Aerospace & Defense Players Face Historic Backlog in Highly Disruptive Environment. Addressing Key Issues – Ranging from Supply Chain to Sustainability – Critical to Accelerating Ramp-up, AlixPartners study says

• Commercial aircraft backlog grows 18% to 15,000 orders, equal to more than 9 years of production
• Air traffic exceeds 2019 levels globally, led by Americas. EMEA and Asia volatile around pre-pandemic level
• Airline capacity, profitability growth expected to continue; economic backdrop is mixed, coupled with ongoing labor and fleet challenges
• Global military expenditures will continue to rise following 6% global increase in 2023, driven by ongoing conflicts 
• Space industry increasingly disrupted; traditional players pressured on cost, schedules as competitive forces escalate
• New sustainability policy initiatives can translate through subsidies or carbon tax avoidance to as much as 13% operating cost savings, ~8% emissions reduction
• EU/US policy updates driving SAF adoption would require $150 billion in annual industry capital investment by 2035 
• Advanced Air Mobility entering critical phase; many players highly leveraged, potentially in need of financial restructuring and liquidity amid certification race
• M&A -- driven in part by sustainability concerns, interest-rate outlook, and AI – will build momentum in space, defense and government services, while uncertainty overshadows commercial aerospace

NEW YORK (July 9, 2024) – Fundamentals in the Aerospace & Defense industry are expected to continue strengthening throughout 2024. However, the sector must urgently address supply chain and quality challenges that are slowing ramp-up plans and threatening the ability of commercial aircraft manufacturers to work through a historic backlog that exceeds 15,000 aircraft, or nine years of production, according to comprehensive analysis published by AlixPartners, the global consulting firm.

The 2024 AlixPartners Aerospace, Defense and Airlines Outlook provides deep analysis of several important influences – ranging from geopolitical conflict, supply chain kinks, and talent shortages to sustainability, quality, and ramp-up concerns – each with critical impact on the complex A&D ecosystem. The study forecasts further post-Covid recovery for many segments. Disruption still abounds, requiring the commitment of significant investment and strategies to accelerate innovation, flexibility and adaptability.

“The A&D industry is experiencing several tailwinds, including robust demand for air travel, increased defense spending, healthy commercial airplane orders, and an insatiable appetite for anything related to space,” said Stefan Ohl, global co-leader of AlixPartners Aerospace & Defense practice. “Four years after the pandemic’s outbreak, however, profit and revenue performances along with outlooks are choppy across various A&D segments; global economies are volatile; deglobalization is accelerating; and the industry is facing a steep, demand-driven ramp-up accompanied by multiple operational and financial hurdles.”

“Challenges include ongoing supply chain disruptions, high interest rates, persistent inflation, and increasing tension around the world,” Ohl said. “Meanwhile, the industry must supercharge its decarbonization efforts or risk missing key sustainability targets that many stakeholders want A&D companies to hit.”

10 Interconnected Forces Disrupt A&D

The industry is facing 10 main disruptive challenges in 2024 that are “deeply interconnected,” the Outlook found. In addition to ramp-up headaches, these challenges include wars in Ukraine and the Middle East; tensions in Asia-Pacific; supply chain disruption; talent shortages; growth in space; a renewed effort to improve quality; increases in private-equity activity; and sustainability.

“The list of disruptive events affecting the industry obviously presents A&D players with substantial opportunity for years to come,” said David Wireman, global co-leader of AlixPartners Aerospace & Defense practice. “If mismanaged, these forces will derail performance and growth.”

 Several disruptive forces have influenced various corners of the global A&D industry, including dealmaking activity, which was relatively subdued last year but poised for momentum in 2024, according to AlixPartners. Sustainability, vital to addressing increasing ESG-related pressure, is slowly emerging as a driver for deals either aimed at acquiring transformative assets or carving out those seen as ESG-dilutive. While private equity firms are now rationalizing ‘higher-for-longer' interest rates, they are struggling to keep pace with strategics.

The firm expects private equity to remain active on the sell side, with operational improvement underpinning most investment theses. Other factors influencing M&A include artificial intelligence and major national elections in the U.S. and Europe. Defense, space and government services are all expected to be dealmaking hotspots. Production uncertainty, questions about the future of the aerostructure segment, and the retirement of aging fleets, meanwhile, will drive commercial aerospace activity.

Sustainability In Focus

The industry’s target of meeting net zero emissions by 2050 is applying pressure to invest in the development of sustainable solutions, the report said. By 2040, the latest generation of aircraft (introduced in 2017 for narrowbody and 2010 for widebody) will represent 61% of the fleet and will begin to be replaced by more efficient aircraft.

“The industry needs to step up its efforts and consider all elements of the air traffic equation,” said Pascal Fabre, EMEA co-leader of AlixPartners Aerospace & Defense practice. “For the industry to deliver on its net zero commitments, fleet renewal, SAF and flight and ground operations improvement will be key pillars but will need to be complemented by measures including demand reduction and carbon-removal.”

Recent policy updates provide opportunities for improvements in operations, both in flight and on the ground, according to the study. These updates are capable of potentially delivering financial benefits through subsidies or carbon tax avoidance, leading to 7 to 13% savings on operating costs and reducing emissions by around 8%.​

Meanwhile, EU and U.S. policy updates, accounting for 50% of world air traffic, could drive adoption of Sustainable Aviation Fuels (SAF). The mandated SAF production ramp-up will require an expected $150 billion per year in capital investment by 2035.

Air Traffic Flies Beyond Pre-Covid Levels

Global air travel demand is back at or above 2019 levels in most parts of the world, reflecting normalized travel behavior and intensifying the spotlight on consumer spending patterns, the study said. While Asia is still lagging in demand and capacity recovery, improvements are expected to continue throughout 2024 and beyond.

Investors are optimistic as global commercial airlines are expected to achieve net profitability in 2024 above 2019 levels​, sustained by still high-ticket prices in a capacity constrained environment. These capacity constraints result from ongoing aircraft delivery issues (especially related to Boeing’s 737 MAX) and GTF engine reliability issues keeping hundreds of aircraft out of service until 2026. New labor agreements signed post-COVID also put significant downward pressure on many airlines’ margins​.

Low-cost carriers tell a mixed story. In Europe and the Middle East, low-cost carriers increased their capacity share beyond pre-pandemic levels. In the U.S., meanwhile, share remains steady. North American and several European low-cost carriers have fallen behind network carriers in terms of profitability and are pressured by cost and proactive competition on fares from network carriers.

Renewed Focus on Defense

Defense funding continues to thrive as global military expenditures reached $2.3 trillion, notching the sixth record year in a row, according to the study. Conflict in Israel, however, places greater stress on the defense industrial base already struggling to meet increased demands from Ukraine. China is increasingly joining Russia as the pacing threat for the West and its allies, making peer-level leaps in advanced military fields of space, hypersonic missiles, and quantum computing technologies.​

While defense sector lead times are improving, they are still not back to pre-Covid levels. “Program management is arguably the top issue facing defense firms,” Ben Brooks, a partner in AlixPartners Aerospace & Defense practice, said. “Delivering on time and on budget has never been more important.”

Brooks also highlighted how scarce talent is in this segment, particularly among production roles such as skilled tradespeople, welders and machinists. Project management and systems engineering talent is also lacking to meet the demands driven by the increased complexity of requirements and weapon systems​.

Challenging Ramp-Up Complicates Commercial Aircraft Story

The Outlook found the commercial aerospace sector is facing its fastest and steepest ramp-up ever at a time when industry debt levels remain high. Refinancing costs are prohibitive, and the trend will continue in 2024 as interest rates remain high. Upcoming maturities pose a problem for many players.

Investment is needed, however. AlixPartners projects additional production capacity is required across all programs, with segments fighting each other for capacity, resulting in a trade-off between new equipment and aftersales for equipment and engine OEMs. 

The ramp-up issues are exacerbated by the lingering impact of workforce shortages that date back to the Covid outbreak, draining competencies and bandwidth across the value chain, the study said. The supply chain is another trouble spot. While materials shortages and inflation are easing, suppliers are financially fragile and still struggling to absorb the high level of working capital needed for ramp-up, labor shortages, and increased interest rates.

Skyrocketing Interest in the Final Frontier

The space industry is accelerating, growing 6.3% in 2023 and now representing a $510 billion market, substantially led by services and highly concentrated in the United States. Space continues to be the hope for the next trillion-dollar industry within A&D.

The study found there are several sources of disruption OEMs must contend with, including vertical integration; new entrants willing to buy share; demand for new Low Earth Orbit (LEO) launchers; massive space funding increases; and the emergence of low-cost reusable launch competition. Ukraine and other factors are leading to enormous funding increases for space programs along with defense programs.

How Long will the MRO ‘Golden Age’ Last? 

Maintenance, repair and overhaul providers are experiencing a continued tailwind as delays and performance issues with next-generation platforms lead to longer-than-expected utilization of mature fleets. Revenues in 2023 generally eclipsed pre-Covid levels, the study found, with equipment MROs driving the outperformance. Engine durability concerns will fuel short-term demand.

MRO growth, registering a more than 30% compound annual growth rate since 2020, is expected to slow to 2.1% in coming years. This takes place at an important time, as more than half of the current in-service fleet will be retired by 2033, according to AlixPartners, prompting a shift from older to new platforms. 

A labor shortage is among the stiffest headwinds facing MROs, AlixPartners said. The talent war and other factors, including a scarcity of parts, leads to MRO demand significantly outstripping supply.

AAM Players Enter Critical Phase

Advanced Air Mobility is a hot topic. Still, this is a segment not without significant challenges. Financial vulnerability is a clear headwind as AAM players enter the critical phase of entry into service, testing both the economic and technological viability of many applications.

Funding, the report found, is among the primary challenges as most AAM players need new financing before entry into service later in the decade. Today, funding is a mix of public, private and corporate investors increasingly impatient as market valuations of many AAM companies are volatile. AlixPartners expects an increase in financial restructurings and a scramble for additional liquidity as they progress in the certification race. 

“The state of A&D is forcing industry stakeholders to plant one foot firmly in the present at a time when planning and investment for the future is as daunting as ever,” Fabre said. “The companies and investors that come out on the winning side of this equation understand the need to approach short-term risks and opportunities with a long-term mindset.”

About AlixPartners

AlixPartners is a results-driven global consulting firm that specializes in helping businesses successfully address their most complex and critical challenges. Our clients include companies, corporate boards, law firms, investment banks, private equity firms, and others. Founded in 1981, AlixPartners is headquartered in New York, and has offices in more than 20 cities around the world. For more information, visit www.alixpartners.com.

 

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