Commercial & Defense Industry Update
Oklahoma Aerospace Summit & Expo
Tulsa Convention Center, Tulsa, OK
6-8 June 2011
Presented by
Hal Chrisman, Principal
AeroStrategy LLC
Photo: US Air Force
Agenda
Defense Market Outlook
Commercial Market Outlook
Aftermarket Implications
© 2011 AeroStrategy
OAA Aerospace Summit 2011
2
Defense
Market
Outlook
US And Western Europe Face Massive Structural
Deficits That Must Be Addressed …
Fiscal Summary For USA And Select Western European Countries
2011
Defense
Budget (B
US$)
Defense
as % of
GDP
2011
Deficit
2011
National
Debt
Nat’l Debt
as % of
GDP
USA
$698 B
4.7%
$1.5 T
$14.3 T
91%
UK
$60 B
2.7%
£131 B
£1.1 T
77%
France
$59 B
2.3%
€ 102 B
87%
Germany
$45 B
1.4%
€ 60 B
€ 1.7 T
€2T
Italy
$37 B
1.8%
€ 69 B
€ 1.9 T
120%
Spain
$16 B
1.1%
€ 67 B
€ 693 B
64%
Greece
$9 B
3%
€ 17 B
€ 320 B
142%
Country
© 2011 AeroStrategy
OAA Aerospace Summit 2011
80%
Source: IMF World Economic Outlook April 2011
SIPRI Military Expenditures Database
3
Defense
Market
Outlook
… Some European Union Countries Are Changing Military
Spending Plans As A Result Of Budget Pressures …
Germany
France
Spain
Cuts up to $9B
through 2016
At least $3B cut
over next 5 years
Cut 5% since 2009
Greece
Planned cuts of 10%
Eurofighter
A400M
•Cost overruns,
•Reduced orders
•Cancelled orders?
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: AeroStrategy analysis
4
Defense
Market
Outlook
… While The US Has Been Slowly Coming To Terms
With The Current Fiscal Situation …
2001-2010 US Defense Budget And
Annual Budget Deficit
Robert Gates
Secretary Of Defense
“Given the fiscal challenges facing the nation, the
Department of Defense must make every dollar
count. But as I’ve stressed before, this effort is ...
about getting more bang for the buck by shifting
resources”
“The reductions would likely fall most heavily on
our operations and maintenance accounts. Cuts
in maintenance could force parts of our aircraft
fleet to be grounded… Cuts in operations would
mean fewer flying hours…all of which directly
impacts readiness.”
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: IMF World Economic Outlook April 2011
SIPRI Military Expenditures Database
5
Defense
Market
Outlook
… But Recent Rhetoric Suggests That This Will Change
Quickly
FY 2010 & 2011 Defense Base And OCO Budget Comparison
FY 2010
FY 2011
Change
Percent
Milpers
$152,997
$151,842
($1,155)
-0.8%
O&M
$291,763
$294,428
$2,665
0.9%
Procurement
$135,889
$134,164
($1,725)
-1.3%
RDT&E
$80,655
$80,905
$250
0.3%
Mil Const
$23,379
$17,319
($6,060)
-35.0%
$2,425
$3,108
$683
22.0%
$4,683
$4,568
($115)
-2.5%
$691,971
$686,317
($5,457)
-0.8%
Family
Housing
Resolving
Funds
TOTAL
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: DoD FY 2012 Budget Request
6
Defense
Market
Outlook
The History Of The F-22 Sheds Some Light On The
Future Of New Weapons Systems
Current Programs At Risk?
Aircraft
Initial Production
1,368 Aircraft
Font too way
small
JSF
V-22
2,456 (p)
430 (p) / 135 (b)
1,600
Major Aircraft Review
1,196 Aircraft
Navy version terminated in
1992
1,400
Programs Probably Safe
1,200
F/A-18E/F
C-130J
P-8
515 (p) / 454 (b)
307 (p) / 120 (b)
117 (p)
1,000
800
Successive Program
Reductions thru FY2007
600
Programs Definitely Safe
400
Final F-22 (187)
EA-18
UH-60M
MH-60R/S
114 (p) / 28 (b)
1,221 (p) /270 (b)
572 (p) / 238 (b)
200
0
1980
1991
1994
1997
© 2011 AeroStrategy
2001
2007
2011
OAA Aerospace Summit 2011
Source: Teal Group
7
Defense
Market
Outlook
As The Economic Growth Shifts, The Relative Size Of
Domestic Defense Budgets Will Shift As Well …
2010 – 2020 GDP Versus Military Expenditures
19%
Asia &
China
26%
Asia &
China
36%
© 2011 AeroStrategy
OAA Aerospace Summit 2011
?
Source: CIA World Factbook
Economist Intellgence Unit
8
Defense
Market
Outlook
… While The Rise Of China Will Change The
Geopolitical Environment …
• China’s defense capabilities are growing in parallel with
its torrid economic growth
−
−
−
−
South
China
Sea
China’s Share Of Global GDP*
• In addition, China is expanding its use of foreign aid,
diplomacy, and alliances throughout Asia, Africa and
Latin America to support its national interests…including
access to raw materials, shipping lanes, and oil
• China’s rise, in turn, is creating angst throughout Asia
and beyond from potential rivals
−
−
−
−
−
−
−
© 2011 AeroStrategy
Defense budget growing 8-10% per annum
Expanding deep-water navy
Large investments in asymmetric warfare capability
Unexpected unveiling of J-20 Stealth Fighter program in 2010
USA
Japan
India
South Korea
Vietnam
Russia
Australia
OAA Aerospace Summit 2011
China’s J-20 Steath Fighter
Source: IMF, Global Security ;
Note: GDP data in purchasing power parity
9
Defense
Market
Outlook
…And That Will Drive Defense Budgets In Asia Pacific
2010 Estimated GDP, Asia Pacific
Countries
© 2011 AeroStrategy
Country
GDP
Growth
(20112015)
Key Programs
Japan
3.0%
Fighter Replacement
P-1 Maritime Patrol
India
10.4%
Fighter Competition
Attack/Utility Helicopter
Multiple Other Programs
Australia
1.2%
F-35 JSF
S. Korea
6.1%
Utility Helo (KUH)
Figher Replacement (JSF)
Taiwan
10.8%
Attack Helo (AH-64)
Utility Helo (UH-60)
OAA Aerospace Summit 2011
Source: CIA World Facebook
AeroStrategy analysis
10
An Outbreak Of Democracy Could Slow Growing Military
Budgets In the Middle East
2011 Middle East Defense Budgets And Percentage Of GDP
Global Average =
3.6% of GDP
Saudi Arabia
Defense
Market
Outlook
© 2011 AeroStrategy
Countries With
Political Instability
OAA Aerospace Summit 2011
Source: CIA World Facebook
AeroStrategy analysis
11
Defense
Market
Outlook
Threats Faced Today Are Different Than 20 Years Ago,
Dictating A Change In The Nature Of Warfare …
Conventional Warfare
ISR
© 2011 AeroStrategy
Irregular Warfare
Parapublic
OAA Aerospace Summit 2011
Expeditionary /
Urban Warfare
12
Defense
Market
Outlook
Technological Innovations Such As The UAV Have
Driven Growth In Battlefield Intelligence
Airborne ISR Full Motion Video Collection (Flight Hours)
Source: US DoD Briefing
© 2011 AeroStrategy
OAA Aerospace Summit 2011
13
Defense
Market
Outlook
Para-Public Missions Have Grown And Driven The
Demand For More Vertical Lift Capability
Examples Of Parapublic Missions
Drug Interdiction
Humanitarian
Border Patrol
Plan Colombia: $1B
international aid program
includes the acquisition and
support for approx. 100
helicopters
US Civil and Military Forces
have participated in over 30
humanitarian missions since
2001, most requiring significant
vertical lift
US Borders And Customs
Patrol has added 50 helicopters
in the past decade (total force
on 70) and expected to add 55
more in the next 5 years
Source: AeroStrategy analysis
© 2011 AeroStrategy
OAA Aerospace Summit 2011
14
Defense
Market
Outlook
Expeditionary Battlefield Requirements Are Driving
Demand For Vertical Lift, ISR, And Transport Aircraft
The Impact Of Expeditionary Warfare Of Aviation Needs
Mission
Expeditionary Warfare:
Robust Intel And
Communications (C4ISR)
Technological
Interoperability
Impact
Fighters
Helicopters
Tactical
Transport
Flexible and Swift Logistics
Adaptive Force Packaging
Strategic
Transport
ISR
UAV
Source: AeroStrategy analysis
© 2011 AeroStrategy
OAA Aerospace Summit 2011
15
Over The Next Decade, Fixed Wing Aircraft Production
Will Be Replaced In Part By UAV Production …
Defense
Market
Outlook
Units
Worldwide Military Fixed Wing Aircraft Production (2011-2020)
Mission, CAGR
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: OAG Aviation
16
… While Helicopter Production Is Expected To Remain
Relatively Flat
Defense
Market
Outlook
Units
Worldwide Military Rotary Wing Aircraft Production (2011-2020)
Helicopter OEM
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: OAG Aviation
17
Agenda
Defense Market Outlook
Commercial Market Outlook
Aftermarket Implications
© 2011 AeroStrategy
OAA Aerospace Summit 2011
18
Commercial
Market
Outlook
Air Transport Production Rates Are Driven By The
Complex Interrelations Of Several Factors
Air Transport Production Demand Drivers
Aircraft operating
factors
(utilization, speed, size, load factors)
Economic
Growth
Air Travel
Demand
Aircraft
Demand
For Growth
Required
Aircraft
Air Travel
Value
Proposition
Temporary
Storage
Total
Aircraft
Demand
Current
Fleet
Retired/
Scrapped
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Aircraft
Demand For
Replacement
Source: AeroStrategy
19
Commercial
Market
Outlook
Oil Prices Are Approaching The High Levels Of The
2008 Price Spike…
Annual Average Fuel Costs 1978 to present
(cents per gallon)
Current: 30+% of
airline expenses
March
2011
price
2002: 11% of
airline expenses
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: Air Transport Association, IATA
20
Commercial
Market
Outlook
…Which Is Changing The Economics Of Aircraft
Operation…
US Airlines – 2009 Fuel Costs/ASM (cents)
Fuel cost/
ASM
(cents)
Losers
Winners
Losers
High fuel costs
exacerbate aircraft
cost differences
Winners
*
gal
* 2009 figures are
based on $1.75 $1.95 gallon fuel
© 2011 AeroStrategy
AMM
Source: US Air Transport Association
21
Commercial
Market
Outlook
...And Contributing To A Surge Of Aircraft
Retirements...
Air Transport Retirements and Deliveries
Aircraft
Production breakdown
~60% for growth
~40% for replacement
Deliveries
400 Retirements per
year is the new normal
Retirements
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: Airline Monitor
22
Commercial
Market
Outlook
AeroStrategy Developed Three Scenarios For Air
Transport Production Rates Based On Fuel Prices
2011 – 2021 Air Transport Production Scenarios
Aircraft Demand
Factor
Optimistic
Nominal
Pessimistic
Long-term Oil Price
(WTI)
$50-60/bbl
$80 – 120/bbl
$150+/bbl
Average Global GDP
growth
~4%
~3%
~2%
Average Global RPK
growth
5.1%
4.4%
3.6%
Net Return of Parked
Aircraft
400
Nil
Nil
Total 2011-21 Aircraft
Retirements
5,100
5,600
6,000
7.7
8.0
8.2
32,900
30,400
27,000
17,000
16,000
12,500
Aircraft Utilization
(hrs/day)
2021 Projected fleet
(2010 = 20,500)
Aggregate 2011-21
Aircraft Production
Downside Risk Outweighs Upside Opportunities
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Sources: AeroStrategy analysis, Airline Monitor
23
Commercial
Market
Outlook
In AeroStrategy’s Nominal Scenario, Air Transport
Production Exceeds 1,600 By 2021
Units
Air Transport Nominal Production Scenario 2011-2021*
By OEM
Aircraft Demand
Factor
Long-term Oil Price
(WTI)
Nominal
$80 – 120/bbl
Average Global
GDP growth
~3%
Average Global
RPK growth
4.4%
Net Return of
Parked Aircraft
Nil
Total 2011-21
Aircraft
Retirements
5,600
Aircraft Utilization
(hrs/day)
8.0
2021 Projected
fleet
(2010 = 20,500)
30,400
Aggregate 2011-21
Aircraft Production
16,000
* Drop in production rates from 2014 to 2016 is due to a change in orders, shifting from
legacy aircraft to next generatin
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: AeroStrategy
24
Agenda
Defense Market Outlook
Commercial Market Outlook
Aftermarket Implications
© 2011 AeroStrategy
OAA Aerospace Summit 2011
25
Aftermarket
Implications
The Air Transport And Military Aftermarket Combined
Were Almost $130B In 2010
AIR TRANSPORT
MILITARY
• Airlines and freight carriers
• Attack, transport, trainers
• Turboprop and jet aircraft
• Fixed- and rotary wing
• Fleet of about 25,000
• Fleet of about 39,000
• 60 million hours a year or ~ 2,400 per aircraft
• 11 million hours a year or ~ 300 per aircraft
2010 Air Transport MRO Market
2010 Military Sustainment Market
$43.6B
$87.1B
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Aftermarket
Implications
AeroStrategy Anticipates Mid-To-Upper Single Digit
MRO Growth In 2011…
Air Transport MRO Market – Realized Supplier Revenue($B) *
Realized supplier
revenue
60
Fundamental MRO
demand
50
2012: Low double
digit growth
40
30
2011: Mid-to-upper
single digit growth
2009: MRO demand
20
down 15-20%
• 2-3% global GDP
growth and
modest airline
profitability
10
2010: 1-3% growth
0
2008
© 2011 AeroStrategy
2010
2012
2014
2016
OAA Aerospace Summit 2011
Key Assumptions
• Fuel costs in $80
– $110 /bbl range
2018
• Some make up for
deferred
maintenance and
modest inventory
restocking
Source: AeroStrategy
* Constant 2009 US$
27
Aftermarket
Implications
… But The Impact Of High Fuel Prices Could Further
Change Airline Supply Chain Practices …
Factors Supressing Fundamental MRO Demand
Economic Crisis
+%
Depressed Demand
2008-2010
2009/10: Reduction to
fundamental demand
from destocking and
deferred maintenance
“Normal”
MRO Demand
Supply Chain Practices
•Burn Inventory
•Deferred Maintenance
•Cannibalization / Surplus
(Fundamental
Demand =
realized
supplier
demand)
-%
+%
High Fuel Prices
Further Depressed Demand
2010-2012
2009/10: Reduction to
fundamental demand
from destocking and
deferred maintenance
“Normal”
MRO Demand
Supply Chain Practices
•Aircraft Retirements
•Parting Out
•Excess Surplus Parts
(Fundamental
Demand =
realized
supplier
demand)
-%
© 2011 AeroStrategy
OAA Aerospace Summit 2011
2010/11: MRO demand
suppressed by aircraft
cannibalization and
high use of surplus
parts….
Source: AeroStrategy
28
Aftermarket
Implications
…And Future Growth Will Be Highly Dependent On
The Fluctuation In Fuel Prices
MRO Growth Scenarios Based On Fuel Costs
Best case
Oil < $80/bbl
Nominal case
Oil $80 – 110/bbl
Worst case
Oil > $110/bbl
AeroStrategy
Forecast
• Fuel costs fall to less than
$80/bbl
• Falling costs boost GDP,
air travel growth, and
airline profits
• Facilitates return of
hundreds of aircraft from
storage – which need MRO
© 2011 AeroStrategy
• Fuel costs remain in $80110/bbl range
• Modest (2-3%) global GDP
growth…and airline
profitability
• Fuel costs limit return to
service of most stored
aircraft
OAA Aerospace Summit 2011
• Fuel costs escalate to
>$110/bbl…or much higher
• A dramatic spike in fuel
costs could lead to a “W”
shaped recession and
reduced air travel growth
• Airlines again in red, which
results in further capacity
reductions and cost cutting
• More aircraft to desert
Source: AeroStrategy
29
Aftermarket
Implications
Recent Rhetoric Suggests That All Aspects Of The
Defense Budget Will Feel Pressure …
“Although reducing the defense budget
cannot alone solve our deficit problem, it is
hard to envision an overall solution that
does not include some contribution from the
20 percent of government spending that
goes toward defense.”
– Deputy SecDef Bill Lynn
© 2011 AeroStrategy
30
Aftermarket
Implications
… And Reductions In O&M Spending Will Impact The
Military Aftermarket
Billions
2010-2015 North America & Europe Military Sustainment Forecast
Recovery to expected levels
by 2014?
Lower utilization reduces
sustainment … or lower
budgets reduce readiness
which lowers utilization
10% reduction in utilization
for aircraft excluding
helicopters and fixed wing
transport results in a 6%
decline in sustainment
spending
All Values In 2010 U.S. Dollars
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: AeroStrategy analysis
31
In Summary….
 US And Western Europe face Massive Structural Deficits That Must Be
Addressed resulting in severe defense budget pressures
 China’s Emergence As A Great Power Creates Angst Throughout Asia
… and drives Asian Defense budgets
 An outbreak of democracy in the Middle East could slow robust growth
in defense spending
 Changing mission requirements drive increasing need for ISR, vertical
lift and fixed wing transport
 UAVs are the bright spot is fixed wing production and rotary wing
production is projected to be flat
• Aircraft economics have fundamentally changed as a result of high fuel
prices, leading to premature retirement of hundreds of aircraft
• The air transport MRO market, after a difficult recession, is currently
valued at $43.6 billion
• The parting out of aircraft is suppressing a rapid recovery in MRO
demand with 15-20 aircraft parted out per month
• The shape of MRO recovery is tightly linked with the price of oil
• 2011 MRO demand growth of mid-to-upper single digits is anticipated in
the nominal scenario
• Long-term MRO growth will be 3.3% CAGR, led by engines and
modifications
© 2011 AeroStrategy
OAA Aerospace Summit 2011
Source: AeroStrategy
32
Thank you for your attention!
1
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© 2011 AeroStrategy
OAA Aerospace Summit 2011
33