Industrials Outlook: Aerospace & Defense

 

As the geopolitical landscape continues moving with uncertainty and the world is entering a phase of heightened technological development, a constant focus is on the aerospace and defense sector. As a whole, the A&D (Aerospace and Defense) industry strengthened in 2018 as revenues increased by 7.65%, almost quadrupling last year’s 2.1% growth. Events such as the political dispute between the United States and China pose security threats for many involved governments. In response, the United States government has signed the omnibus spending bill, which set the Department of Defense’s budget at $700 billion, about a 20% increase in two years.

As a whole, Deloitte analysts expect a growth in global defense spending at a CAGR (compounded annual growth rate) of 3.0% from 2017-2022. Tensions in developing countries such as India also factor into this continued growth, which shows little signs of slowing down. As cyber threats continue to evolve, there is also a greater need for cybersecurity to help companies protect their clients' personal information. Therefore, global cyber security spending is expected to grow at an annual rate of 10.2% to $248.26 billion over the next five years.

Aerospace


At the moment, the aerospace market is dominated by large key players, such as Airbus and Boeing, which control a combined 92.4% of the commercial aircraft market. Growth in the aerospace industry is fueled by a rise in the middle class, which is estimated at an additional 140 million individuals annually. This leads to increased capital expenditure in related fields such as air travel, which was accounted for with the record high backlog of commercial aircraft at 14,215 units at the end of 2017.  The industry is facing increased demand and is becoming consolidated and efficient in moving forward.

Increased global fears of warfare and border disputes and increased trade activity are the primary drivers for growth in the aerospace sector. With the Pentagon pivoting its defense focus towards China, Russia, North Korea and Iran there is a renewed market for aerospace presence in these regions. China is also active in land disputes such as that in the South China Sea, which contributes to the overall security threat in the region. As a result, aerospace defense companies with a large government client base have seen a sharp uptick in their contract flow.

Lockheed Martin, with U.S government agencies as its largest client has recently been awarded a $2.9 billion contract for the manufacture of missile warning satellites for the U.S Air Force. This is reflective of the tense political situation worldwide and translates into overall gains for the aerospace defense sector.

On the basis of aerospace manufacturing and transportation, the industry is also showing significant signs of growth. Globalization and an increasing reliance on intellectual capital have resulted in businesses and individuals traveling overseas at one of the highest rates in recent years. In total, revenue passenger miles increased 7% in 2017, which is above 6% annual growth for the third consecutive year. As a result, major aircraft manufacturers are looking internally towards agile growth of their processes, as well as key acquisitions in the M&A space to continue innovating.

Boeing recently acquired a majority stake in the commercial aircraft arm of Brazilian plane maker Embraer SA for $3.8 billion, effectively thrusting the large American maker into the lower end market of aircraft. The expansion of aerospace company operations through M&A opens up the possibility for increased solutions for large-scale institutional clients, such as governments and private contractors.

Furthermore, the opportunity for machine learning and automation in aiding the manufacturing process is a touted possibility in the sector. Drone use for inspection of aircraft wear and tear and inventory management on blockchain systems are just a few examples of the potential for future aircraft production, and these can be potentially implemented into company processes in the coming years. As a whole, the aerospace sector is in the process of entering the next generation of solutions and has a positive forward outlook

Defense


Increasing global tensions are driving growth for the defense industry. The U.S and China have recently taken aggressive stances toward each other. Trump imposed multiple tariffs on Chinese goods, with China responding by imposing their own tariffs on U.S goods. Both countries are increasing their defense spending to prepare for a potential war. There is also increased demand for defense and military products in emerging markets. For example, ISIS is a major threat to countries in Africa, such as Syria, Iraq and Afghanistan. These countries are forced to spend money on defense to protect themselves against terror strikes and cyber-attacks. Due to these global tensions, defense stocks will become hot investments for the next 5 years.

The leaders in defense are the participants of the Pentagon’s MQ-25A “Stingray” competition. This competition was designed to create the U.S Navy’s first carrier-based drone, with Boeing winning the competition and a $805 million contract to produce four naval drones. The competitors also included Lockheed Martin and General Atomics.

Lockheed Martin is the world’s biggest defense contractor and specializes in aerospace defense. General Atomics is a private company that specializes in creating military drones. 

Another driver for the defense industry is the need for cybersecurity. Cyber-attacks, such as data threats, ransomware and malware outbreaks, can cause critical disruption for unprepared countries. Data breaches have surged over the past years, with digital security company Gemalto reporting that 1.38 billion records were breached in 2016 and 1.9 records breached in the first half of 2017. These data breaches can lead to leaked personal data and identify theft, which has affected 15.4 million consumers.

Due to these threats, the cybersecurity market is expected to grow from $138 billion in 2017 to $248.26 billion in 2022. The main attackers are Russia, China, Iran and North Korea, who have been testing destructive cyber-attacks that are aimed toward the U.S and its allies.

To combat this, U.S government has invested much of its spending towards companies that can protect them from these attacks. Companies that the U.S has relied on include Booz Allen Hamilton, Palo Alto Networks and CyberArk. Booz protects the government's information through encryption, which has shown to be the most effective way to protect data. Palo Alto Networks protects its customers through next-gen firewalls, and is best positioned among its competitors to experience robust growth in 2019. CyberArk is unique because it actually protects companies from internal threats such as corporate spies or disgruntled employees. As a whole, the defense sector is in the process of heating up as countries have prioritized spending on defense to protect themselves from other countries and cyber-attacks.

In conclusion, the aerospace and defense (A&D) industry has experienced significant growth in 2018, with expectations of greater growth in 2019.

On the aerospace side, global fears of warfare have caused the government to sign contracts with aerospace securities to protect themselves from outside threats. Due to growing globalization and improved transportation, many middle-classes citizens from emerging markets have travel overseas at a extremely high rate. Finally, major aerospace manufacturers are looking to move into the M&A space in order to attract new clients.

On the defense side, global tensions have resulted in a large amount of countries spending money on defense to protect themselves from cyber-attacks and missile/drone attacks. The U.S government has taken many steps to give defense companies new opportunities, such as increasing the defense spending bill and creating competitions between the defense titans to improve technology. Overall, the A&D industry is anticipating the emergence of conflict and new-age technology, and it is well-positioned to reap its benefits.

By Liam Minerva - Industrials Director, Baruch IMG, Nikhil Kumar and Anqin Chen - Industrials Analysts, Baruch IMG