The Industry Continues to Re-shape

Aerospace, Defence, Rail & Advanced Manufacturing Industry Update

7 September 2020

While the vast majority of manufacturers have survived the Covid-19 crisis so far, it is likely that we will see increased level of stress during the final months of the year – and accelerated mergers and acquisitions (M&A) activity lasting into the first half of 2020. Buyers in both the UK and overseas are already on the look-out for acquisition opportunities, though valuation processes are changing in the wake of the pandemic; current order books and past revenues now receive less weight, with a focus instead on understanding potential targets’ competitive positioning, their partnerships, operational strength and liquidity.

Consolidation is ongoing, both through M&A and internal reorganisation. Aerospace companies are seeking to rebalance their output, diversify and invest to keep their businesses going. This can range from increasing Defence content to diversifying into sectors such as Rail and Medical Devices and also moving up the supply chain by offering sub-assemblies rather than just components. Disposal of non-core and non-profitable assets will help companies save cash in the short term but can pose competition risk in the future in some cases. For companies who have the cash and the ability to turn businesses around, the disposed assets can be real value. Some may not be viable but others will be almost as soon as they are out of mega corporations, giving them the independence and agility to reduce costs and improve in a short period of time. Shedding assets will allow companies to focus more investment into the future of their core offerings. In Aerospace this is electrification, hydrogen propulsion, light weighting, digitalisation and automation.

Boeing, for example, is considering whether to consolidate its 787 production into one location; it currently manufactures in two separate plants but has reduced its Dreamliner production rates as demand has fallen sharply, with airlines looking for smaller, lighter and more efficient aircraft. Such changes to production are rare, underlining the impact of the drop in demand – and suggesting Boeing does not expect it to return in the near future.

Similarly, Rolls-Royce has announced it is targeting disposals, including of its ITP Aero business and “other assets”, and that it is “reviewing a range of options” to generate ￡2bn and strengthen its balance sheet. The aerospace giant has already increased its liquidity this year, adding ￡6.1bn in the first half and agreeing a term loan of ￡2bn in the second half to help it weather the uncertainty.

In some cases, M&A activity is more strategic. For example, BAE Systems has strengthened its technology and data portfolio with the acquisition of Techmodal, the Bristol-based consultancy. The deal will add to BAE’s existing strengths in this area, in a market where the Ministry of Defence last year launched the Defence Digital initiative; Royal Navy, for example, has set out an ambition to become a fully “digital navy” by 2025.

Supply chain support needed

The industry group ADS has set out the case for an “Aerospace Supply Chain Investment Fund. Government support for the sector has helped keep companies afloat in the short term, it says, but will not be sufficient to get businesses through in the medium to longer term, or provide the funding needed for recapitalisaton and structural adjustment. Reduced production has left many suppliers with excess capacity and stock, ADS points out, plus rising debt is undermining competitiveness. Some may slip into insolvency without help.

Given the disruption to supply chains this would cause – and the enduring damage to the UK’s competitiveness – ADS is proposing a long-term supply chain fund that would be financed by industry, private finance and government. The fund would recapitalise critical UK supply chain companies and support M&A activity to drive restructuring. The facility could also support innovative start-ups in the sector.

One source of help available is Supply Chains for the 21st Century (SC21), an improvement programme launched 13 years ago to accelerate competitiveness in aerospace and defence. The latest iteration of the scheme, which is fully funded, is currently inviting participation from companies and will run for three years; there is scope for more than 70 companies to take part. More details here.

Defence spending announced

The Ministry of Defence has awarded a ￡3m contract to NP Aerospace, which will demonstrate the use of hybrid electric drive systems on ground vehicles. The project is being delivered in collaboration with General Dynamics Land Systems UK, Supacat and Magtec.

Internationally, Japan has plans to purchase 105 F-35 strike fighters in a deal already approved by the US. The purchase, if it goes ahead, would give Japan a total of 147 such planes, ahead of the UK, which has plans to buy 138 F-35s, though behind the US, the world’s largest fleet. This is good news for UK companies in the F-35 supply chain, which will benefit from the transactions.

Public sector support for rail continues

The Office for National Statistics has reclassified train operating companies currently operating under emergency measures agreements with the UK and Scottish governments as public non-financial corporations. The ONS points out that the risks of running such businesses are now being almost entirely borne by the government, with TOCs unable to borrow money, increase or reduce their workforces by more than 5%, or set ticket prices lower than they were immediately before their EMAs were agreed.

The current EMAs with franchised passenger TOCs are set to expire on 20 September and negotiations about the future are ongoing. Industry sources suggest some TOCs have been resistant to the terms of successor agreements proposed by the Department for Transport.

Meanwhile, the government has announced the launch of the Transport Acceleration Unit to speed up the delivery of transport projects. Transport secretary Grant Shapps says the new unit will be in place this month and will report directly to him. The unit will work with specialists who have significant experience of delivering infrastructure projects; this is timely, given the scale of projects currently planned for the UK, as well as the possibility of export opportunities for the UK’s rail industry.

Elsewhere in the public sector, Solihull Metropolitan Borough Council has granted planning approval for the HS2 Interchange station, including the surrounding public realm and a 2.3km automated people mover link to Birmingham International station, the airport, and the NEC. Construction is due to start in 2024.

HS2 itself has launched the Innovation Accelerator Programme. It wants to recruit two cohorts of five small companies each year, which it will work with and support to develop new digital products and services for HS2. Applications close on 18 September. More details here.

France is also seeking to support its rail sector, unveiling a financial support package worth €4.7bn as part of its national post-pandemic recovery plan. The French government has also committed €35bn to Grand Paris Express, Europe’s largest infrastructure project, with a timeline stretching beyond 2030. The aim is to expand Paris’s underground network with four new lines and extensions to two existing lines. With Covid-19 adding to delays to the project, France is understood to be very keen to attract overseas participation in the scheme, to increase innovation and stimulate competition.

To this end, the Department for International Trade and the Railway Industry Association will run a webinar on the Grand Paris Express project on 2 October at 9.30. Full details here.

Elsewhere, Network Rail has organised a virtual event for suppliers on 6 October at 10am. Register here.

General Manufacturing sector news

August’s Manufacturing Purchasing Managers Index, published on 1 September, registered a figure of 55.2, indicating that manufacturing activity in the UK is rising at its fastest pace in six years. However, this was from a low base and was actually slightly lower than anticipated; the broader market context remains that job cuts are likely as the government continues to unwind the Job Retention Scheme (JRS).

Still, new research from MakeUK does give reason to be positive. A third (31%) of manufacturers currently have no staff furloughed, its latest Manufacturing Monitor reveals, while more than half (54%) now think it will take less than 12 months to get back to normal trading conditions.

However, the research also shows that 62% of firms think the JRS should be extended for critical sub-sectors. MakeUK itself argues this is crucial to support the UK’s strategic industries, which are otherwise at risk of losing key skills and falling behind international competitors. Almost a quarter (23%) of firms disagree with the government’s determination to close the scheme and 17% think it should be extended for all businesses. Significant numbers also say the scheme should be reintroduced in the event of another lockdown, and that we now need a new scheme to replace the JRS.

MakeUK points out that similar schemes in Belgium and Germany have already been extended, to the end of 2020 and 2021 respectively, while the Australian government is extending its JobKeeper Payment scheme until March. In France, a new long-term short-time work scheme in specific sectors is planned for sectors where companies will suffer enduring loss of business from the pandemic.

The aerospace and automotive sectors are especially in need of an extension to the JRS, MakeUK says, given their position at the cutting edge of technology, which is likely to vital to growth in the future. The organisation points to official data showing these two industries are the UK’s largest investors in research and development, accounting for more than two-thirds of such spending. The sectors are also among the hardest hit by Covid-19, with many job losses already announced and output predicted to fall by 33% (a ￡4.6bn loss in value) and 14% (￡1.3bn) in automotive and aerospace respectively.

Across manufacturing as a whole, meanwhile, reshoring now looks to be an increasingly important agenda item. Bloxwich-based manufacture Albert Jagger Engineering is one business proving what might be possible. It has worked with catapult centre MTC to bring the production of almost 250,000 fastening components back to the UK, achieving savings of 20%-30% in the process. The efficiencies come from a new factory layout, the introduction of new technology, retraining and a 50% decrease in stockholding costs.

Finally, on 10 September, Santander and MakeUK published the latest manufacturing sector fact card, providing a crucial update on the importance of the industry to the UK economy. The cards include data ranging from export statistics to employment figures; we will look at the figures in more detail in our next briefing.

?Halil Bedevi MSc, CEng, FMM, MIET is the Head of Aerospace, Defence, Rail & Advanced Manufacturing sub-sectors within the Manufacturing Sector Team at Santander UK. He is responsible for leading and directing Santander’s strategy in driving client primacy and growth across the above four key manufacturing sub-sectors.