Overview:
In the wake of a rapidly changing geopolitical landscape, marked by events such as the Russian invasion of Ukraine and the tension between China and the West, the industry has showcased resilience and adaptability. As the global economy recovers from the repercussions of the COVID-19 pandemic, the defense sector remains robust, demonstrating signs of a strong rebound. This resilience is further underscored by the increasing defense budgets worldwide, particularly in response to rising geopolitical tensions. The U.S., for instance, has emphasized perceived strategic threats, channeling focus toward areas like electronic warfare and cybersecurity. Furthermore, the industry is not just about traditional warfare equipment; it’s evolving. Emerging markets, such as advanced air mobility and space, are gaining traction, indicating the industry’s forward-looking approach. However, challenges persist, from supply chain disruptions to talent shortages, which the sector must navigate to maintain its growth trajectory. As we move further into 2023, the defense industry’s role in shaping global peace, security, and technological innovation becomes even more paramount.
The global aerospace and defense industry is at a pivotal juncture, characterized by transformative opportunities and challenges. According to EY’s analysis, it underscores the potential for a massive influx of up to $800 billion in new spending, signaling a transformative phase for the industry. This growth, however, comes with its set of challenges. The industry must significantly enhance program performance, especially in an era where geopolitical risks and supply chain challenges are more pronounced than ever. The Russia-Ukraine conflict has had ripple effects on the European economy, emphasizing the need for the aerospace and defense sectors to be agile and adaptive. Innovation remains at the heart of this evolution, with a clear focus on technology priorities. Yet, the race for talent, especially in cutting-edge technology domains, is becoming fiercely competitive, necessitating a reimagining of talent acquisition strategies. Moreover, by 2040, according to a report by Morgan Stanly, satellite broadband is projected to constitute a significant 50% of the global space economy’s growth. This surge is not just about connectivity; it’s about affordability and accessibility. As satellites pave the way for cheaper broadband Internet services, the cost of data is set to plummet, especially with the increasing demand from sectors like autonomous vehicles and the Internet of Things. Technological strides, such as reusable rockets and the mass production of satellites, are further driving down costs, making space more accessible than ever.
Why Aerospace and Defense is recession-proofed?
Firstly, the nature of defense spending is often counter-cyclical. In times of geopolitical instability, nations tend to bolster their defense capabilities. This surge in defense budgets, as seen with the US Congress’s record-setting allocation and Germany’s significant defense budget hike, ensures a steady flow of funds into the defense sector, even when other sectors of the economy might be contracting.
Secondly, the aerospace sector, particularly commercial aviation, has shown adaptability in response to economic challenges. While air travel has historically moved in line with macroeconomic trends, the current scenario is different. Despite potential economic downturns, there’s a strong demand for both air travel and new, more-efficient aircraft. Airlines, in response to factors like rising fuel prices, are likely to place orders for newer, fuel-efficient aircraft, benefiting manufacturers and the broader supply chain.
Furthermore, the A&D industry’s long-term contracts and the essential nature of its products and services provide a buffer against short-term economic fluctuations. Defense contracts, in particular, span multiple years, ensuring a consistent revenue stream. Similarly, while commercial aircraft orders might see some deferrals, the long lead times and substantial backlogs provide a cushion against immediate economic shocks.
Lastly, the industry’s capacity for innovation plays a crucial role. With clear technology priorities and a drive for innovation, the A&D sectors are continually evolving, making them adaptable to changing economic landscapes. The focus on areas like satellite broadband, as emphasized by other reports, further diversifies the industry’s portfolio, reducing its reliance on any single revenue stream.
Key Developments for Commercial Aviation, Cargo, and Defense.
Commercial Aviation:
- The global markets for commercial aviation and the aerospace industry have strong rebound momentum.
- Exports rebound.The pandemic led to a significant decline in US commercial aviation exports, plummeting by $57.4 billion from $147.4 billion in 2019 to $90 billion in 2020. However, there has been a partial rebound in the US A&D exports, witnessing an 11.2% increase from 2020 to 2021, reaching a value of $100.4 billion. This growth is distributed between civil and defense aviation in a 65:35 ratio. In 2021, the US exported A&D products to 205 countries, with the primary recipients being France, Canada, Brazil, the UK, and Singapore. Preliminary monthly data for 2022 indicates a continued recovery in US civil aircraft, engines, and parts exports. It’s projected that the 2022 figures for the civil sector might surpass the 2021 numbers by approximately 50%.
- International Travel restrictions eased:Nations have started to relax their COVID-related restrictions. For instance, the US made mask-wearing optional from April 2022 onwards. Meanwhile, China has lightened its travel limitations and COVID-19 protocols, leading to a noticeable eagerness among overseas Chinese communities to visit.
- Commercial Aviation rebound: In 2022, global passenger traffic, gauged in revenue passenger kilometers (RPKs), surged by 64.4% relative to 2021, reaching 68.5% of the traffic seen in the pre-pandemic year of 2019. International travel in 2022 saw a remarkable increase of 152.7% from 2021, achieving 62.2% of the numbers from 2019. In comparison, US domestic air travel in 2022 experienced a modest growth of 10.9% over 2021. This modest rise can be attributed to significant domestic travel spikes during holidays in 2021. By the end of 2022, US domestic traffic stood at 79.6% of the total for 2019.
Cargo:
- High Inventory levels:The growth outlook for 2023 is expected to hinge on elevated inventory levels and the evolving stance of China’s stringent anti-COVID-19 measures. These policies saw a relaxation in December 2022 for the first time, prompted by widespread public demonstrations. However, the long-term growth trajectory for the air cargo sector remains optimistic. Boeing anticipates global cargo traffic to double in the upcoming two decades, leading to a 60% expansion in the global cargo jet fleet, reaching over 3,600 jets. Notably, conversions are projected to make up two-thirds of this fleet. Technological advancements and innovations will likely persist in small to medium-sized cargo aircraft, emphasizing the transition towards more environmentally friendly fleets.
- Rebuild of Mriya:The Mriya, a colossal cargo jet crafted in Ukraine during the 1980s, faced significant damage from shrapnel on the inaugural day of the Russian incursion. However, efforts to restore the Mriya commenced in the spring of 2023. Reusable components from the debris are being salvaged by its owner, Antonov, a state-owned entity, with plans to integrate them into the frame of an unfinished twin model.
Defense: The world’s defense industry in the coming decade seems poised for significant expansion.
- Continue growth: In 2022, global military expenditure witnessed a 3.7% increase in real terms, reaching a new peak of $2.24 trillion. The major contributors to this figure were the US, China, and Russia, which together made up 56% of the global spending. The ten leading defense firms globally amassed revenues totaling $485.5 billion in 2021, marking an average revenue growth of 7.1%. Additionally, the top 100 defense companies experienced a revenue surge for the sixth consecutive year.
- Growing geopolitical tension: To date, as Russia and Ukraine war progressed, over 40 nations have extended military assistance to Ukraine, with 18 of them dispatching heavy weaponry and dedicating more than 0.1% of their GDP to support Ukraine. Moreover, as the United States and its NATO allies continue to support Ukraine, they are depleting their weapon reserves, both modern and dated, and are facing challenges in restocking them. The diminishing inventory encompasses a range of equipment, from missiles, rockets, and drones to anti-aircraft and other surface-to-air defense systems. Besides, the collaborative efforts of Canadian and American military and civilian personnel led to the interception of Chinese surveillance balloons in February 2023, thrusting NORAD 147 into the spotlight for the first time in a long while. Previously, in June 2021, Canada had pledged CDN$ 5 billion over a span of six years to extensively update NORAD’s outdated systems.
Conclusion:
The increasing demand for aviation is obvious. The travel bans underscored the business world’s reliance on the seamless movement of human resources in a globalized market. By 2023’s close, the aviation sector is anticipated to bounce back to its pre-pandemic stature, with its growth rate projected to be almost twice that of the global GDP. The defense industry also expected growth in 2023. The heightened geopolitical tensions prevalent today are driving defense expenditures to unprecedented levels annually. With numerous countries increasing their defense budgets by double-digit percentages, the industry is projected to witness a robust single-digit growth rate in 2023. Furthermore, the supply chain and workforce challenges that notably impacted defense production in 2022 are anticipated to see progressive amelioration in the coming year. All in all, those factors make right now a great time to invest.
Suggestion Buy: Boeing
Boeing, along with Airbus, showcases a trajectory distinct from many airline companies, indicating potential opportunities for investors. Here are the rationales:
- Pricing Pressure on Airlines: Speculations are abundant about airlines’ capacity to increase ticket prices to counterbalance rising operational costs. With ticket sales being the commercial aviation sector’s backbone, the inability of airlines to adjust their pricing models could lead to dire financial outcomes. Notably, even industry leaders like Delta, United, and Spirit hint at subdued optimism. Though premium airlines such as Delta and United experience lesser impacts due to minimal margin compression, the overall sentiment remains cautious.
- Projected Demand Dynamics: A significant chunk of the industry’s hope lies around December’s festive season, anticipating a boost in domestic travel demand. The projections predominantly point towards a plateauing demand until the year-end holiday season.
- Bright Spots in the Aviation Sector: Contrary to the prevailing sentiment in the commercial aviation domain, the broader international aerospace arena showcases promise. Companies like Boeing and Airbus are on a commendable recovery path. Boeing’s sales, for instance, surged by a remarkable 40%, hinting at a strong resurgence.
- Opportunity with Upstream Companies: The current challenges underscore the value proposition of upstream companies like Boeing and Airbus. These entities, having demonstrated resilience and growth, emerge as potentially lucrative investment avenues. Investors might find it strategic to pivot their focus towards these firms, capitalizing on the potential they offer.
Some recommending Investing targets: Lockheed Martin, Boeing, Raytheon, ETFs.
