Global Impact of Recession on Aerospace and Defense
                                                                                                   - By Madusudanan Ramani

Recession

The current recession started in the US December 2007. Some of the key trends that are expected during the current recession are:

  • Volatility of crude oil price,

  • Prices of other commodities such as metals are expected to be remain low on account of subdued demand,

  • Interest rates are expected to be low on account of lower demand and lower cost of raw material,

  • Increased role of government in business, and

  • Consolidation activity is expected to take place at lower valuations, with smaller participants selling out.

Crude Oil

The price of crude oil has come down steeply from the levels of $140 a barrel seen in the June-July 2008. It dropped to levels of $40 a barrel by December 2008. The price of crude oil had come down on fears of recession and a consequent drop in demand. It has increased to levels of $65 a barrel in June 2009 on account of increased optimism of recovery and subsequent increase in demand for the crude oil.

Chart 1.1 depicts the price of crude oil during the period 2008-2009






The sharp drop in price of crude oil is expected to reduce the fuel cost of airlines and improve profitability. Fuel as a percentage of expenses is expected to come down from levels of 32.0 percent in 2008 to 25.0 percent in 2009.

Outlook for the sector in 2009

The earnings of the manufacturers such as Boeing, EADS, Embraer and Bombardier might not be affected in a big way because of the huge order book that was accumulated during the boom period. The earnings of the defense firms might be affected due to reduced allocation of funds by the government towards military and defense. The earnings of the passenger carriers flown might come down in 2009. The drop in passengers flown has been steeper than cut in capacity, which remains a huge challenge for the carriers. The airlines have yet to fully reap the benefits of drop in prices of crude oil as they would have hedged the part of the fuel requirement at higher price.

M&As and PE Deals

The value of the top 10 M&As in 2008 was $11.98 billion, down from $20.1 billion in 2007. The size of total M&A deals has fallen from $32.9 billion in 2007 to $14.3 billion in 2008. The top 10 M&As accounted for 96.0 percent of the total deal value in 2008 against 78.0 percent in 2007. The number of deals started falling from 69 in the first quarter of 2008 to 33, 32 and 33 in second, third and fourth quarters of 2008, respectively.

Chart 1.2 depicts the A&D deals, (World), 2007-2008




 


Due to recession, the average size of a PE deal has fallen from $207.8 million in 2007 to $77.5 million in 2008. The PE/VC activity is expected to increase if the valuations slip even further.

The deals outside North America and Europe have been increasing in number. The industry participants are expected to increase their presence in the Asia-Pacific region through M&As. The outbound deals from the Middle East region are expected to be less than the previous years (2006-07), due to less invest-able surplus (Petro-dollars) in the region.

Performance of Various Segments of Industry

Defense The prospects of the global defense industry looks bleak due to recession and the credit crunch. Global defense spending is expected to reduce due to increased allocation to stimulus packages.

Aircraft Manufacturing Due to the credit crunch, the major companies are cutting their capital expenditures. Some of the deliveries are expected to be delayed on account of recession.

Commercial Airlines The airlines are planning to cut capacity in the near future and delaying the procurement of newer aircraft fleets. The lower crude oil price will reduce the overhead of the airlines.

Strategic Recommendations

The recommendations that can be implemented to remain competitive are:

Focus on green trends,
Strategic tie-ups,
Rationalizing the assets base,
Concentrating on fuel efficient aircraft, and
Route optimization.


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