Ignore the sonic boom of hype: first aircraft makers must deliver
The defence industry is one of those for whom, like the media, bad news is good news. The juicy prospect of a Pacific arms race, threats from North Korea, a meddling Russia, terrorism and a Middle East in ferment should lighten the mood of military aircraft manufacturers at this week’s Farnborough air show.
But by and large, the same companies that make military planes also make civilian aircraft, and they are struggling to handle the enormous growth seen over the last five years.
As they try to avoid delays in their clogged supply chains, it’s unlikely that military spending will ride to the rescue.
This is especially true in Europe. Donald Trump might think, rightly, that European countries should turn on the spending taps to defend themselves. He’s a fan of Vladimir Putin, whom he met in Helsinki yesterday, but also a critic of Germany’s reliance on Russian energy.
He’s a big fan of rising defence spending, with a neo-conservative, John Bolton, for a national security adviser, but also a classic American isolationist keen to avoid expensive military exercises and entanglements abroad. His policies are, in other words, somewhat unpredictable.
Despite that, analysts at BAML are convinced that we are “at the beginning of a defence budget upcycle”. The US defence budget, by far the world’s biggest, fell and then stagnated under Barack Obama, but it has started to shoot up again under Trump. This might benefit some US contractors, but they are already trading at premiums to the S&P 500 last seen during George Bush’s “war on terror”, when Washington plunged $2 trillion (£1.5 trillion) into Iraq. Trump has no appetite for a similar war. He just likes shaking generals’ hands and cutting ribbons on new kit. That’s not a very good fundamental basis for buying defence stocks.
In theory, European spending should be rising to hedge against Trump’s unreliability. But, unlike the US, EU countries are constrained by fiscal conservatism and where they are willing to spend extra to placate their angry voters, it’s not going to go on big-ticket military equipment. Meanwhile, the biggest aerospace companies showing off their wares at Farnborough this week are already choked with new orders for commercial aircraft. Airbus currently has orders on its books for over 7,000 aircraft – compared to the 10,000 of its aircraft currently in operation.
Boeing’s order book is nearing 6,000. Globally, backlogs have been rising since 2007, when they were around 4,000, to nearly 13,000 today.
The challenge for both Boeing and Airbus is not getting new business but delivering on the promises they have already made without imposing years-long delays on their customers.
Airlines could be forgiven for tempering their new orders in the expectation that they aren’t going to get deliveries of existing ones on time.
The good news for plane makers is that traffic continues to rise, despite threats of trade wars and economic downturns. Unlike trade, air traffic has continued to grow at a faster pace than GDP, especially in the Asia Pacific region. The ongoing trends of rising wealth and globalisation keep feeding through into rising numbers of passengers, despite the threatening political rhetoric and apocalyptic headlines. Another bright spot for aircraft manufacturers is the growth in services surrounding their products.
Focusing on maintenance and operations would allow them to shift their revenues from capital-intensive goods delivery towards smoother, reliable fee-generating contracts.
That would at least help to hedge against the strain of delivering on their swollen order pipelines. Both military and commercial supply chains have been causing headaches. Aside from the need to fulfil commercial orders, Airbus has faced problems in delivering on military contracts too.
Its A400M heavy troop carrier has been beset by changing and conflicting specifications from the seven Nato governments that agreed to buy it, generating billions in writedowns. It desperately needs to sign up some other states as customers to dig itself out of the hole.
Analysts covering Airbus and Boeing have started to talk about consolidation and delivery more than growth. New entrants like Bombardier, Embraer and China’s Comac are challenging the dominance of the big two. But even they have struggled to deliver new aircraft without help (in particular Bombardier has been forced into a tie-up with Airbus and Embraer with Boeing). Given the regulatory hurdles and investment required, it has been years since a truly new technology entered the scene. Instead, the major players have been engaged in an update “arms race”, pressuring one another by announcing models that incrementally improve on the last one and challenging rivals to do the same.
Farnborough visitors will no doubt be wowed by announcements, presentations and exciting demonstrations. Boeing has set the tone with its announcement of a £3.6bn deal for new freighters with DHL. There is even talk of a revival in supersonic aircraft, although it’s hard to see how a major expansion in noisy supersonic passenger jets would gain public approval.
The truth, though, is that the industry is struggling to swallow the growth it has already enjoyed. Defence analysts might talk about a new spending cycle and rising tensions, but there’s little real sign that most Western governments are prepared to start splashing massive new cash on brand new military equipment.
The long-term trends of rising air travel might be positive and the shift into aircraft services could help to improve revenue models in future, but the medium term certainly isn’t a story of unconstrained growth and spending booms (sonic or otherwise). Instead, it’s about testing whether the major players can do everything they have promised to do.
‘The truth is that the industry is struggling to swallow the growth it has already enjoyed’