocks and bonds, smaller firms, in most cases, either depend upon owner equity or bank loans. Because of the near failure of our banking system, the Federal Reserve has created a safe haven for banks to safely earn back what was lost. Banks traditionally kept about $50 billion of their deposits in non-interest bearing Federal Reserves but now with the Fed paying interest, Federal Reserves made up of bank deposits have grown to more than a trillion dollars. This is money that cannot circulate in the economy as loans to small and medium sized businesses.

IMPLICATION: As the banking system continues to recover, the Federal Reserve will force banks to withdraw these funds which will begin to fuel aerospace manufacturing expansion in 2011.
 

Indicator # 4: Aerospace Corporate Profits
Tracking corporate profits is a great indicator. In our free enterprise system, markets are very quick at telling us whether we are on the right track. At the end of the third quarter of 2010, of the 20 firms listed to the right, 15 of them – or 75% – beat Wall Street earnings estimates while 95% earned an after tax profit.

While overall U.S. corporate profits in Q3 2010 are the highest in history at $1.427 trillion, aerospace company profits have recovered, just not as well. Aerospace company profits peaked at $5.4 billion in Q2 2008 and fell to a low of -$118 million in Q4 2008. In Q3 2010, aerospace company profits are at about $4 billion, a significant V-shaped recovery.

IMPLICATION: Aerospace earnings will continue to rise and or remain steady throughout 2011. Aerospace will lead the recovery and overall expansion of the U.S. economy in 2011.

Indicator #5: Planes on Order
Facts are facts, and the facts are that in the commercial world, planes are on order. The most recent reading from Barr Group reflects an estimate of 7,052 commercial aircraft in the U.S. Of these, 6,505 are currently in active service, with 773 additional planes on order and 547 currently being stored. Air carriers have trimmed their fleets, cut costs, and have become more profitable. They want the newer, more fuel efficient, longer range and larger capacity aircraft.

Global military budgets have hit hard economic times and have stalled the purchase or development of new aerospace weapon systems. As a result, the global military aircraft fleet is either mature (51%), old (38%), or new (11%) according to the “Aerospace Economic Report and Outlook 2010.” In a world that continues to prove itself unstable, old and mature aircraft will be replaced with more fuel efficient aircraft. Of great concern to many is the projected cuts in DoD budgets in 2012 and beyond.

With commercial and military aircraft orders on the rise, air traffic will be expanding quickly. This trend continues despite the relative rising cost of fuel and fewer airline employees. Looking longer-term, there is better news for MROs and airlines as demand increases. There is a bright light at the end of the tunnel for both, and it is not a fast train moving in their direction.

IMPLICATION: U.S. defense spending on aerospace will decline in 2011 while commercial aerospace will expand in 2011. The age of global military aircraft fleets and higher commercial passenger and air cargo will demand more aircraft and more and more expenditures on MRO (maintenance, repair, and overhaul).

Aerospace and Defense in 2011 will be impacted by limited budgets in the U.S. and Europe, but continuing operational requirements and some major acquisition programs in Latin America, the Middle East, and the Asia Pacific regions will keep the overall global markets growing at a moderate but steady rate. Spending for satellites and services, fixed wing aircraft, helicopters, missiles, transports, training, logistics, and maintenance spending for defense aerospace are projected to be limited in each region. This will require the MRO industry to be creative and competitive in this comparatively horizontal market. For western nations doing business in these areas, expect tough negotiations on technology transfers and local manufacturing, with offsets being expected. MROs must identify new market needs and value added services that support airline requirements and optimize their services.

Indicator #6: The Business and Political Environment
Like no other industry, aerospace is not only dependent on resources and business capacity but on a beneficial political environment. The question industry often face is locating in the right community that not only supports what they do but is willing to be a partner. The rush to pull us out of a downward spiral has driven two major trends that will foster aerospace manufacturing growth in 2011 and beyond.

First, business has had a one-time opportunity during the recession to cut costs, trim compensation packages, let go of the worst (least efficient operations), and build upon the best (most efficient operations). Workers, suppliers, OEMs, primes, and many others have all been flexible in trying to turn this situation around. All of this has left many aerospace manufacturing firms with less leverage, better union contracts, and leaner than ever before to withstand the ever increasing global competition. Hence, aerospace continues to be the only major manufacturing sector in the U.S. with a significant trade surplus.

Second is looking for local government as a partner. State and local government has come to realize the benefits and future of aerospace. Across the U.S., local government is creating newer and better opportunities for aerospace. For example, Leesburg, FL, (just outside of Orlando) has launched an ambitious project called LEAP (Leesburg Enterprise Aerospace Plan). LEAP offers more than 3,000 acres of industrial land near an interstate highway; opportunities to develop a duty free/free trade zone; low relative utility, housing, and construction costs; a possible reduction in tax rates through Enterprise Florida; and an international airport, which plans to serve more than 60 million passengers a year estimated to fly into the region by 2028 (to find out more see barrgroupaerospace.com).

The AERO Indicator
Say it all in one number. Are we safe and on course? The AERO Indicator mathematically combines all the above economic data and more into one forecasting number.

The AERO Indicator is a weighted average from a group of regression analyses of moving averages of very current aerospace commercial and defense related data, a survey measure of industrial opinions, and a daily index of stock market prices of a select number of small, medium, and large aerospace companies whose business is dominated by aerospace products, parts, and services. The weighting of AERO indicator averages, indexes, surveys, and the time frame used in forecasting, is proprietary to Barr Group Aerospace.

How to Read the Indicator
The reading of 101.38 for November 2010 means that, during the next six months, the U.S. Aerospace and Defense Manufacturing Sector will grow at a 1.38% annual rate.

Skies are Clear at 30,000 feet

The aerospace manufacturing sector has recovered slower than the overall economy, but is poised to lead the growth of the economy in 2011. All indicators point to slow growth during the next six months. Then we predict the rate of growth to increase, despite cuts in DoD spending. While DoD spending is projected to fall during the next few years, direct and indirect spending on aircraft and missiles is projected to only fall from $100.4 billion in 2010 to $97.8 billion in 2011, or 2.6%.

The Aero Indicator predicts a slow start in 2011 but fueled by idle capacity, wider sources of capital funding, higher sustainable profits in both the commercial and defense manufacturing sectors, growth of cargo and passenger traffic, more planes on order, and higher demand for MRO – all with local and state political support – should result in a very good year for aerospace manufacturers. While larger firms have already recovered, smaller firms will soon follow.

Contributors to the forecast
Dr. Saul “Sonny” Barr is the senior economist at Barr Group Aerospace and professor emeritus of economics and finance at the University of Tennessee. His company has provided economic development, consulting, and training services to the Pentagon, Goodyear, Raytheon, Honeywell, Alcoa, Embry-Riddle Aeronautical University, local airports, and government, as well as many others. Statistics, including news and commentary, is updated minute-by-minute on the AeroWeb. For detailed information about the AeroWeb, go to barrgroupaerospace.com.

Nathan K. Smith Industry Analyst and Brad Curran Senior Industry Analyst Business Unit: Aerospace & Defense Frost & Sullivan, provided their look at the aerospace industry.

Founded in 1961, Frost and Sullivan has more than 40 global offices with more than 1,800 industry consultants, market research analysts, technology analysts, and economists. Frost and Sullivan’s mission is to research and analyze new market opportunities for corporate growth and is considered the world leader in growth consulting and the integrated areas of technology research, market research, economic research, corporate best practices, training, customer research, competitive intelligence, and corporate strategy. frost.com

According to Frost and Sullivan: 
Defense aerospace procurement will remain stable in 2011 with proven equipment designs and incremental system improvements. The top global aerospace defense firms will continue to dominate the 2011 market, but expect further consolidation among European manufacturers. State subsidized Russian, Chinese, and Korean aerospace companies have price advantage and will experience the fastest grow rates.

Premiering in the March 2011 Issue: 
Raising The Barr, a monthly forecast for the Aerospace and Defense market by Dr. Saul “Sonny” Barr, will begin in the March 2011 issue of Aerospace Manufacturing and Design, where he will discuss trends, statistics, and leading indicators in the aerospace and defense markets.