2013 Global aerospace anddefense industry outlookExpect defense to shrinkwhile commercial aerospacesets new records
2ContentsOverview 3What is the global outlook for defense spending in 2013? 4Defense budgets in the U.S. are falling — what will be the directimpact on defense contractors in 2013? 6Will foreign sales improve the fortunes of the global defense industry? 6Commercial aircraft production reached record levels — can this continue? 7Transformation of the air traffic control (ATC) system — is the return oninvestment realistic? 8Will the business jet and general aviation markets finally rebound in 2013? 9Changes in UK and European Union export control regulations —how is that impacting the industry? 10What is expected in the Canadian industry in 2013? 10What is expected for India in 2013? 11Is merger and acquisition activity in 2013 expected to increase? 11What are the preliminary financial performance results for 2012 andwill it get better in 2013? 12In the context of the expectations for 2013, how is the A&Dindustry doing? 13Contacts 14Methodology: Nine months in 2012 top 20 global A&Dcompany performance 15
3OverviewThe global defense segment is expected to see continueddeclines in revenue for the third consecutive year, due todecreased military spending, principally in the United States(U.S.) and Europe. On the other hand, the commercialaircraft segment is expected to reach record levels ofrevenues in 2013, just coming off its best year ever forproduction in 2012. This Deloitte Touche Tohmatsu Limited(DTTL) Global Manufacturing Industry group 2013 outlookfor the global aerospace and defense (A&D) industryprovides observations about the challenges, issues, andopportunities in the sector. Figure 1 shows three keyfinancial performance metrics for the top 20 global A&Dcompanies in the first nine months of 2012 versus 2011.Defense and security — Defense revenues were flatthrough the first nine months of 2012 at the globallevel, but in the U.S., revenues continued to decline atnegative .5 percent year over year. Indeed only 3 out ofthe top 13 defense contractors doing business with theU.S. Department of Defense (DOD) experienced revenuegrowth.1Continued global economic challenges coupledwith revenue gaps and cost pressures in 2013 may result inadditional decreases in revenue, lower returns on investedcapital, as well as margin contraction for many defenseindustry companies, creating pressure to consolidate inorder to squeeze out excess defense segment capacity.In response, the segment is likely to undergo morestreamlining of its cost structure, divestiture of non-coreassets, and additions of gap filling, as well as gamechanging acquisitions. Companies have also renewed1 Deloitte Touche Tohmatsu Limited (DTTL) Global ManufacturingIndustry group analysis from the first nine months of 2012 data forthe U.S. companies and analogous documents for the Europeancompanies, December 2012. Please see Methodology section in thereport for further information on the analysis.Figure 1: Top 20 global A&D companies’ financial performance in the first nine months of 2012 versus 2011Company 2012 Revenue yearover year (YoY)percentage change2012 Operatingprofit YoYpercentage changeOperating margin YoYbasis points (bps) change2012 versus 2011Boeing 20.8% 10.2% -75 bpsEADS 14.0% 82.5% 163 bpsLockheed Martin 2.3% 14.2% 98 bpsGeneral Dynamics -0.4% -4.9% -55 bpsNorthrop Grumman -5.8% -6.9% -14 bpsUnited Technologies* 10.4% -3.3% -177 bpsRaytheon -2.1% 12.8% 164 bpsFinmeccanica -0.6% 203.5% 1004 bpsGE Aviation* 4.2% 1.7% -46 bpsSafran 14.3% NA NAThales 8.0% NA NAL3 Communications -0.3% -5.6% -57 bpsHoneywell Aerospace* 7.0% 15.7% 140 bpsTextron 10.6% 74.7% 265 bpsBombardier Aerospace* -8.3% -15.7% -46 bpsHuntington Ingalls Industries 0.9% 1900.0% 545 bpsHarris -2.3% -59.8% -944 bpsExelis -4.5% 8.7% 125 bpsEmbraer 13.2% 18.5% 40 bpsMitsubishi Heavy Industries Aerospace* -5.8% -760.0% -319 bpsTotal 6.7% 14.0% 54 bps*Partial company results based on A&D activities.Note: The above companies represent the largest A&D companies (based on 2011 annual data) for which quarterly performance financials areavailable during the compilation of this study. NA represents data that is not available.Source: Deloitte Touche Tohmatsu Limited (DTTL) Global Manufacturing Industry group analysis from the first nine months of 2012 data for theU.S. companies and analogous documents for the European companies, December 2012. Please see Methodology section in the report for furtherinformation on the analysis.
4foreign military sales efforts into new geographic marketswhich face increasing threats to national security. Effectiveexecution of such strategies will be necessary in order fordefense contractors to mitigate against more aggressivecompetition.Commercial and business aircraft — Growth incommercial aircraft manufacturer’s revenues is expected toreach record levels in 2013, based on increased productionrates and the introduction of the next generation aircraft.It is likely that 2013 may continue the new trend of globalproduction levels above 1,000 aircraft per year for thethird year in a row (see Figure 4). Backlogs are expectedto continue growing, with airlines continuing to updatetheir fleets with new fuel-efficient aircraft in order tostay competitive. Suppliers to aircraft original equipmentmanufacturers (OEMs) are likely to be challenged to keeppace with production requirements and are expected toinvest in skills development, tooling, and manufacturingcapacity. Finally, for the first time in several years, theindustry may experience an uptick in demand, albeitmodest, in the business aircraft segment as well.2 Outlook — The A&D industry is becoming more globaldue to heightened competition, growing travel demands,and increased security requirements in emerging markets.Globalization provides opportunities for lower cost andfor technologically advanced product introductions.Increasingly, these products can be designed andmanufactured virtually anywhere, anytime, largely due tothe Internet and advancements in digital product definition,design, and manufacturing software. Globalization is alsoaffecting product selections, in that military and commercialcustomers alike are requiring that value be “offset” byplacing work in their countries of origin. This tendency islikely to continue, as traditional countries are pressuredto keep their jobs at home, but is balanced by the needfor companies to grow revenues and continue to reducelabor costs. The trend in the industry towards globalizationis also marked by new market entrants, particularly inthe commercial aircraft segment, some of which receivegovernment financial support that may potentially inviteWorld Trade Organization (WTO) review considerationin future years. For both the defense and commercialsegments, it is expected that more governmentalscrutiny and compliance requirements will be required onacquisition practices in the areas of anti-bribery, anti-moneylaundering, and ethical business practices in order toprovide a greater level-playing field of competition.2 Honeywell Aerospace, Global Business Aviation Forecast, 28October 2012, http://aerospace.honeywell.com/markets/business-aviation/2012/10-October/global-business-aviation-forecast.What is the global outlook for defense spendingin 2013?Global spending with defense contractors is expected todecline in 2013 due to the onset of U.S. defense budgetcuts, continuing the pace set in 2011 with a 3.3 percentdecline, followed by a nominal decline so far in 2012.The declines are mostly made up of defense budgetreductions in the U.S., United Kingdom (UK), and therest of Europe, offset with smaller aggregate increases,principally in China, Russia, India, Saudi Arabia, the UnitedArab Emirates (UAE), and Brazil. The decline may be morepronounced if the U.S. Budget Control Act automatic cuts,referred to as “sequestration,” also comes into effect.3In 2011, global defense spending, inclusive of armedforces personnel, is estimated to be US$1.7 trillion, withthe U.S. maintaining the highest spending level, nearly fivetimes the defense spending of China, followed by Russia,UK, and France.4Figure 2 shows the top defense spendersglobally in 2011. It should be noted that nine countriesspent over US$40 billion for defense in 2011.The nominal amount spent on defense does notnecessarily equate to the importance, requirements, orpriority of defense in terms of affordability. Countries suchas Saudi Arabia for example spend a significant amountof their national budget on defense because they havenational wealth created by their oil industry, securityrequirements based on their location in the Middle East,and historical precedent. Israel spends a significant amountof its national wealth on defense for good reason — theirhomeland has experienced major military conflicts sixtimes since their founding in 1947. China, Russia, India,Brazil, South Korea, and others are increasing their defensespending rapidly due to either their wealth creatingaffordability and/or national security interests.Figure 3 illustrates the affordability and importance ofdefense by comparing military expenditures with grossdomestic product (GDP) for selected countries in 2011.The analysis shows that Saudi Arabia spends the highestpercentage of its GDP on military expenditures at 8.4percent, followed by Israel at 6.8 percent, and thenthe U.S., Russia, and South Korea.5The global averageGDP spent on defense is 2.5 percent — which is a bitoverstated — considering the U.S. raises the averagesignificantly with a large portion of total expenditures.63 CNN Opinion, “Clock ticking to disastrous defense cuts,” 9 August2012, http://www.cnn.com/2012/08/09/opinion/bennett-sequestration-defense-cuts/index.html.4 Stockholm International Peace Research Institute (SIPRI), SIPRIMilitary Expenditure Database, accessed on 8 November 2012,http://www.sipri.org/databases/milex.5 SIPRI Yearbook 2012, Armaments, Disarmament and InternationalSecurity, accessed on 8 November 2012, http://www.sipri.org/yearbook/2012/files/SIPRIYB12Summary.pdf.6 Ibid.
5Figure 2: Global military expenditures by country in 2011 (US$ millions)$16,446$17,871$24,659$26,706$30,799$34,501$35,360$46,745$48,531$48,889$59,327$62,535$62,685$71,853$142,859$711,421$1,727,513IsraelTurkeyCanadaAustraliaSouth KoreaItalyBrazilGermanySaudi ArabiaIndiaJapanFranceUnited KingdomRussiaChinaUnited StatesWorldSource: Stockholm International Peace Research Institute (SIPRI), SIPRI Military Expenditure Database, accessed on 8 November 2012,http://www.sipri.org/databases/milex.Figure 3: Global military expenditures by country as percentage of gross domestic product in 20111.0%1.3%1.4%1.4%1.6%1.9%2.0%2.2%2.3%2.5%2.6%2.6%2.8%3.9%4.7%6.8%8.4%JapanGermanyCanadaBrazilItalyAustraliaChinaFranceTurkeyWorldIndiaUnited KingdomSouth KoreaRussiaUnited StatesIsraelSaudi ArabiaSource: SIPRI Yearbook 2012, Armaments, Disarmament and International Security, accessed on 8 November 2012,http://www.sipri.org/yearbook/2012/files/SIPRIYB12Summary.pdf.
6Defense budgets in the U.S. are falling — whatwill be the direct impact on defense contractors in2013?United States defense budget reductions of US$487 billionover 10 years have been agreed to by U.S. administrationand congressional constituents as part of the BudgetControl Act of 2011.7This equates to an estimatedreduction of US$25 billion of addressable spend fordefense contractors, or an estimated 12 percent of their2012 estimated revenues.8As of press time, the automatic“sequester” budget reduction of an additional US$492billion over nine years starting in January 2013, had yetto be resolved.9If it occurs, taken altogether, that is likelyto imply a reduction in force structure, (e.g., soldiers,sailors, airmen, etc.), as well as a reduction in investmentaccounts (e.g., research and development (R&D), newprogram starts, numbers of units ordered, etc.). Assumingthat sequester cuts will be proportional and that theentire amount is cut, it is estimated that up to another 12percent of defense and government contractor budgetsare likely to be impacted, all else being equal.The impact on the industrial base is likely to be significant,given that essentially one out of four people in the defensecontractor base within the U.S. would be potentiallyimpacted between both tranches of the Budget ControlAct and the possibility of being downsized out of theworkforce, should the additional US$492 billion cut takeeffect.10This could mean that the U.S. defense industrymay not be able to afford to keep certain technologycapabilities alive in the industrial base. It might also meanthat there may not be enough work to support two ormore companies in certain technologies, thus potentiallyreducing competition.U.S. defense contractors in 2013 are likely to be challengedto execute programs of record on schedule and on budget.For those programs experiencing significant delays andcost over-runs, there is potential for scale-back or eventermination. Nunn-McCurdy breaches will likely be treatedmore seriously than in the past, due to the inability toabsorb cost over-runs due to budget limitations.117 Aerospace Industries Association, “The Real Defense BudgetChallenges Lie Ahead,” 26 January 2012.8 Ibid; Deloitte United States (Deloitte Development LLP), TheAerospace and Defense Industry in the U.S. — A financialand economic impact study, 7 March 2012; and DTTL GlobalManufacturing Industry group analysis, December 2012.9 Congressional Budget Office, “Estimated impact of automaticbudget enforcement procedures specified in the Budget ControlAct,” 12 September 2011, http://www.cbo.gov/sites/default/files/cbofiles/attachments/09-12-BudgetControlAct.pdf.10 Ibid.11 U.S. Government Accountability Office, “Trends in Nunn-McCurdyBreaches and Tools to Manage Weapon Systems Acquisition Costs,”29 March 2011, http://www.gao.gov/products/GAO-11-499T.No matter the outcome of the budget sequester action,there is likely to be continued pressure to reduce defenseexpenditures. There is likely to be continued debates onseveral important questions and challenges to U.S. defenseand security policy and investment priorities. These possiblyinclude: how will the U.S. President work with Congressto meet the security requirements in response to a nucleararmed Iran, instability in the South China Seas, continuedthreats from North Korea, the continued violence in theMiddle East, and increased cyber-attacks.These matters are expected to be most important in2013, as it relates to the financial performance of thedefense industry. The formulation of a renewed U.S.defense strategy, coupled with the resulting war fighterrequirements, and ultimately the defense budget, will likelyprovide the guidance necessary for defense contractorsto size their workforce appropriately, to understand whatrevenues they can count on, and therefore what theirfinancial performance will be in 2013 and beyond.Will foreign sales improve the fortunes of the globaldefense industry?As the largest purchaser of defense equipment andservices, the U.S. defense budget associated withcontractor spend is still the largest in the world, accountingfor approximately 50 percent of global procurementspending.12Even though reductions in the U.S. DODbudget are expected to be in the US$24 billion to US$50billion per year range, the budget will still be five to sixtimes the size of its nearest peer country. These budgetreductions are likely to have two main impacts on theglobal market.13First, non-American A&D companies doingbusiness with the U.S. government will likely still continueto do business there, albeit at a lower level of participation,all things being equal. However, a “one size fits all”generalization would not adequately describe the outlookfor these companies in 2013. In particular, there may becutbacks to specific programs that could disproportionatelyaffect certain European companies due to their programconcentration. Additionally, new program down-selectsmay occur in 2013 that could significantly strengthen aforeign contractor’s U.S. presence if they are successful inwinning new projects.12 Census Bureau, Aerospace and Defense Industry Association ofEurope, “Key Facts and Figures 2011,” September 2012; and DTTLGlobal Manufacturing Industry group analysis, December 2012.13 Deloitte United States (Deloitte Development LLP), The Aerospaceand Defense Industry in the U.S. — A financial and economicimpact study, 7 March 2012.
7In response to declining sales to the U.S. government,A&D companies in the U.S., will likely strengthen theirmarketing and competitive positioning in emergingmarkets, particularly in India, Brazil, South Korea, Japan,Saudi Arabia, Taiwan, Singapore and, the UAE. Thesecountries, with their increasing wealth and growingsecurity concerns, are expected to increase their purchasesof sophisticated weapons systems, where U.S. companieshave competitive strengths. European A&D companiesalso will likely increase and intensify competition for theseforeign military sales opportunities.However, declining sales in traditional markets, balancedwith the upside of foreign military sales, will likely result inan overall decline in global defense revenues in 2013.Commercial aircraft production reached recordlevels — can this continue?The commercial aircraft segment is experiencing a virtuallyunprecedented and prolonged up-cycle, as demonstratedby recent increases in production by both Boeing andAirbus. This trend is being driven by growth in passengertravel demand particularly in Asia and the Middle East,as well as the need for more fuel-efficient aircraft. Itis anticipated that 2013 will likely result in increaseddeliveries of the Boeing 787 Dreamliner, and progress ofnew aircraft programs underway globally. Market forecastsof top large commercial aircraft manufacturers describe anexpectation of between 27,350 and 34,000 commercialaircraft to be produced over the next 20 years.14Thedifficulty in keeping commercial airlines profitable, basedon the volatility and mostly long-term increase in fuelcosts, is generating requirements for more fuel-efficientaircraft. This is driving demand for derivative aircraft thatare equipped with next generation engine technology. Thesales order success of the Airbus 320NEO and the Boeing737MAX have demonstrated that industry technologyinnovations can create significant product demand.15Fuel efficient jet-engine propulsion is one of the mostsignificant technological innovations that have come tothe commercial aviation market in the last few years.16Because the price of jet fuel continues to impact the abilityfor global airlines to make a profit, the introduction ofnew jet power plants which lowers fuel consumption isan industry game changer. With a claimed fuel-efficiencysavings in the range of approximately 15 percent, airlines14 Boeing, Current Market Outlook 2012–2031, http://www.boeing.com/commercial/cmo/pdf/Boeing_Current_Market_Outlook_2012.pdf, copyright 2012, accessed on 13 November2012; and EADS, Global Market Forecast 2012–2031, September2012, http://www.airbus.com/company/market/forecast/.15 Ibid.16 Aspire Aviation, “The engine battle heats up,” 10 May 2011.are requesting that commercial aircraft producers developproducts incorporating these advances.17Thus, in thelast few years, new programs such as the Airbus A320NEO, the Boeing 737 MAX, the Bombardier C-Series, theMitsubishi Regional Jet (MRJ), the AVIC ARJ21, the COMACC919, the Irkut MS-21, and more recently the Embraer ERJproduct line, are planning customer deliveries in the nextseveral years that will incorporate these new power plants.As of early-December 2012, engine producers have rackedup 7,252 orders and options for new next-generationregional and single-aisle commercial aircraft power plants,making them among the best-selling products in aircraftproduction history.18Figure 4 illustrates a 30-year history and forecast for largecommercial aircraft orders and production, including aconsensus estimate for 2013. It should be noted that theseven-year moving average for production is expectedto exceed 1,000 aircraft by 2013. This is quite anaccomplishment given that only about 23 years ago, theseven-year moving average for aircraft production wasapproximately 500 aircraft per year (see Figure 4).17 Aviation Week and Space Technology, “Smooth Start For GTF FlightTests,” 22 August 2011; and Aviation Week and Space Technology,“Virgin America Launches CFM Leap On A320NEO,” 15 June 2011.18 Seeking Alpha, “Narrow-body jet engines to mean wide profits,”26 September 2012; and CFM, “New C919 orders push total LEAPorders past 4,300 engines,” 14 November 2012.
8Figure 4: History and forecast for large commercial aircraft orders and production (1981 to 2013E)05001,0001,5002,0002,5003,000Orders Production Seven-year moving average productionYearQuantitySource: The Boeing Company, News release: “Boeing Reports Third-Quarter Results and Raises 2012 Guidance,” accessed on 8 November 2012,http://www.boeing.com/news/releases/2012/q4/121024a_nr.pdf; EADS, ”Guidance 2012,” 8 November 2012, http://www.eads.com/eads/int/en/investor-relations/financials-guidance/guidance/guidance_2012.html; RBC Capital Markets, Analyst report from May 2012 and August2012, accessed on 8 November 2012; Credit Suisse, Analyst report from June 2012 and October 2012, accessed on 8 November 2012; MorganStanley, Analyst report from June 2012 and August 2012, accessed on 8 November 2012; Reuters, “Boeing targets 1,000 civil jet orders in 2012,” 11June 2012, http://uk.reuters.com/article/2012/06/11/uk-boeing-idUKBRE85A0X520120611; MarketWatch, “Airbus backs 2012 sales view of600-650 planes,” 10 June 2012, http://www.marketwatch.com/story/airbus-backs-2012-sales-view-of-600-650-planes-2012-06-10; and DADavision Company, Analyst report from May 2011, accessed on 8 November 2012.Transformation of the air traffic control (ATC)system — is the return on investment realistic?Air transportation system (ATS) transformationinitiatives globally, including the U.S. Federal AviationAdministration’s (FAA) NextGen program, and as well asEurope’s public-private Single European Sky ATM ResearchProgramme (SESAR), are expected to be implemented by2025.19When fully implemented, satellite-based navigationand the related transformational programs are expectedto save an estimated 3 billion gallons of fuel, 4 millionflight hours in delays, and 29 million metric tons of carbonemissions globally each year.20With the expectation ofincreased demand for travel in the next 20 years,21thenew technology associated with satellite positioning,navigation, and timing systems is expected to increase fuelsavings per flight by orders of magnitude, while reducingcongestion and weather-related delays.19 Eurocontrol, “10 projects that changed the face of Europeanaviation,” 8 February 2011.20 Deloitte United States (Deloitte Development LLP), Transforming theGlobal Air Transportation Systems — A Business Case for ProgramAcceleration, 10 May 2011.21 Fox Business, “Airbus lifts demand forecasts on Asian growth,” 19September 2011.It is expected that the net benefit of implementing globaltransformation initiatives could result in significant financialvalue.22Specifically, the projected net present value ofglobal transformation programs through to 2035 isUS$897 billion.23The estimated regional breakdown isas follows24:• U.S. NextGen program, US$281 billion• Europe’s SESAR program, US$266 billion• Rest of world, US$350 billionGlobally, the estimated savings accrued by differentbeneficiaries include:• Passengers, 34 percent• Airlines, 31 percent• Overall economy, 30 percent• Air navigation service providers (ANSP)/airports/ATCorganizations, 5 percent of the total benefits22 Deloitte United States (Deloitte Development LLP), Transforming theGlobal Air Transportation Systems — A Business Case for ProgramAcceleration, 10 May 2011.23 Ibid.24 Ibid.
9There are many challenges and risks to meeting theplanned implementation date for ATS transformationinitiatives. These include, but are not limited to, funding,technology risk, regulatory reform, ATC procedures,technical and certification standards, harmonization,and workforce transformation. Given the highly complextechnology involved and the requirement for safetyand reliability, successful deployment will likely requireadditional effort and possibly a new approach, such asthat being proposed for the U.S. FAA NextGen programpublic-private financing initiative.25There may also besignificant risk that due to U.S. economic fiscal constraints,implementation of the NextGen program will be delayed,making 2025 potentially not achievable. Furthermore, there may be some scaling back of thecapabilities, which would delay the return on investmentfor such programs but could also contribute to risks ofglobal harmonization and interoperability with SESAR.Given the financial condition of the airline industry, it maybe a challenge to require airlines to pay for the necessaryequipage of new technologies on board the aircraft, if thetiming or amount of return on investment is not assured. Plans will need to be developed and implemented toaddress aviation system delays attributable to the surfaceenvironment. ATS transformation and technology platformbenefits are dependent on the successful resolution ofcapacity challenges, including the insufficient numberof runways, gate shortages, and over-scheduling offlights during peak traffic periods. Avoiding the cost ofsystem delays, whether these are occasioned by airbornecongestion or ground-based constraints, is a benefitto be achieved. However, in order to achieve this, thedevelopment and implementation of plans that addresssurface-based delays will be critical. 25 Ibid.Will the business jet and general aviation marketsfinally rebound in 2013?The general aviation segment was expected to reboundslightly from the devastating impact experienced to orders,employment, and revenues that began with the economiccrisis in 2008.26Shipments for all segments of the generalaviation sector experienced continued increases thoughthe first three quarters of 2012.27Total shipments grew 4.2percent, while total billings increased 1.4 percent throughthe first three quarters of 2012.28 Figure 5 shows thechanges in shipments for piston, turboprop, and businessjet segments, as well as total billings for the first ninemonths of 2012, compared to the same period in 2011.29Business jet manufacturers are expressing cautiousoptimism, albeit tepid, for 2013. With several years of adeep recession in general aviation sales, particularly forpiston and turboprop aircraft, there is sentiment that theindustry has reached the bottom and a return to growth isforecast for this segment of the industry. Several reasonsmay explain the challenges the general aviation industryfaces in returning to growth. These include the number ofhigh quality previously-owned general aircraft available inthe market, tighter credit conditions, the smaller numberof younger people obtaining pilots licenses, and finallythe higher cost of fuel. On the bright side, China is in theprocess of liberalizing its air space and expects the generalaviation industry to lead business jet aircraft growth inthe country, due to the increasing number of wealthyindividuals and burgeoning middle class. Sales to theMiddle East also are expected to follow the same patternand will contribute to the slight increase in orders.3026 GAMA, “General Aviation Airplane Shipment Report,” 7 November2011; and Aircraft Owners and Pilots Association, “GAMA: Declinein aircraft deliveries slows," 7 November 2011.27 GAMA website, accessed on 8 November 2012, http://www.gama.aero/media-center/press-releases/content/gama-issues-third-quarter-shipment-report-shows-signs-steadiness.28 Ibid.29 Ibid.30 Avjet Corporation, “Private Business Jets — A Global Perspective,” 1December 2011.Figure 5: First nine months of 2012 shipments of business and general aviation aircraft manufactured worldwide (US$ billions)2012 2011 ChangePistons $597 $577 +3.5%Turboprops $368 $333 +10.5%Business jets $428 $427 +0.2%Total shipments 1,393 1,337 +4.2%Total billings (US$ billions) $12.3 $12.1 +1.4%Source: General Aviation Manufacturers Association (GAMA), “GAMA Issues Third Quarter Shipment Report, Shows Signsof Steadiness Across Segments,” 7 November 2012, http://www.gama.aero/media-center/press-releases/content/gama-issues-third-quarter-shipment-report-shows-signs-steadiness.
10Changes in UK and European Union export controlregulations — how is that impacting the industry?Around the world, several important new initiativesimpacting export control regulations are influencing theglobal A&D industry. Most notable is the implementationof the U.S. and UK Defence Trade Cooperation Treaty(DTCT) which came into effect in April 2012.31This treatyallows the export of certain military items and servicesbetween an “Approved Community” (AC) within the U.S.and UK and without the need for individual export licensesor approvals to:• Facilitate trade• Combine military and counter-terrorism operations• Promote co-operative security• Enhance and streamline R&D, production, andgovernment contract programs and platformsCompanies supporting government programs andbuilding large platforms can benefit from this treaty tostreamline their supply chain and reduce their exportcontrol administrative burden, provided that certainconditions are met. This treaty has the potential toincrease business interoperability in an environmentwhere greater cooperation and subcontracting isperformed through intricate supply chains and throughcomplex military platforms designed and built throughinternational cooperation. Similarly, the U.S. and Australiawill be implementing a Defence Trade Cooperation Treaty(DTCT) with almost identical benefits and requirements.32Additionally, the UK is taking a proactive approach ingrowing its position in the defense segment by draftingdefense trade agreements with Brazil and Turkey andsigning treaties with Japan, France, and Bahrain. Thisstrategy is elevating the UK as a desirable market to baseoperations or distribution sites for global A&D companies.Within the European Union (EU), most Member Stateshave implemented the “Transfer Directive” which requiresEU Member States to: establish a three-tier licensingsystem; set uniform criteria for transfers of controlledmilitary items within the EU; and to simplify the process forintra-community transfers of military items.33By creating amandated, harmonized and simplified licensing program,31 UK Ministry of Defence, U.S.-UK Defence Trade Co-Operation Treaty,March 2012, http://www.bis.gov.uk/assets/BISCore/eco/docs/mod-docs/12-678-us-uk-defence-trade-cooperation-treaty-uk-mod-procedures.pdf.32 U.S. Department of State, The U.S.-Australia Defense TradeCooperation Treaty, 14 November 2012, http://www.state.gov/r/pa/prs/ps/2012/11/200520.htm.33 Official Journal of the European Union, “Directive 2009/43/EC of theEuropean Parliament and the Council,” 6 May 2009, http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:146:0001:0036:en:PDF.the EU-wide policy allows the efficient movement ofmilitary-controlled items within the EU, enabling suppliersand OEMs to transfer military items throughout the EU forR&D, production, repair, maintenance, and other purposeswith remarkably less administrative burden.As defense budgets are reduced and supply chainsbecome more complex, updated regulations in exportcontrols can significantly improve the speed of exports tohonor contracts and other trade requirements, as well asopen markets to increase trade through less bureaucraticprocesses saving time and money.What is expected in the Canadian industry in 2013?With revenues of CAD$22.4 billion in 2011, up 6.7percent from CAD$21 billion in 2010, and with 87,000people working in the industry, up 7.4 percent from81,000 in 2010,34the Canadian A&D industry showsstrong performance leading into 2013. The increasingdemand for civil aircraft, which represents more than 76percent35of the Canadian A&D industry, represents themain driver for growth in the segment in 2013. Given itsrelatively low dependence on the defense segment, theCanadian A&D industry is not impacted as much from thedefense downturn in the U.S. and in Europe. Furthermore,Canadian defense will likely soon begin to see the benefitsof the National Shipbuilding Procurement Strategy whichawarded contracts to two Canadian shipyards that willhave an estimated aggregate value of CAD$35 billion overthe next 20 years.36The contract decisions are tied withthe Industrial Regional Benefits (IRB) requirements whichare expected to enable the Government of Canada toleverage major investments in A&D programs to encouragelong-term industrial development.37For the civil aircraft segment, the supplier base will likelycontinue to experience pressure from the OEMs to providemore integrated products. This new reality of the supplychain may also accelerate the consolidation in the supplierbase, which has been anticipated over the last few years.34 Aerospace Industries Association of Canada (AIAC), The State ofthe Canadian Aerospace Industry — Performance 2011, July 2012,http://aiac.ca/uploadedFiles/Canadas_Aerospace_Industry/Industry_Statistics/2011%20Statistics%20%20State%20of%20the%20Canadian%20Aerospace%20Industry.pdf.35 Ibid.36 Government of Canada, Canada News Centre, “Results ofthe National Shipbuilding Procurement Strategy,” 19 October2011, http://news.gc.ca/web/article-eng.do?mthd=tp&crtr.page=1&nid=629989.37 Ibid.
11The emergence of new OEMs in China, Japan, and Russiato the global A&D industry will generate opportunities forthe Canadian supplier base. The Canadian A&D industryalready exports 73 percent of its products (60 percentin the U.S. and 24 percent in Europe).38These newOEMs will provide future opportunities for the CanadianA&D industry to increase its exports, while requiring theCanadian supplier base to adapt to changes in the globalsupply chain.What is expected for India in 2013?Due to the increasing demand in A&D equipment for thearmed forces, India continues to be one of the promisingA&D markets in the world. Milestones in certain deals areexpected to be achieved in 2013, such as submarines,missiles, and, the Indian Air Force Medium Multi-RoleCombat Aircraft (MMRCA).39More overseas companies willbe involved in the Indian market and new joint venturesare likely to be signed between Indian private and overseascompanies.India offers not only an attractive market, but also givescost advantages relating to basic design and engineeringservices, components, and assemblies manufacturing.This advantage could lead to the integration of overseassuppliers that directly supply equipment to the Indiangovernment with the local manufacturing sector.The Indian government will continue to focus onindigenization with increasing presence of Indiancompanies that could expect certain fiscal and economicbenefits from the government. Indian companies will likelysucceed with the help of foreign companies which createsa benefit for both. Once indigenous manufacturing takesroot, R&D for the indigenous military industry and civilaircraft is likely to be the other focus area of the Indiangovernment.Offset contracts of aggregate value of more than US$4.5to US$5 billion (INR 25,000 crore) have been signed byIndian companies with foreign companies since the offsetpolicy came into effect in 2005.40Over 80 percent of theseare contributed towards procurement by the Indian Air38 Ibid.39 Indian Military News, “India to spend $74.5 billion on weaponsduring 2012-13,” 18 August 2012, http://indianmilitarynews.wordpress.com/2012/08/18/india-to-spend-74-5-billion-on-weapons-during-2012-13/; and The Hindu, “We have greatpotential to export missiles to friendly nations: Saraswat,” 29 April2012, http://www.thehindu.com/news/states/andhra-pradesh/article3365043.ece.40 Business Standard, “Defence offsets cross Rs 25,000 cr biggercontracts loom,” 14 August 2012, http://www.business-standard.com/india/news/defence-offsets-cross-rs-25000-cr-bigger-contracts-loom/483241/; and SP Aviation, Issue 9 of 2012 onoffset at page numbers 7 and 8.Force and the balance by the Indian Navy. The Indian Armyexpects to execute offset contracts in 2013 or in 2014.41With the new offset guidelines of 2012 and theassumption of a formal civil offset policy, the total offsetopportunity for the commercial segment is to be valued atUS$10 to 15 billion.42Foreign direct investment of 26 percent in the defensesector is expected to remain at the same level in 2013,although there have been suggestions to increase this to atleast 49 percent, and then ultimately to 74 percent or 100percent.43This matter is likely to continue to be debatedin 2013.Is merger and acquisition activity in 2013 expectedto increase?Anticipated reductions in defense budgets will drive theneed for a more efficient cost structure in the defensesegment, while capacity demands in commercial aircraftcontinue to fuel efforts to increase market penetrationat key customers. As such, it is expected merger andacquisition (M&A) activity throughout the A&D sectorwill likely increase in 2013. This is likely to be driven bya variety of factors, including the ongoing recalibrationof markets after the recent global economic crisis onboth corporations and private equity firms. Specifically,investable cash, as well as borrowing capacity will likelylead many companies to pursue M&A activity as a vehiclefor growth and a means of accessing new markets.Many A&D companies have used their cash over the lastseveral years to pay down debt, buy back stock, increasedividends, and to make elective contributions to pensionplans. At the beginning of 2012, global A&D companieshad an estimated US$47.1 billion in free cash flow, andsome used this asset to participate in the M&A market.44M&A deal value in the A&D industry in 2012 wasapproximately twice the level from the previous year,driven in large part by the US$16 billion GoodrichCorporation acquisition by United TechnologiesCorporation.45Additionally, the vast level of capital raised41 Deloitte India analysis, December 2012.42 Confederation of Indian Industries, “Aerospace,” accessed on 8December 2012, http://www.cii.in/Sectors.aspx?enc=prvePUj2bdMtgTmvPwvisYH+5EnGjyGXO9hLECvTuNtzD8aRMyMwXwIukeRiZBns.43 Discussion paper on foreign direct investment on defense sectorreleased by The Department of Industrial Policy and Promotion,Ministry of Commerce in May 2010 for public comments.44 DTTL Global Manufacturing Industry group, 2011 Global A&DIndustry performance wrap-up, 9 July 2012,http://www.deloitte.com/view/en_GX/global/industries/manufacturing/9dd2bc0ad0e58310Vgn VCM2000001b56f00aRCRD.htm.45 DTTL Global Manufacturing Industry group analysis, December2012; and data from Capital IQ accessed on 8 November 2012.
12by private-equity firms in previous years should serve asa driver to deploying those funds in 2013 and beyond.Private equity investors are likely to compete for many ofthe same assets as strategic buyers and in some cases maypay higher values. During 2012, multiple deals, large andsmall were announced and similar or higher levels of M&Aactivity are expected for 2013.It is expected that activity will remain high within thecommercial aircraft supplier market, given the anticipatedoverall increases to production levels and new programramp-ups. Buyers will likely continue to use M&A to positionthemselves on these growing commercial programs, as wellas increasing scale and integration capabilities to becomemore relevant to the customer. Within the defense world,the challenges of the defense industry decline will likelylead to reductions in many defense programs as mentionedabove, as the governments look for ways to reduce budgetdeficits. This will likely have a negative impact on overalldefense industry attractiveness of certain assets. At thesame time, expect ever increasing budget support for, andtherefore M&A interest, in those areas which support “newrealities” technologies, such as next generation intelligence,surveillance, reconnaissance, precision strike, cyber-security,energy security, data fusion, mission software development,and unmanned and autonomous controlled vehicles. Alsoexpect there to be a pickup in equipment maintenance,repair and overhaul activity.Figure 7: Top 20 A&D companies by commercial aerospace versus defense revenue, operating earnings, andoperating margin (US$ billion) Commercial aerospace Defense Ninemonths2012Ninemonths2011Change(2012 versus2011)Ninemonths2012Ninemonths2011Change(2012 versus2011)Revenue $152.8 $134.6 13.6% $171.6 $171.7 0.0%Operating earnings $12.6 $10.2 23.5% $16.6 $15.3 8.2%Operating marginpercentage8.2% 7.6% 8.8% 9.6% 8.9% 8.2%Source: DTTL Global Manufacturing Industry group analysis from the first nine months of 2012 data for the U.S. companies and analogousdocuments for the European companies, December 2012. Please see Methodology section in the report for further information on the analysis.What are the preliminary financial performanceresults for 2012 and will it get better in 2013?Through the first three quarters of 2012, the globaldefense industry appears to have slowed the patternof decline, which started in 2011, with only a negative.05 percent global decline in defense segment revenuesas development programs have begun low rate initialproduction deliveries, and as increased foreign militarysales helped offset lower defense sales volume in theU.S. and Europe.46However, on a more positive note, theoverall global sector revenues grew 6.7 percent to US$332billion, entirely due to continued revenue growth in thecommercial aircraft segment, which grew 13.6 percent,more than making up for a flat defense segment.47Figure 6: Average performance of the top 20 global A&Dcompanies during nine months in 2012 compared to ninemonths in 2011 (US$ billion)Metrics Ninemonths2012Ninemonths2011ChangeRevenue $332.0 $311.2 6.7%Operating earnings $28.1 $24.7 14.0%Operating marginpercentage8.5% 7.9% 6.8%Source: DTTL Global Manufacturing Industry group analysis from thefirst nine months of 2012 data for the U.S. companies and analogousdocuments for the European companies, December 2012. Pleasesee Methodology section in the report for further information on theanalysis.46 DTTL Global Manufacturing Industry group analysis from the firstnine months of 2012 data for the U.S. companies and analogousdocuments for the European companies, December 2012.47 Ibid.
13Commercial versus defense and U.S. versus Europefinancial performance: In reviewing the top 20 globalA&D companies, it was estimated that the commercialaerospace segment grew revenues 13.6 percent, while thedefense segment revenues were flat (see Figure 7).48Inaddition, it was estimated that the commercial aerospacesegment operating earnings jumped 23.5 percent, whiledefense segment operating earnings grew 8.2 percent.49It is expected that 2013 will mirror the results as of thirdquarter in 2012,50with declining revenues in the defensesegment offset with increased revenues in the commercialaircraft segment, resulting in overall low growth for theentire global sector. Suppliers exposed to the commercialaircraft segment (e.g. complex aero-structures, electronics,systems, propulsion, and navigation) will likely improvetheir financial performance due to higher deliveryvolume. Lower tier suppliers supporting major defenseprograms will likely see declines in revenues and financialperformance due to reduction in unit deliveries, delay inproject awards, loss of highly competitive down selects,or program cancellations. As the pace and reality oflower defense spending takes hold, it may become moreapparent that the global defense industry has excesscapacity, which in turn may create opportunities forindustry consolidation. It is anticipated that much of theindustry consolidation will occur at the supplier level,although it is expected that unique circumstances mayresult in a large OEM merger or combination in Europeor North America. With high-cash generation for thelast decade, many A&D companies are positioned foracquisitions with stronger cash positions and a record lowinterest rate environment.48 Ibid.49 Ibid.50 Deloitte Development LLC, Mid-year 2012 top 20 global aerospaceand defense company financial performance analysis, 2 October2012; and DTTL Global Manufacturing Industry group analysis,December 2012.In the context of the expectations for 2013, how isthe A&D industry doing?Although it has only been 109 years since the WrightBrothers first flight, the industry has contributedfundamentally to the way consumers live, work, travel,and communicate with the technologies created,and continued innovations developed in jet aircraft,communications satellites, the Internet, and globalpositioning systems, for example. Also, the industry isprimarily responsible for the reduction of casualties inarmed conflict due to the technology innovations thatincreasingly keep war fighters out of harm’s way withunmanned aerial vehicles, sophisticated surveillancesensors, and over the horizon strike capability. Thisindustry has created the technology innovations thathave contributed to the very fabric of society — from theability to communicate globally around the clock from ourpersonal digital assistants, to safe and efficient air travel, tosecuring our borders, and defending our way of life.If past is a prologue, expect game changing technologyinnovations to continue to be created within the globalA&D industry into the future. In the defense segment,some of the science and technology being developedinclude directed energy and high powered microwaveweapons, hyper-sonic missiles, long-range, and high-altitude unmanned aerial systems, satellite-based highresolution full motion video cameras, and extraordinarysoftware that can trace financial transactions of knownterrorists. For commercial applications, interestingtechnologies are being experimented with that can harvestsolar power from space-based solar arrays, converted tomicrowaves, or high voltage wireless signals, to ground,air, and sea-based distribution networks. The prospects ofefficient supersonic commercial aircraft that can addressthe sonic boom and environmental challenges of thepast are highly anticipated. These kinds of innovativetechnologies will change our society in immeasurableways. Just like during the first century, the industry haschanged the way humans interact on a global basis. This isindeed something to look forward to in the near-term, aswell as in the future.
14ContactsTom CaptainGlobal A&D Sector LeaderDeloitte Touche Tohmatsu Limited (DTTL)+1 206 716 firstname.lastname@example.orgPauline BiddlePartnerDeloitte UK+44 118 322 email@example.comGianluca Di CiccoPartnerDeloitte Italyfirstname.lastname@example.orgGilbert FayolPartnerDeloitte France+33 1 55 61 66 email@example.comNidhi GoyalDirectorDeloitte India+91 124 679 firstname.lastname@example.orgDan HaynesPrincipaland U.S. Consulting A&D leaderDeloitte Consulting LLP in the U.S.+1 404 631 email@example.comMichael HessenbruchPartnerDeloitte Germany+49 711 16554 firstname.lastname@example.orgJohn HungPartnerDeloitte China+86 21 email@example.comEllen MacNeilPartnerDeloitte Tax LLP in the U.S.+1 202 378 firstname.lastname@example.orgKevin McFarlaneManaging DirectorDeloitte Corporate Finance LLC in the U.S.+1 213 553 email@example.comFrank MilanoPartnerDeloitte & Touche LLP in the U.S.+1 860 725 firstname.lastname@example.orgKoji MiwaPartnerDeloitte Japan+81 80 4359 email@example.comJose Othon Tavares de AlmeidaPartnerDeloitte Brazil+55 11 51 86 firstname.lastname@example.orgMartin VezinaPartnerDeloitte Canada+1 514 393 email@example.comGeneral (USAF retired) Charles WaldDirector and Senior AdvisorDeloitte Services LP in the U.S.+1 571 882 firstname.lastname@example.org
15Methodology: Nine months in 2012 top 20 globalA&D company performanceThis analysis is based on key metrics for top 20 global A&Dpublic companies chosen on the basis of A&D revenue size(based on 2011 annual data). The report uses the latestaudited and unaudited results through 30 September2012 for each company. Goodrich and SAIC were notincluded in the top 20 as United Technologies completedthe acquisition of Goodrich in July 2012 and SAIC’s fiscalyear ends in January and the third quarter 2012 releaseoccurred following our 30 September 2012 cut-off date.By using the data from respective companies’ auditedand unaudited results into the calculation framework,DTTL’s Global Manufacturing Industry group analyzed theindustry’s performance during the nine months of 2012.The analysis of U.S. compared to non-U.S. companies usesthe constant conversion approach to eliminate the effectof any foreign currency fluctuations from year to year.In the commercial versus defense segment analysis, theanalysis compares and contrasts the performance of thetop 20 global A&D companies on the metrics of revenue,operating earnings, and operating margins. The aggregaterevenue of the top 20 companies from commercial A&Dis not equal to the total revenue as total revenue includesa certain portion of non-A&D revenue of companies’ thatare majority A&D. The commercial/defense split of all thetop 20 companies was only available for a select groupof companies on a quarterly basis. Companies disclosingthe commercial/defense split or disclosing its business asone or the other, are: Boeing, EADS, Raytheon, Thales,Honeywell Aerospace, Bombardier Aerospace, Textron,and Huntington Ingalls Industries. For the remainingcompanies, the study used the commercial and defensepercentage of revenue published in the company’s 10-K orannual report. Additionally, only a few companies provideda breakout of commercial and defense operating earningsas one or the other (Boeing, EADS, Thales, BombardierAerospace, and Huntington Ingalls Industries); for theremaining companies, the study used the commercialand A&D percentage of revenue as a proxy to estimatethe respective operating earnings. A few companies donot give a detailed break up of their commercial A&Drevenues. The following approach was used for thesecompanies:• Harris: Segment revenue is separated into U.S.government revenues and foreign military sales (FMS).For lack of information, all U.S. government revenuesare assumed to be defense related. The remainingsales of the RF Communications and GovernmentCommunications Systems segments are taken ascommercial aerospace revenues, while the remainingrevenues for the Integrated Network Solutions segmentare not considered as commercial aircraft, given its otherend markets (e.g. healthcare, energy).
16• Northrop Grumman: The company reports its revenuebetween the U.S. government and other customers.Since there is no detailed disaggregation of U.S.government revenues, the study assumes it as alldefense-related sales.• Raytheon: Company filings separates U.S. governmentrevenues (from DOD and from non-DOD customers);however there is no detailed reporting of internationalsales between commercial A&D. This study assumes thatall international sales including FMS are defense relatedsales.• Exelis: For lack of information, the study assumes allinternational sales to be defense related.Further, as Safran and Finmeccanica do not publicly reportthe mix of commercial and defense sales, the study hastaken the following approach:• Safran: Defense News51states in its annual ranking ofTop 100 defense contractors in 2011 (latest available)that Safran has 20 percent defense revenues in 2011.The study assumes the remaining company revenues arerelated to commercial aerospace.• Finmeccanica: Defense News52states in its annualranking of Top 100 defense contractors in 2011 thatFinmeccanica has 60.5 percent defense revenues in2011. The remaining company revenues are adjusted fornon A&D businesses (e.g., Energy, Transportation, andother activities) to arrive at commercial aircraft revenues.A&D revenue• To calculate A&D revenue for an individual company, itwas necessary to determine the percentage of revenueassociated with A&D activities. In calculating suchpercentage, a check was made to see whether thecompany explicitly stated an A&D revenue figure in itsnine month 2012 filings. In such a case, the explicitlystated percentage was directly used. If such percentagewas not explicitly stated, the company’s various businesssegments or end markets were analyzed and consideredthose which are related to A&D in estimating the A&Drevenue percentage. In the case of United Technologies,since the A&D revenue percentage is not explicitly statedby the company in its third quarter 2012 release, the2011 revenue percentage in the Form 10-K was used toarrive at its A&D revenues.51 Defense News, Top 100 for 2011, accessed on 8 November 2012,http://special.defensenews.com/top-100/charts/rank_2011.php.52 Ibid.• Once assigned A&D percentages to all of the companies,companies were put into two categories: thosecompanies with less than 60 percent of their respectiverevenue from A&D and those companies with equal toor more than 60 percent of their respective revenue fromA&D. If a company derives less than 60 percent of itsrevenue from A&D, only the revenue generated by theA&D part was taken. However, if the company derivesequal to or more than 60 percent of its revenue fromA&D, total revenue for company was used.• In determining industry A&D revenue, a summation ofthe A&D revenue of all constituent 20 companies wascalculated.Operating earnings and margin percentage:• In calculating A&D operating earnings, a two-prongedapproach (same as above) was adopted, which statesthat if a company derives less than 60 percent of itsrevenue from A&D, only the operating earnings clearlyassociated with the A&D part was applied. However, ifthe company derives equal to or more than 60 percentof its revenue from A&D, the total operating earnings forthe company was used.• Two companies: Thales and Safran do not reportoperating earnings on a quarterly basis, so their earningscould not be included in the study.• The companies’ A&D operating margins were calculatedby dividing their respective A&D operating earnings bytheir respective A&D revenues.• Operating earnings for the industry is the summation ofoperating earnings of all constituent 20 companies.• Operating margin for the industry was calculated as:total industry operating earnings as a percentage of totalIndustry revenue.