The aerospace supply chain begins to pivot

HEADLINES

The lead story this quarter is the pivot from tactical actions in response to the impact of the pandemic (on top of the MAX return to service delays) to the start of companies either taking strategic actions or positioning themselves to do so. To be sure, there are many firms who are still fighting a defensive battle, for example Rolls Royce, but others have largely completed their tactical cost reduction actions and are now considering what their business should look like as the industry slowly recovers. This is going to be the start of a crucial period where leaders will separate from the pack and the weaker members of the herd will suffer the fate of those that fall behind. 

COMPANY HIGHLIGHTS

              Boeing, as most expected, announced they will combine 787 production lines in Charleston. That also effectively indicates that Boeing does not expect to return to a rate approaching 14 a month as Charleston simply does not have that capacity on their Final Assembly Line. The Charles Edwards forecast, in fact, shows that they never do in the forecast period. Boeing disclosed that they expect that only about half of the 737MAX’s they have stored (450 total stored) would be delivered in 2021. They are also producing more 787’s than are being delivered and expect to do so in the 4th quarter of this year as well. Their cash and marketable security balance dropped by $4.7B in the 3rd quarter to $27.1B, buoyed by the $25B bond sale this year. They do not expect to be cash positive until 2022.  They appear to need a new product, which is, of course a cash user.

              This brings us then to Embraer.  Other than Airbus’s own cash burning small single aisle, the A220, Embraer is the manufacturer of the only other small single aisle / large regional jet. Embraer has their own cash issues. CEO Francisco Gomes Neto publicly stated that they are actively pursuing business partners to help with commercial products.  Boeing and Embraer failed to reach agreement on the sale of Embraer commercial operations but an arrangement still makes sense for both of them. Boeing gets a new product without a huge development outlay and delay getting to market and Embraer gets cash to focus on other parts of the business.

              Airbus is faring better than Boeing but not without significant challenges of its own. They too are building above delivery and growing an inventory of finished aircraft (approximately 135 as of 11/6). Although Airbus indicated in their 2nd quarter earnings call that inventory would be burned off by the end of 2021, they failed to make the same commitment in the third quarter call, leaving open the possibility of a finished goods inventory balance going into 2022. This does not lend a lot of support to their public desire to increase the A320 rates from 40 to 47 in 2021. Airbus continues R&D efforts on future aircrafts while waiting for a new product move by Boeing.

              Spirit and ASCO mutually terminated the agreement to sell a portion of ASCO’s business to Spirit. Spirit also announced closing their McAlister production facility but did finalize the purchase of Bombardier’s commercial operation. The rationale for that purchase was primarily to obtain resin-infused composite capability and diversify their customer base as the operation produces A220 wings now for Airbus using that technology. As stated earlier though, the A220 is a program in need of cost reduction so there is some pressure there.

              Some of the moves made by Spirit were examples of what the larger supply chain is doing. Curtiss-Wright announced they were pivoting away from build-to-print structures revenue sources exiting their long-standing 737 actuation business because the margins were unsustainable. Curtiss-Wright also followed another supply chain trend by closing their Queretaro facility. Solvay announced multiple closures and then finally announced the sale of their composites business to Hexcel giving Hexcel new revenue sources and giving Solvay an exit from the market. Honeywell announced the acquisition of Ballard Unmanned Systems to expand their presence in the hydrogen market. L3Harris gave an update to their divestiture plans which they estimate as approximately 1/3 complete. 

CLOSING THOUGHTS:  The Repositioning Period Begins

              It is important to note that the impact of the pandemic-induced contraction on the aerospace supply chain has been worse on the OEM’s for reasons discussed in our 2nd quarter newsletter (if you want more insight, call or email us). 

With the tactical actions largely behind us, what can we expect in this period where companies reposition themselves? Some clear trends are:

·       Movement away from build-to-print, particularly in structures.

·       Continued search for more diversified revenue sources.

·       Some companies with multiple verticals exiting like Solvay.

·       Companies changing production systems or locations. An example besides the closures listed above would be Pratt & Whitney’s decision to open a new facility in Greenville, North Carolina to better position themselves for production when growth returns.

However, with any meaningful growth at all, much less a return to 2019 levels, pushed off until 2022 at the earliest, cash strapped companies will have to carefully choose among these and other options to avoid taking a fatal step. Just about every company needs to take steps to be in position but the footing is very treacherous. A mistake in this environment is not easily recovered from.