For the commercial aerospace supply chain, now comes the hard part.
Leading aircraft OEMs are issuing aspirational—and debatable—post-pandemic commercial aircraft production rate outlooks, pressuring suppliers to spend money so they can be ready to hike manufacturing. Yet labor forces and factory capacity have been slashed by one-quarter, one-third or more, and price wars may be coming as stored inventory must be cleared.
- Deep pockets, customer diversification and performance results will buoy suppliers
- Consolidation will ramp up, especially in lower-tier levels under stress
New purchase orders and long-term agreements increasingly reflect the trickle-down effects of lower near-term demand and longer-term competition between Airbus and Boeing. Meanwhile, raw material prices are rising, as are prices from forging and casting providers. Above all, companies must manage new mountains of debt accumulated in response to COVID-19, as well as access additional capital needed to prepare for rate increases, business operation digital overhauls and other demands.
Ultimately, according to several industry interviews with Aviation Week and comments made by executives and advisors at industry events and investor briefings, leaders expect a smaller, more streamlined supply chain to emerge as aircraft OEMs struggle to reach, and possibly exceed, pre-pandemic production rates in coming years. “The people with the deeper pockets are going to win the battle at the end of the day,” says Eric Bernardini, managing director of the aerospace practice at AlixPartners.
Financial analysts see stress building in the near term, particularly for suppliers focused more on commercial aviation (see supplier dependence chart). According to a May 20 report from a team of Moody’s Investors Service analysts, many suppliers will generate negative-to-flat free cash flow as earnings remain muted through the first half of 2022. Working capital investments also will eat into the limited cash generated.
That setup is tough on its own. “However, several very low-rated companies have weak liquidity and performance issues that predate the coronavirus,” the Moody’s team said. “Absent material improvements in operating performance or financial support from third parties, these companies may face financial distress and potential restructuring over the next 12 to 18 months.”
To be sure, the Moody’s team says, the supplier base has enough liquidity now after record debt-raising efforts in 2020. A combination of aggressive cost-cutting measures and ongoing financial support from OEMs and Tier 1s also will provide the base with enough liquidity to navigate near-term cash flow pressures.
The top-tier support likely will come via less onerous and quicker payment terms, access to vendor financing and, in specific cases, allowing some suppliers to maintain a build rate higher than the broader supply chain to minimize overhead fixed costs that are weighing down their finances.
“In the fourth quarter, we were holding customers to previously established delivery dates, even maybe when they wanted to slide them out in some cases,” says Astronics Chairman, CEO and President Peter Gundermann. “We had the inventory; we had it built. We had a schedule, which we had agreed to.
“So that’s one of the things that was kind of going on through the whole industry in terms of the whole destocking phase,” he continues. “We took inventory that we would probably have preferred not to, and so did our customers.”
Top-tier customers assert that they have been helpful. “We have a very detailed methodology for rate readiness that we are working on with our suppliers,” says Spirit AeroSystems CEO and President Tom Gentile. “For the most part, infrastructure, capital, that’s all in place. We have to make sure that they didn’t mothball anything during this pandemic period, but those things, for the most part, are in place. The keys are the raw material orders and then also rehiring some of the labor to make sure that that’s in place.
“The other thing we’ve been doing is working closely with the suppliers to provide assistance,” Gentile says. “We’ve reached out [to] and helped, in a variety of ways, almost 600 suppliers with close to $1.9 billion of support; that support includes contract extensions, inventory purchases, vendor financing programs—a variety of different mechanisms to provide support to them.”
Still, suppliers feel pinched. “We are squeezed between two realities: the OEM that wants to push the term of payments [out], and the raw material providers who are at the same time increasing [prices] because they know they are in the monopolistic position,” says Guillaume Gasparri, executive vice president for business development at DCM Group.
“We all got hit pretty hard during the pandemic, at all different levels,” echoes Sylvain Boisvert, general manager at Safran Canada. Severity depended on how diversified you were, what programs were affected and other factors. “We see a recovery coming up in different shape, also,” he says.
A study by consultancy Aero-Dynamic Advisory on the effects of COVID-19 on the North American supply chain found that nearly 50% of those surveyed rated the financial impact as “severe,” including 65% of Canadian companies polled. More than half of all respondents cut their workforces 10-30%. Structures, interiors and casting suppliers expect “huge negative revenue” results this year. Avionics and metals processing suppliers expect less severe outcomes only by comparison.
“It’s still structurally a smaller industry for the time being,” says Aero-Dynamic Senior Associate Mike Stengel.
Fortunately, government stimulus and pre-existing work in progress (WIP) sustained suppliers through the pandemic. “As they went into a cash-conservation mode, they were able to live off of that,” says Aero-Dynamic Managing Director Kevin Michaels. Banks have been lenient, too, for many reasons. In all cases, diversified suppliers serving the defense or nonaerospace customers would be best positioned to weather the pandemic’s effects.
But the industry will see attrition (see transformation timeline). “By all accounts, many, many suppliers are on life support right now,” Michaels adds. The fallout will pick up as suppliers need to spend to meet the restart of purchase orders from OEMs and Tier 1s. Early pandemic estimates that up to 20% of lower-tier suppliers could exit the industry still may be accurate.
“If you’re a Tier 1 supplier, what does it mean? Like OEMs, the Tier 1s are going to purge underperforming and noncore assets,” Michaels says, pointing to Triumph Group exiting aerostructures. In the top tier, avionics and systems suppliers are least vulnerable in this downturn due to their diversification and aftermarket revenue. Aerostructures and interiors suppliers are seeing the most pain.
Among subtiers, Tier 3s will suffer most. “At the Tier 3 [level], that is where we see the biggest attrition is happening,” Michaels says. Tier 4 suppliers, which provide forging, casting and mill products, will feel the downturn as well. But significant attrition is not expected, as they are already big companies that generally are diversified.
Another fragile ecosystem is aeroengines, according to Alex Krutz, managing director at consultancy Patriot Industrial Partners. “The first aerospace supply chain pain point will likely be within the airplane engines segment, which historically already had issues during demand increases and past supercycle ramp-ups,” Krutz says. In 2018, at the peak of demand for the Airbus A320neo narrowbody aircraft, Pratt & Whitney said that about half of its suppliers were not delivering on time for their geared turbofan (GTF) engine.
“These past supply chain challenges are important to know since 80% of the parts for GTF are produced by the supply chain and shipped into Pratt & Whitney for assembly and testing,” Krutz adds. “This supply chain model is similar for other engine-makers like General Electric and Rolls Royce.”
Ironically, new orders are not the panacea that they may appear to be on the surface. That is because even as the destocking trend works itself out—expected through this year broadly—suppliers will be financially squeezed to pay for long-lead items needed next for manufacturing.
“That’s what’s now going to drain whatever you have left in your wallet,” says Torsten Welte, a consultant at Roland Berger. “Before, you didn’t have the new order for a long time, right? If you ordered them, you had a contract already. Now, you stopped, and you have to reorder. And you have to pay that from the piggy bank, basically, and the piggy bank is really low.”
Also, the new orders have yet to truly appear. Airbus and Boeing have garnered headlines and stoked optimism in some corners such as Wall Street with their recent rate outlooks (AW&ST May 31-June 13, p. 28). Those are welcome after the 59% production drop in large commercial aircraft in 2018-20, according to Roland Berger advisors, the largest percentage since the early 1970s U.S. recession and oil crisis. New production may not recover until 2024, with suppliers missing out on the equivalent of about two full years of manufacturing output by then.
Notably, the latest OEM musings are soft, unofficial production guidance—still not the hard, bankable production rate forecasts of the pre-pandemic era. “Will this public communication be enough for suppliers to increase capacity, increase staffing and order raw materials to meet these rates once again? Suppliers for both programs are saying this messaging in public forums is a good sign—but the demand signals in portals are not clear and lead to a much murkier picture,” Patriot’s Krutz says. “Hopefully soon, actual system demand will match the positive public messaging.”
Meanwhile, pricing will remain the bugaboo of the supplier base. “Prices will be very intense,” says Bernardini of AlixPartners.
While the supply chain will ultimately meet OEM expectations as they adjust to reduced demand, managers told Accenture’s aerospace team, as part of their latest Commercial Aerospace Insight Report, that many providers continue to face challenges as some unidentified Tier 1 suppliers ask their respective suppliers for price cuts of 5-20%.
Almost half of Accenture’s surveyed aerospace executives expect raw material costs to remain the same over the next 6-12 months, but more than 60% expect increasing costs across production labor, raw materials and parts over the longer 18-month time horizon. Likewise, 63% expect subsystem and parts costs to remain the same over the next six months, but a majority expect those to increase by mid-2022.
Ironically, a leading cause of concern is having enough skilled workers and factory capacity to meet future demand even as layoffs and footprint consolidation continue. One-third of executives surveyed by Accenture expect their suppliers will not be able to meet expectations and deliver on time over the next six months.
Nonetheless, industry advisors remain adamant that suppliers must act now to prepare for the future, whether it is a quick recovery, as OEM guidance would suggest, or slower.
According to Bernardini, suppliers must: stay financed, get liquidity and horde cash as needed; continue to lean on inventory and WIP as cash-conservation tools; and build scenarios at 3/6/12 months for tactical decisions and at five years for strategic ones, at least at program levels. For the latter decisions, he advised suppliers to: launch long-term digital transformation and manufacturing overhaul initiatives now while production rates are low, revisit make-versus-buy decisions, focus on sustainable lines of business, divest noncore assets, and monitor key suppliers and be ready to respond to distressed ones with backup plans such as insourcing work or dual-sourcing.
Indeed, Boisvert of Safran says suppliers must take a step back while they can and prepare for a future work surge, regardless of the current circumstances. “[They must] invest in their manufacturing. Performance, quality and on-time delivery have never been more important,” he says.
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