October 2017

Preparing for Takeoff

From mills and service centers to market analysts, the outlook for aerospace is gaining altitude.

By Jonathan Samples, Associate Editor

After 12 years of unprecedented growth, the aerospace market came back down to earth in 2016. Production issues with the newest generation of single-aisle jetliners and ensuing inventory surpluses carried over into 2017, thus far prompting a year of relatively flat growth in the industry.

Despite movement away from the record numbers seen during the most recent supercycle, analysts are very optimistic the commercial jet market is priming its engines and preparing to take off yet again. “We’re feeling confident, even though we are not in record turf this year,” says Richard Aboulafia, vice president of analysis at Teal Group – a market research firm based in Fairfax, Va. “This is literally the first year in about a dozen years that we are not in record turf. However, things are looking pretty good.”

Recent slowdowns in the aerospace market were primarily due to production issues with two jet families: Airbus’ A320 and Boeing’s 737. These two jets account for roughly half of the commercial jet segment, which itself accounts for approximately 60 percent of the entire aerospace market. Together, the A320 and 737 make up 25-30 percent of industry output, and they are also the two most metal intensive, according to Aboulafia.

“Predictably enough, both Airbus and Boeing are having a hard time figuring out to build the new generation of planes,” he says. “If it weren’t for the problems with those jets, we would have grown nicely, and I would be talking about yet another great set of record numbers.”

The next-generation 737 MAX and A320neo have all new engines, and that means new production models and learning curves. Because of those hiccups and because these two planes carry much of the industry, the aerospace market as a whole suffered. The large jetliner segment grew just 1.7 percent in 2016, meaning it was unable to make up for significant declines in the business aircraft, civil rotorcraft and defense segments.

Overall, the compound annual growth rate for the entire aerospace industry was down 2.5 percent last year. “This should have been a much faster growth year, and that’s where you had that problem with the A320neo and the 737 MAX just being delayed,” Aboulafia says. “But suffice to say, where we’re going with single aisles is onward and upward.”

These and other issues trickled down the supply chain, affecting both aerospace metal producers and distributors. Slow production ramp ups with Boeing’s 787, Airbus’ A350 and other wide bodies also put pressure on the supply chain, creating incentives for service centers to get inventories as lean as possible.

A period of destocking in the aerospace supply chain was one result of this downward pressure.

Steve Scheinkman, CEO at Oak Brook, Ill.-based Castle Metals, says the area where you’re seeing destocking is primarily in aluminum plate products. “It’s a matter of what the forecasts were going back to when the manufacturer’s projected out what the requirements were going to be,” he says. “Those forecasts were not hit, and therefore, there’s some excess inventories that have to move out of the system in order to create the right balance between material to be produced and the material that’s already on hand.”

That’s where service centers come in. Scheinkman says, now more than ever, it’s important for aerospace metals distributors to work closely with their subcontractor base on very detailed forecasts to ensure inventories are where they need to be.

“Because of the degree of the forecast plan that we do with our contractual accounts, we’re able to self-correct the inventory as we see changes in either production rates or in the businesses that our customers have,” he says.

“Where we see more of the overstocking is on the transactional side, when you’re selling to a general market, as opposed to specific contractual accounts.”

Still, he adds that excess inventories can affect retail prices in the transactional market, as well as bring down the amount of metal one might order from the mills. That destocking period is one reason why some mills saw relatively flat demand last year.

Keith Harvey, president and COO of Kaiser Aluminum, says there were some negative effects on his company’s aerospace business due to destocking, but adds that the market looks strong going forward. “The probability of some minor destocking still exists, but for the most part, they righted the demand with changes to single-aisle builds and double-aisle builds. So, we anticipate a fairly good market recovery.”

David Hess, interim CEO at Pittsburgh-based Arconic, expects his company’s aerospace segment to grow revenues by about 2-3 percent in 2017, despite the effects of destocking. “Some of this growth will be partially offset by headwinds we’re seeing because of some of the expected wide-body ramp down and some of the destocking that’s going on in the aerospace supply chain,” he said during a presentation at the Jefferies 2017 Industrials Conference in August.

Despite these issues, there are several reasons why analysts and industry executives believe the aerospace market will bounce back in in 2018.

The main reason analysts are expecting the commercial jet market to gain altitude in coming years is record airline traffic. “Globally, more people than ever seem to want to fly, and those record growth rates are fueling airline profits and orders,” says Aboulafia. “I’ve never seen anything like these numbers. That has me feeling good about this market.”

Additionally, higher fuel costs and relatively low interest rates helped give airlines a major incentive to replace older jets with newer, more fuel-efficient models. This led to large amounts of orders for commercial planes, creating an enormous backlog of more than 10,000 jetliners.

New orders have dipped so far this year, as interest rates and oil prices have begun inching closer together, but Aboulafia isn’t too concerned. “Basically, the best years of our market are closely linked with the biggest years of that bifurcation,” he explains. “It’s still significant enough that people do want to re-equip. There are a few people who have had second thoughts, but for the most part, people are sticking with the enormous number of jetliners that they’ve ordered.”

A third reason for optimism is the impact of emerging markets, particularly China, which is quickly becoming one of the largest jetliner markets in the world. Ever-growing numbers of Chinese tourists and business travelers bode well for the industry, according to Aboulafia, who points out that more traffic means more growth.

“That’s probably the single biggest macroeconomic trend that has transformed this business,” he says. “This is all very welcome news for the airline business.”

So, what does this all mean for the 2018 outlook and beyond? From 2004 to 2015, large jetliner deliveries saw a compound annual growth rate of 9.2 percent, driving the aerospace industry’s unprecedented 12-year supercycle. Aboulafia expects significant growth to return to the industry as soon as next year and continue into the coming decade.

“This doesn’t appear to be stoppable,” he says. “We appear to be taking a break right now because of industrial concerns. But in terms of the economic fundamentals, we’re heading toward a market that will be three times bigger than when this whole thing started.”

Service centers and mills appear to share his optimism. During Reliance Steel & Aluminum’s second-quarter conference call in July, Bill Sales, executive senior vice president of operations, said strong demand is a major reason the Los Angeles-based company has a positive outlook for the aerospace market.

“The backlog of orders for commercial aerospace planes remains healthy, and we expect build rates should continue to improve modestly in the second half of 2017, led by single-aisle planes,” he said. “We are extremely pleased with our strong position in the aerospace market and look forward to increasing our market share as overall demand continues to grow.”

Castle’s Scheinkman shares that outlook, saying his company expects the market to maintain its strength for the foreseeable future. “Projected build rates are strong going forward in the aggregate, but clearly the growth is in single-aisle planes.”
But, he’s also looking to grow Castle’s aerospace business and stave off unfavorable market forces in other ways, such as innovative partnerships with subcontractors and mills. “That’s where we see our growth opportunities, so that we’re not reliant on the vagaries of the market but instead relying on the value that we provide to the supply chain and, ultimately, to the cost of the plane.”

On the mill side, Arconic expects revenues to grow in its aerospace and defense markets, driven primarily by increased deliveries of new engines. “We expect revenue growth in the market segment to accelerate in 2018, as the next-generation engines and narrow bodies continue to ramp up, and we get the effects of the destocking headwinds in back of us,” Hess said.

Kaiser’s president agrees. “If you looked out from now over the next five or 10 years, you might not see the kind of growth we had in the previous 10 years, but we’re still looking at 2-3 percent growth of that business over that period of time,” Harvey says. “It’s still very good, and we expect a stronger year next year than what we experienced this year.”

A return to growth so quickly after the most recent super cycle, which took the aerospace industry from $40 billion when it began to almost $120 billion today, is unheard of, according to Aboulafia.

“They taught me never to say it’s different this time. Well, I think it’s different this time,” he says. “I think enough stuff is aligning together to give us some really solid growth for the next five years at least, and then it’s a very modest and gentle correction after that. I’m not worried about this market at all.”

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Thursday, March 22, 2018