Frost & Sullivan Aerospace and Defence Outlook , 2009

James Cooper - Diogenis Papiomytis -Nathan Laryea The widely reported collapse of global financial institutions and subsequent economic crisis is a new factor for consideration

Issue 15 - April 2009

Global Defence Outlook 2009
The ongoing crisis has emerged at a point where defence markets are generally seen to be making a significant transition. A variety of factors and stimuli have been acting on the market, ensuring healthy growth for industry, particularly over the previous 5 years. Defence customers across the globe have been focusing on widespread modernisation and overhaul of military capabilities to meet emerging threats and requirements. This effort has involved purchasing and integrating technology with considerable associated expense and also helped industry and end-users innovate and adopt new approaches to business. Thus we have seen a tendency to focus on the total cost of ownership of defence programmes, on the aftermarket support and increased outsourcing services, best shown through the UK’s contracting for availability arrangements.

Whatever influence the economic crisis has on defence markets must take this rapidly changing picture as its baseline reference, in order to avoid falsely attributing impact without due. In truth, Ministry’s of Defence are looking to reduce their exposure to risk and to cost-growth on defence procurements, whilst seeking to adopt best-in-class technology in shorter-timeframes. Certainly, tighter government budgets as a result of the economic crisis and ongoing modernisation needs will support this wider ongoing trend. However, the crisis acts as a contributing factor, not one with such importance that it has major singular influence. In actual fact, contradictions and underestimation of programme costs within existing long-term equipment plans is likely to have a greater pressure on projects and possible cutbacks.

Instead, Frost & Sullivan believe we will see the economic crisis acting indirectly to introduce new dynamics to the defence market. It has to be said that the wider global impact of these dynamics is relatively unimportant compared to other factors, such as ongoing operations in Afghanistan.

Perhaps the most noticeable short-term impact will occur as new competitive forces are introduced to the market. In countries where there is significant economic fallout and a reliance on the IMF for bailouts, such as in Eastern Europe, it is highly likely that major defence programmes will be significantly delayed. In the past, delaying major defence programmes has been a pre-condition for receiving IMF aid. In other major countries such as Spain and Italy, similar outcomes might be seen without the involvement of the IMF, due to significant lack of funding available. As GDP falls, so do defence allocations.

Despite this, Frost & Sullivan still believe there are significant opportunities worth pursuing the market. The accessible defence market is globalizing rapidly, with the emergence of new markets that offer significant Growth opportunities for defence companies. Frost & Sullivan research suggests that if current trends continue, with an expected fall and stabilization of the US Defence budget and continued economic growth and rivalry in Asia-Pacific, the North American market will be less valuable than Asian-Pacific markets. If anything, this is further exacerbated by serious financial and economic down-turn in the US and Europe particularly affected.

India has rapidly become a market of interest for many US and European defence manufacturers, as Russia’s share of the market is falling dramatically. Over the next ten years, India is expected to spend up to US$100 Billion on defence procurement, with particular attention to modernisation and acquisition of best-in-class systems when possible. In a related point of interest, it is also notable that there is ongoing change in the order-of-battle, with many states seeking to make wide ranging personnel cuts in order to afford more high-tech equipment – in Asia-Pacific, many countries such as South Korea and India are decreasing their force personnel at a time when they are also rapidly increasing their defence spending.

Global Commercial Aviation Outlook 2009

The current global economic recession, which officially started in 2007, is not forecasted to have as great impact on the aircraft manufacturing supply chain as initially feared. The main stakeholders affected have been the airlines, who have initiated capacity cuts to match supply with expected demand levels. Nonetheless, airlines have been late to react to the economic conditions, as in both 2007 and 2008 we saw a string of massive aircraft orders, in line with their ambitious expansion plans, followed by significant capacity cuts in the last quarter of 2008 and the first of 2009.

Once again airlines have been mistiming their restructuring plans, as the air transport industry will soon enter a recovery phase, after widespread speculations that we have already reached the bottom of the economic cycle. Frost & Sullivan believes that 2010 will be a positive year for commercial aviation, and airlines will need to be flexible enough to bring back capacity as soon as this is needed; essentially opting for long-term parking of existing aircraft, as opposed to aircraft retirements and order/delivery cancellations.

On the other end of the spectrum, some aircraft manufacturers have made announcements to cut capacity, although it is equally important for them to keep the flexibility to meet demand levels and avoid closing down factories or laying off large numbers of permanent personnel. Facing the risk of losing their competitiveness when growth starts again, aircraft manufacturers and their own suppliers will have to be adaptive.

The Regional Jet market has been hit the hardest, with Embraer projected to deliver 115 aircraft this year, down almost 30% from 2008. However, both Airbus and Boeing are expected to buck the trend as they both enjoy very strong order backlogs that would help them go through this crisis virtually unscratched. In fact for Airbus, the A320 family backlog now stands at an all-time high of 3,125 aircraft and its 2009 production is fully booked. Profitability for both players will be lower, or even negative as is expected for Airbus’ parent company EADS, but their main reaction to this crisis will be to postpone expansion plans, rather than cut their output.

Turkish airlines have been less affected than their Western European and North American counterparts from this downturn, with the country’s flag carrier THY announcing a 26% rise in net profit for 2008, compared to the previous year. This can be explained due to the rising popularity of Turkey as a tourist destination and a business centre for multinational companies, as well as its growing importance as a transit hub for passengers travelling from Europe to Asia and vice versa. A large aircraft order for over 100 aircraft is expected during 2009, something that is likely to happen at this year’s Paris Le Bourget Air Show. At the same time the Turkish MRO industry is expected to gain prominence, assisted by the strong Euro and its competitive labour rates. Finally we do expect that foreign manufacturers and aftermarket suppliers will be further looking into Turkey for potential Joint Ventures.

Civil Security Outlook 2009
Like defence, civil security is driven by threats and is fuelled by government spending. As long as the threat perception remains high the market should continue along an upward trajectory, retaining a steady course through the current recession. Modern terrorism currently represents the most pressing and direct threat to civil security globally, with a high number of terrorist incidents recorded each year since the turn of the century. The current Al-Qaeda inspired brand on terrorism, focused on the infliction of maximum damage to predominantly civilian targets, has been the catalyst for increased governmental emphasis on domestic security. Whilst the attacks of September 11th 2001 seem increasingly distant with the passage of time, its effects on the global civil security market are still tangible.

Interestingly, civil security in its modern post 9/11 form has never had to weather an economic cycle. The potential impact of the current recession is therefore the subject of great debate. Whilst it is commonly accepted that civil security is resistant to the current economic downturn, many analysts have gone a step further and suggested the market is completely insulated from its effects, that it is in fact recession proof. To what degree is this true?

The civil security market does contain entrenched market drivers that will not be overtly affected by the recession. Fear of terrorism endures, not just in the West, but in an increasingly diverse spectrum of countries including China, Egypt, the UAE and Turkey. Border security continues to be a major issue, with the United States and Saudi Arabia currently financing multi billion border security programs. The World Cup in South Africa (2010), The Canada Winter Olympics (2010), The London Olympics (2012) as well as the annual Mecca pilgrimage will combine to bolster large event security. Investments in airport and mass transportation security are also likely to continue. These drivers, underpinned by politics as opposed to economics, all help contribute to the resilience of the global civil security market.

In some respects the global recession may prove to be a source of further opportunities for those in the civil security arena. With countries like the United States and Japan making huge investments in expanding national infrastructure as a means of economic stimulus, future opportunities will present themselves in critical infrastructure protection. Others construction projects included under the umbrella of economic stimulus, such as those related to mass transportation, will also require a security apparatus. In some instances economic stimulus packages will see money directly channelled into civil security, as was the case in the United States where the American Recovery and Reinvestment Act (2009) saw an additional US $2.8 billion made available for civil security.

The global recession can also create opportunities by altering the security dynamic. For example Illegal immigration and people trafficking invariably become more pronounced in times of economic downturn, carrying implications for border security. Economic hardship has historically been the catalyst for violence, extremism and social disorder threatening the fabric of nations. All forms of criminality, including more modern cyber threats, are likely to increase during a civil security downturn ensuring governments must maintain a sturdy civil security apparatus.

The civil security market is cushioned from the full effects of the current recession given the events driven nature of the industry. Downturns in the economy are secondary to high threat perceptions and the necessary expansion of security apparatus. The continual evolution of Al-Qaeda inspired terrorism continues to present security challenges to governments, even if sensitivity to the overall terrorist threat has lessened since 2001.Airport and mass transportation security continue to be priority investment areas. Securing borders remains a pressing issue, as does large event security. In some instances, downturns in the economy can be a boost for civil security as the threat posed by illegal immigration, crime and public disorder invariably goes up.

This is not to suggest that the civil security market is recession proof. It isn’t. The effects of the recession may be felt in more subtle and indirect ways then other industries, but they are felt. The political momentum that drove the market for so long after 9/11 has ceded in the wake of global financial meltdown. Political leaders are focused on economic recovery rather then investing in what is, in the case of most western nations, an already robust civil security apparatus. In addition the number of speculative opportunities on offer to suppliers is likely to decrease due to delays in areas such as airport and retail construction.

The market is therefore best characterised as being recession resistant rather then recession proof. It will maintain a positive growth trajectory, but that growth will likely to be curbed to some degree due to the current economic environment. The United States will continue to be engine of the global market through the recession, though demand from countries such as China, India and Saudi Arabia will increasingly support global growth. The threat driven nature of the business ensures that a major attack on a western capital would likely usher in a new rush of civil security spending, completely negating any effects of the recession. Presuming the threat perception remains at its current level, it will remain a secondary issue compared to the economy.