4 May 2017 Global Equity Research Aerospace & Defense

Global Aerospace & Defence The Ideas Engine series showcases Credit Suisse’s unique insights and investment ideas. THEME Research Analysts Olivier Brochet Winter is coming; structural change likely for 44 20 7888 8508 [email protected] the aerospace supply chain Robert Spingarn 212 538 1895 ■ Reducing the margin gap: In this Ideas Engine Series report, we analyse [email protected] how airframers like Airbus and Boeing can leverage technology disruptions Julian Mitchell to reduce the margin gap with their suppliers, drawing on the expertise of 212 325 6668 [email protected] Credit Suisse's global research teams across the whole aerospace supply Andre Kukhnin, CFA chain. The profit impact will be gradual but we believe it will be instrumental 44 20 7888 0350 in reducing the valuation gap, with suppliers ex aerostructures trading on [email protected] 2019E EV/EBIT of c.12.0x, while airframers trade on c.8.0x on average. This Charles Brennan CFA would expand and perpetuate the significant gap reduction that we expect 44 20 7883 4705 [email protected] over 2017-20E (see Figure 1), as airframers' earnings grow with volumes. Curt Woodworth, CFA Figure 1: Airframers' / suppliers' operating margin gap 212 325 5117 [email protected] 20.0% 20.0% 15.0% Neil Glynn, CFA 15.0% 44 20 7883 6929 10.0% [email protected] 10.0% Specialist Sales: Andrew Bell 5.0% 5.0% 44 20 7888 0479 0.0% [email protected]

-5.0% 0.0%

2016 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2017E 2018E 2019E 2020E HOLT Specialist Contact: Kevin Paul, CFA 1999 44 20 7888 9686 [email protected] Gap suppliers / airframers - rhs Airframers (Airbus+Boeing) Engine makers (5) Suppliers (26)

Source: Company data, Credit Suisse estimates ■ Fundamental triggers and technology enablers: In this report, we conduct a detailed analysis into how airframers are reacting to the decreasing importance of design innovation (e.g. due to reduced supplier- furnished differentiation vs Chinese competitors) and are shifting to process innovation to increase aircraft affordability, leveraging automation, 3D- printing and digitalisation. These technology disruptions may eventually reset the relationship between airframers and their suppliers and allow airframers to recapture some profits; e.g., through deep changes in contracting practices and IP usage. ■ Stock impact: Airbus (Outperform) and Boeing (Neutral, TP: US$200) should see upside to their long-term profit margins. We increase our TP on Airbus to EUR100 (from EUR76), as we expect the discount to the sector to close partially. HEICO (Outperform, TP raised to US$85 from US$76) should benefit from new avenues of growth. Thales (Outperform, TP: EUR102) and Dassault Systemes (Outperform, TP: EUR85) would benefit from digitalisation, GE (Outperform, TP: US$34) and Arconic (Restricted) appear well positioned on 3D printing, while in automation, Siemens (Neutral, TP: EUR135) seems to have the strongest position.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

4 May 2017

Table of contents

Executive summary 3

Margin imbalances between airframers and suppliers at a watershed 8

Technology disruptions may help airframers reshape the balance with the supply chain 24

Consequence 1 – Disruptions to the supply chain 34

Consequence 2 – New opportunities in the supply chain 48

Consequence 3 – Long-term boost to margins and cash for the airframers 62

Airbus Group (AIR.PA) 69

Boeing (BA) 77

Heico Corp (HEI) 81

Dassault Systemes (DAST.PA) 83

Thales (TCFP.PA) 85

Arconic, Inc. (ARNC) 87

Global Aerospace & Defence 2 4 May 2017

Executive summary We believe the aerospace industry is entering the early stages of a substantial metamorphosis that will structurally alter the relationship between airframers and their suppliers, both from a profit and content perspective. In particular, we expect airframers to actively leverage technology disruptions as they try to reduce the margin gap with their suppliers. This Ideas Engine Series report looks into how this may happen and draws on the expertise of Credit Suisse's global research teams, including Aerospace & Defence, Diversified Industrials, Capital Goods, Airlines, Technology, Metals & Mining, and Oil & Gas.

Figure 2: Margin gap between airframers vs suppliers Operating margins in % of revenues, including exceptionals (A+B: Airbus + Boeing)

20.0% 18.0% 16.0% 15.0% 14.0% 12.0% 10.0% 10.0% 8.0% 5.0% 6.0%

0.0% 4.0% 2.0%

-5.0% 0.0%

2011 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Gap suppliers / airframers - rhs Airframers (Airbus+Boeing) Engine makers (5) Suppliers (26)

Source: Company data, Credit Suisse estimates

Stocks that we think look set to benefit from these trends include Airbus (where we increase our TP to EUR100 per share from EUR76), Boeing, HEICO, Dassault Systemes, Thales, GE, Siemens and Arconic. Strategic shift in the relationship between airframers and their supply chain We expect a structural shift in the relationship between suppliers and airframers, aimed at reducing a persistent margin gap that has widened over the years in favour of the supply chain. Suppliers have benefitted from the historical business model decision made at the industry level to cut OE prices to stimulate aircraft sales and recoup them on the aftermarket. An unexpected boost has come from the consolidation of the industry (the top 10 suppliers account for over 60% of the supply chain revenues vs 10-20% in the 1980s) and the higher-than-expected success of some key programmes (over 13,000 A320s have been delivered and ordered vs an initial projection of 700), potentially leading to some excesses. We see several factors that may explain why this shift is happening now:

■ The support given by Western suppliers of engines and systems to Chinese airframers could be seen as 'subsidised' by the benefits derived from the aftermarket on Western jets to absorb the investments made in Chinese products. At the same time, the availability of the same technology to all airframers worldwide puts the competitive positions of Airbus and Boeing at risk and reduces their differentiation versus competitors.

Global Aerospace & Defence 3 4 May 2017

Figure 3: New engine programmes – no longer a technology differentiator for the Western airframers Engine Original platform Airframer Derivative engine Additional platform Airframer CFMI LEAP-1A A320neo Airbus LEAP-1C C919 COMAC Pratt&Whitney PW1100G A320neo Airbus PW1400G MS21 Irkut Pratt&Whitney PW1500G CSeries Bombardier PW1900G E195-E2 Embraer Pratt&Whitney PW1200G MRJ Mitsubishi PW1700G E175-E2 Embraer Source: Company data, Credit Suisse estimates

■ The drop in fuel prices comes with a structural increase in the underlying oil supply, which could prolong that move. This, combined with a flattening of the aerospace technology curve (in terms of the marginal gains it can generate), reduces the relative value of fuel consumption technologies for airframers, which need to turn to other means to reduce the cost of their aircraft.

Figure 4: Aircraft programme launches and oil price – the end of an oil-fuel technology wave? Year of programme launch, Brent in US$ / BBL

160 A320neo 737MAX

A330neo 140 777X 120

A350 100 757 787 A340 / 80 737Classic A330 777 v2 A310 737NG 747-400 A380 60 767 777 A340 v2 A320 MD-80 40 737 A300 20 747 MD-11

0

1976 1998 1965 1966 1967 1968 1969 1970 1972 1973 1974 1975 1977 1979 1980 1981 1982 1983 1984 1986 1987 1988 1989 1990 1991 1993 1994 1995 1996 1997 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016

Source: Credit Suisse research

■ The availability of disruptive technologies can reshape airframers' relationships with the supply chain, with a strategic shift to affordability (from operating cost efficiency to process efficiency) as a way to reduce aircraft costs for the airlines (our airlines team believes that the pressure is set to continue increasing as global partnerships expand). It could lead to a partial disintermediation of the supply chain and airframers may look for new ways to differentiate their programmes in an environment where the supply chain technologies are less relevant and more commoditised. We also see these technologies as giving airframers a new edge in capturing some of the aftermarket profits of the sector by: 1) taking a portion for themselves; and 2) reducing the burden on the airlines, which are increasingly wielding some power to resist.

Global Aerospace & Defence 4 4 May 2017

Figure 5: New platforms launched: major modifications / new systems mostly coming from supply chain Launch Platform Airframer Airframe Wing Cabin Avionics & systems Engine 2005 A350 Airbus      2007 CSeries Bombardier      2008 C919 COMAC      2008 MS-21 Irkut      2008 MRJ Mitsubishi      2010 A320neo Airbus      2011 737MAX Boeing      2013 777X Boeing      2013 E-Jet E2 Embraer      2014 A330neo Airbus      Source: Credit Suisse research

It may eventually lead to a fundamental reset in the relationship between airframers and their suppliers, particularly at the Tier 1 level, where the work is more integration than manufacturing. Technology disruptions as enablers of this strategic shift towards affordability We see the combination of the disruptions coming from automation, additive manufacturing and digitalisation as the enablers of this strategic shift, as they have the potential to displace the existing frontiers between airframers and suppliers and alter how they split the sector's overall profit pie. Automation will help reduce costs and capex over time, and it will increase flexibility and cut cycle times (in some instances by up to 50%) and working capital requirements (WCR) while materially improving quality (and thereby reducing cost variance). Some of the production can be insourced, with lower fixed costs and lower direct labor costs. Additive manufacturing will take market share and help with both costs of production and weight of the aircraft, shortening the development cycle and time to market of any new programme. It will allow some insourcing on a case-by-case basis. Digitalisation will underpin the previous two factors and generate its own direct benefits: quality improvement from having only one 'digital twin' from the design to the operation of the product, cost reduction and increased flexibility as well as opening new markets. It will also modify the way IP is created and used and how returns can be generated from it. Consequence 1 - Risks rising for the supply chain Pressure on the supply chain is likely to arise from 1) cost cutting, 2) a deterioration in contracting policies, 3) some reallocation of work away from traditional sources, 4) a reduction in outsourcing levels and an increase in dual-sourcing where possible, 5) opposition to certain concentration moves, and 6) an effort from airframers to reassert control over the IP they create. Aftermarket business models in particular are likely to face pressure on new programmes. On average in 2016, suppliers' operating margins were 800bp higher than those of the airframers, at 15%. Aerostructures stands at c.11% while systems (where aftermarket content is high) are at 18% and above. This will weigh on the returns of the overall supply chain in the medium term (6-10 years). In the short term (3-5 years), we expect some structural change in aftermarket cycles as new data analytics tools are lengthening component replacement intervals and probably driving more volatility in many suppliers' top lines and margins. Aerostructures will probably bear the brunt of the threat of insourcing for the parts with lower own IP content. Companies operating in this segment will need to invest in disruptive technologies to stave off the pressure, implying significant capex investment and most likely consolidation.

Global Aerospace & Defence 5 4 May 2017

Cabin will also face some risks in its less IP-heavy areas, in particular as 3D printing evolves towards larger parts. We expect airframers to encourage the emergence of credible competitors, which will take some time. The impact on airframers from production delays at Zodiac demonstrates that this remains a critical element of the supply chain that cannot be improvised. Engine makers (which are also OEMs, contracting directly with the airlines) will see pressure, but we think they can pass on much the burden to their own suppliers and can leverage disruptive technologies to their benefit. However, they may have to continuously increase investment in R&D to maintain their relevance for the airframers. Aircraft systems and avionics (as well as their supply chain) may suffer from some disintermediation, in particular when the supplier is essentially an assembler rather than a producer. We think they are likely to see pressure on their aftermarket on future programmes, with Tier 1s passing on pressure to Tier 2s and Tier 3s. In composite materials, Hexcel Corporation (Neutral, TP: US$52) appears more insulated from the rising pressure given significant consolidation and vertical integration over the last decade.

Figure 6: Disruption risk by segment 3D printing Automation Digitalisation Examples of key Tier 1s & Tier 2s Aerostructures and parts - - - Spirit, GKN, Senior, Latecoere, Daher, Triumph, MHI, IHI, Figeac Aerospace, Orbital ATK, Sonaca, PCP, ATI, Hexcel Cabin equipment - = - Rockwell Collins, Zodiac, FACC, Astronics, Heico, Jamco Seats - - = Rockwell Collins, Zodiac, Recaro Engines and parts + = + GE, Rolls-Royce, United Technologies, Safran, MTU, Barnes, Woodward, Meggitt, Heico, Esterline, PCP, ATI Avionics and parts = = - Rockwell Collins, Honeywell, Thales, GE, Esterline Flight systems (fuel, etc.) and parts - = - Safran, Zodiac, Eaton, Parker Hannifin, Honeywell, United Technologies, Heico, Curtiss-Wright, Esterline, Moog Landing systems, wheels & brakes - - = Safran, United Technologies, Heroux Devtek, Meggitt Source: Credit Suisse research

Consequence 2 - New opportunities arising as well Changes often come with opportunities. We see several areas as potentially benefitting from the disruptions we are expecting, even if in some cases the impact is marginal relative to the overall investment thesis for a particular stock. Automation should benefit the small aerospace (non-listed) specialists and the large suppliers of automated systems and robotics such as Siemens (Neutral, TP: EUR135) and Kuka (not covered). However, we think that the aerospace industry is likely to remain a small market for the large automation suppliers. Additive manufacturing can benefit specialised suppliers of 3D printing equipment (Stratasys, for instance) and larger groups producing parts such as GE (Outperform, TP: US$34) and Arconic (Restricted). Digitalisation covers a very wide space and has become a focus area for many corporates. Amongst those where we think it is a key differentiator not diluted into larger entities or a one-way bet on a technology, we would flag Dassault Systemes (Outperform, TP: EUR85) for its PLM offering and Thales (Outperform, TP: EUR102) for its presence in data analytics, artificial intelligence and cybersecurity. PMA manufacturing could make inroads in aerostructures as a way to supply alternative parts at lower costs for the OEMs, and definitely in cabin, which has been a key strategic area for HEICO (Outperform, TP raised to US$85 from US$76), which is the world largest PMA parts supplier.

Global Aerospace & Defence 6 4 May 2017

Consequence 3 – Long-term boost to margins and cash for airframers As a result of implementing these disruptions on new programmes, we expect the profitability gap between airframers and their suppliers to reduce over time, most likely beyond the turn of the decade. We measure the existing underlying margin gap at 800bp today. We believe that airframers as an industry could target a reduction of 200-250bp of this gap in the long run, returning to the levels of the early 2000s. We would expect this to bring the airframers' average margin to c.12-13%. Significant progress in reducing this margin gap is likely to come mostly from new programmes, but the prospects of a structural improvement in underlying profitability should help airframers trade at higher multiples than in the past. New aircraft offerings will become more technologically incremental (remember Boeing CEO Jim McNerney's "no more moonshots"), reflecting the flatter part of both the technology and oil price curves. We expect the airframers will try to capture some of the aftermarket profits, in particular via contract terms evolution and the use of digitalisation. Some areas in the supply chain appear better positioned than others to contain the pressure – e.g. where IP content is high (engines), where the relationship with airlines is not completely reliant on airframers (cabin, engine), where aftermarket is protected by a large non-displaceable installed base (engines, systems) and where technology disruptions can be leveraged for their own profit (engines). Overall, in our view, the main obstacles likely to be faced by airframers on their way to closing this margin gap are:

■ Resistance from the supply chain, with some execution risk as a result;

■ Price pressure from airlines as they reshape their procurement policies and reduce their costs; and

■ Execution challenges on the implementation of the disruptive technologies on new programmes. Closing some of the margin gap may help to reduce the valuation gap, with suppliers ex aerostructures trading on a 2019E EV/EBIT of c.12.0x, while airframers trade on c.8.0x on average (Airbus is at 7.3x and Boeing at 10.5x). For Boeing (BA.N – Neutral, TP: US$200), we think these trends are supportive of its "aspirational margin goal" of mid-teens. We note that BA has already taken the opportunity to recapture some aftermarket business from Spirit Aerosystems (SPR). SPR had been licensed to manufacture and supply certain spare parts with an estimated margin of 30%. BA rescinded the license and now sells the parts itself, and we believe is splitting the margin with SPR, which still performs the manufacturing work. BA thereby captures profit that was previously unavailable, with virtually no incremental cost. Assuming that it can boost the underlying margin of its commercial aircraft activity by 200- 300bp beyond the 10% or above expected for 2020E (11.1% for us and 10.9% for the company-supplied consensus), we think that Airbus (Outperform, TP increased to EUR100 from EUR76) could sustain an EV/EBIT multiple of 10.0x for this branch (broadly in line with its historical average) as long as production is holding, and that it would warrant a peak multiple of 7.0x rather than the level of c.4.0-5.0x seen in 2008-2009.

Global Aerospace & Defence 7 4 May 2017

Margin imbalances between airframers and suppliers at a watershed The margin gap between airframers and their suppliers has grown over the past fifteen years, with most profits in the industry being generated on the aftermarket. This has been amplified by consolidation in the supply chain, building up on early favourable positions of suppliers on programmes that turned out to be more successful than expected (such as the A320). Original Equipment (OE) faces the prospect of remaining a lower-return business as pricing pressure from airlines is not likely to disappear and competition from China is building steadily. The margin boost offered to the supply chain by aftermarket may be perceived by OEMs as a type of 'subsidy' for their Chinese competitors, with all Western suppliers (engines and systems) participating in China's programmes despite its likely lack of profitability in the short-to-medium term. As a result, it may be that supplier-furnished technologies (which leverage the IP of the airframers to a certain extent) become less relevant as a differentiator for OEMs. We expect them to try to alter the economic balance of the sector as a result. Historical margin transfer from OE to aftermarket Historically, the heavy price pressure on new aircraft sold to an airline industry facing rather low profits has incentivised airframers to cut OE prices to secure sales and pass this pressure on to their supply chain, while letting suppliers recoup their OE losses (or low profitability) on aftermarket over time.

Pricing pressure on OE in commercial aerospace Prices for new aircraft have historically been under strong pressure. Actual prices of Airbus aircraft have risen by only a cumulative c.5-10% since 2001 vs +70% for the list prices. Effectively, OEM discounts have moved from c.15-25% in the early 1990s to c.50-55% today.

Figure 7: Airbus list prices since 2001 Figure 8: A320 / 737 list price vs base value in US$m In US$m, base 100 in 2001 – CMV: Current Market Value

450 200

400 180

350 160

300 140

250 120 100 200 80 150 60 100 40 50 20 0

0

2002 2004 2003 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2001 2001 2003 2005 2007 2009 2011 2013 2015

A320ceo A320neo A330ceo A330neo 737-800 - CMV 737-800 - List price A340 A350XWB A380 A320ceo - CMV A320ceo - List price

Source: Airbus Source: Company data, Avitas, AeroDynamic Advisory, Credit Suisse analysis

Global Aerospace & Defence 8 4 May 2017

This price pressure on the OE manufacturers reverberates throughout the supply chain, with price cuts requested from all suppliers. From the 2000s until the early 2010s, the contract pricing pressure has also been offset by delivery price escalation: orders have been extending over several years and escalation clauses have boosted actual delivered prices by 2.0-2.5% per annum, on our estimates. This effect is captured in the actual delivery price calculated by Airline Monitor, as mentioned above. We believe that price inflation for new aircraft will remain subdued for the foreseeable future. In the current environment, with zero interest rates and no inflation for materials (assuming that oil prices remain range-bound), actual aircraft prices are indeed unlikely to significantly increase (if they do not decrease) and escalation has been nullified. As a result, we believe that OEMs will endeavour to continue reducing production costs as a way to reduce prices ahead of the next replacement wave and absorb both competitive pressure and salary increases (as illustrated in Figure 10) without facing a margin squeeze.

Figure 9: PPI - Industrial Commodities Figure 10: US aircraft manufacturing salaries Base 100 in January 1982 – to March 2017 Base 100 in December 2005 – to December 2016

220 450 140

400 130 200 350 120

180 300 110

250 100 160 200 90

140 150 80

100 70 120 50 60

100 0

50

Jan-96 Jan-14 Jan-90 Jan-92 Jan-94 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-16

Dec-90 Dec-98 Dec-06 Dec-07 Dec-15 Dec-89 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-16 PPI index (industrial commodities) Brent (USD/BBL) - rhs

Source: Bureau of Labor Statistics, Thomson Reuters Source: US Bureau of Labor Statistics

Reinforcement of the buying power of airlines and lessors We also believe that the concentration of airlines and lessors in recent years is increasing their buying power, making cost cutting even more necessary for airframers. For airlines, this may come via the reinforcement of alliances rather than actual mergers, as described in the reports below from our Global Airlines team:

■ Global Procurement Partnerships - the future – 4 August 2016

■ Bigger is better in aircraft procurement – 7 October 2016

■ Global Airlines – Procurement partnerships building as a theme – 2 February 2017

Global Aerospace & Defence 9 4 May 2017

In our view, global M&A will likely continue to prove elusive for the airline sector given foreign ownership restrictions. As such, we think the prospect of airlines supplementing their successful revenue-sharing joint ventures with joint procurement partnerships would be an evolutionary step. Joint procurement is building as a theme:

■ Regional M&A holds joint procurement as a central tenet of synergy ambitions – e.g. IAG’s formation via the merger of British Airways and Iberia, and subsequent acquisition of bmi, Vueling and Aer Lingus.

■ Etihad’s equity alliance strategy including Air Berlin and Alitalia focused on achieving better pricing for larger-volume deals to help reduce losses.

■ Qatar Airways has recently built a 20% stake in IAG and has highlighted expectations for procurement savings (it is also buying a 49% stake in Meridiana and 10% of LATAM group).

■ Lufthansa and Etihad have highlighted joint procurement as a strategic objective in their recently agreed partnership. In what has historically been a low-margin, commoditised industry, step changes in purchasing power could be the key to further expansion in returns – or at least the preservation of margins at historically high levels – and we expect this theme to continue to build from here. We also believe that lessors' concentration is increasing the likelihood of additional pressure on aircraft pricing going forward.

Some suppliers leveraging aftermarket The initial choice of suppliers is made by the airframer, who gets the benefit of the OE discount but generally is no longer heavily involved after the entry in service. Airlines are the end customers for the aircraft equipment but in most cases they are not in a position to really influence or choose equipment. Some suppliers are then in a good position to set prices for spare parts to their benefit, when they have aftermarket exposure. This has resulted in a progressive increase in margins for aftermarket suppliers, with most of them having a double-digit operating margin and many of them even being close to or above 20%. Airframers in the commercial aerospace field have struggled to rise to the mid-to-high single-digit range. Suppliers object that this is offset by the high level of customer advances received by the OEMs, which help boost the return on capital employed for the airframers / OEMs. Anecdotally, we also note that in 2016, airlines in aggregate are expected to have generated a higher operating margin (an estimated 8.3 according to IATA, stable vs 2015) than the airframers for the first time in history.

Global Aerospace & Defence 10 4 May 2017

Figure 11: 2016 operating margin in the aerospace industry in % of sales, FY16 except *: FY15

40% 35% 30% 25% 20% 15% 10% 5%

0%

GE Woodward UTC- UTAS Transdigm PCP* Eaton Meggitt Propulsion Safran - Collins Rockwell B/E Aerospace Honeywell Gulfstream Hexcel Spirit Aero. Curtiss-Wright Parker Hannifin LISI Astronics Senior AircraftSafran - Equ. GKN MTU - UTCP&W Thales Esterline Moog Rolls-Royce - TextronCessna Embraer Triumph AviationDassault Latecoere Zodiac Boeing Airbus Bombardier

Airframers Engine makers Suppliers

Source: Company data

Credit Suisse HOLT® shows a growing gap between airframers and suppliers We have used HOLT to assess how profitability has trended over time between airframers and their suppliers. The aerospace activities account for a large part of the major groups in the sector, and most are typically diversified (in defence or in other industrial segments). This limitation prevents us from making precise and detailed conclusions, but the analysis sheds some useful light on the overall trends and balance shifts. Airframers' average CFROI® has fallen sharply to a 20-year trough, pushing below the 2002 trough. In contrast, Engine Makers and Suppliers have seen a positive trend in returns over the past 10 years (Figure 12).

Figure 12: CFROI® of Airframers vs. Engine Makers and Suppliers in %

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Airframers Engine Makers Suppliers

Source: Credit Suisse HOLT

Global Aerospace & Defence 11 4 May 2017

This divergence has been driven primarily by a shift in profitability. Airframers' Operating Margins have stagnated, while Engine Makers and Suppliers have pushed their Operating Margins to peak levels (Figure 13).

Figure 13: HOLT Operating Margin of Airframers vs. Engine Makers and Suppliers in %

24.0

22.0

20.0

18.0

16.0

14.0

12.0

10.0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Airframers Engine Makers Suppliers

Source: Credit Suisse HOLT

Figure 14: Sales / Inflation Adjusted Gross Investment x

1.2

1.1

1.0

0.9

0.8

0.7

0.6

0.5

0.4 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Airframers Engine Makers Suppliers

Source: Credit Suisse HOLT

This spread is reflected in Economic Profit (EP). Airframers are barely generating any EP, with their CFROI being so close to the cost of capital. Meanwhile, Engine Makers and Suppliers have significantly expanded their share of the economic value in the supply chain.

Global Aerospace & Defence 12 4 May 2017

Figure 15: Economic Profit / Inflation Adjusted Gross Investment in %

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0%

-2.0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Airframers Engine Makers Suppliers

Source: Credit Suisse HOLT

Consolidation of the supply chain and programme successes have amplified the margin transfer We believe that this margin transfer has been amplified over time by: 1) the unexpected success of some aircraft programmes; and 2) the consolidation of the supply chain.

Programme success beyond expectations In most cases, suppliers embarked on their current programmes in or before the 1980s, at a time when the supply chain was highly dispersed and delivery expectations were muted. As an example, Airbus targeted fewer than 700 deliveries at launch of the A320, and has now sold over 13,000 units (of which >7,500 have already been delivered, leaving a further 5,500 to go, not including future orders). All the current mainline programmes up until the A380 originate in programmes designed in the 1980s or before: A320, A330, 737, 767, 777 and 747. These aircraft account for c.80% of current production and they (or their predecessor versions) accounted for c.90% of deliveries at the end of the 1990s.

Global Aerospace & Defence 13 4 May 2017

Figure 16: Historical success of 737 and A320 in total number of aircraft delivered or on firm order since launch – regrouped by aircraft family, all versions included - to April 18, 2017

14,000

12,000

10,000

8,000

6,000

4,000

2,000

0

737 777 727 747 787 767 757

A320 A350 A380

Others

A330/340 A300/310

MD90/717

DC9/MD80/ DC-10/MD-11

Delivered On order

Source: Ascend data

There have been changes in the supplier lists for the programmes from one generation to the next, but many of the initial suppliers have remained unchanged (particularly for aerostructures, but also in avionics, aircraft systems and landing gear). This massive commercial success of the leading programmes (A320 and 737) has offered a very large base for the suppliers to obtain scale effects. It also provides a number of them with a much larger aftermarket base than initially anticipated.

Supply chain consolidation We believe that consolidation has reinforced the pricing power of key suppliers in the aftermarket – an unintended consequence in our view of the airframers' desire to reduce OE prices. The pace of consolidation amongst suppliers picked up in the late 1990s, following price pressure from the OEMs (well into a price war themselves) and a reduction in the number of airframers globally. This has resulted in a sector where the top 10 players today account for more than 60% of the supply of aircraft equipment revenues (excluding engines), vs 10-20% in the 1980s, on our estimates.

Global Aerospace & Defence 14 4 May 2017

Figure 17: Main aircraft equipment suppliers (excluding engines) in US$m, 2016 revenues 15,000

Europe US Others 12,500

10,000

7,500

5,000

2,500

0

Meggitt Senior Figeac Aero * UTC Honeywell Safran + Zodiac Rockwell + B/E PCP* Spirit Systems Zodiac Aerospace Safran Rockwell Collins GKN Triumph Transdigm B/E Aerospace Thales GE Stelia * Parker Hannifin Esterline ATI Eaton Moog Heico Woodward Diehl* Liebherr * Curtiss-Wright LISI Panasonic* Hanwha Techwin Daher Amphenol Ball FACC L-3 com Crane ITP* Latecoere JAMCO* BAESystems * Astronics Ducommun Recaro * ASCO * Sonaca* Barnes Orbital ATK * LMI Aerospace MHI * IHI * Heroux-Devtek ST Aerospace *

Source: Company data, * Credit Suisse estimates

This is illustrated in Figure 18, which shows the acquisition paths to the current United Technologies, Honeywell, Safran and Zodiac. Many other groups have followed a similar pattern: Transdigm, Esterline, Eaton, Meggitt, etc. The latest of these moves has been Rockwell Collins' announcement of its acquisition of B/E Aerospace (just completed) and Safran's announcement of its purchase of Zodiac (we described the logic of this potential deal in our report Examining the possibility of a Safran / Zodiac deal, published on 27 April 2016). We believe that this consolidation of the supply chain has been largely encouraged by the main airframers, at least initially, in a bid to:

■ Increase innovation capacity: Larger firms can spend more on development of new technologies and take more innovation risks.

■ Strengthen their financial position: One main risk in the industry is seeing a key supplier fail due to a deterioration in its financial situation (as illustrated in France by the difficult financial restructuring of aerostructures specialist Latecoere or those of Vought in the US in the 2000s, before its reorganisation and subsequent purchase by Triumph).

■ Cut costs: We think the airframers may see consolidation as a way to reduce production costs, allowing OEMs to ask for more price cuts in return (to be recouped by suppliers on the aftermarket). As a result, OEMs have been able to transfer some of the development risks and costs to a number of suppliers via RRSP (risks and revenues sharing partnership) agreements, reducing the capital they need to invest in new programmes.

Global Aerospace & Defence 15 4 May 2017

Figure 18: Elements of consolidation of the supply chain – United Technologies, Honeywell, Safran, Zodiac

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 United Technologies United Technologies Sundstrand Milton Roy Goodrich Rohr Coltec TRW Aeronautical Atlantic Inertial DeCrane Aerospace Microtecnica

Allied Corp Allied Signal Honeywell Signal Companies Honeywell Sperry Aerospace Chadwick Helmuth Baker Electronics Hymatic ERI Dimension Intl IAC EMS

Sagem SFIM Safran Snecma (Messier-Hispano-Bugatti) Messier Dowty TI Group (Dowty) Labinal Technofan Hurel Dubois Boeing Corinth cabling plant Goodrich EPS Eaton Power Distribution

Zodiac Zodiac Aerospace Parachutes de France Air Cruisers Pioneer Weber Aircraft Sicma Aero Seat Amfuel Monogram Intertechnique ESCO Icore Evac train Avox Systems C&D Aerospace In-Snec PISA Driessen Adder TIA Sell GmbH Cantwell Cullen & Co Heath Tecna IMS NAT Contour IPS TriaGnoSys PPP Greenpoint Tech Enviro systems

Source: Credit Suisse research

This aftermarket success may have led to excesses As a result of supply chain concentration and programme success, supported by continued pressure from OEMs on pricing, suppliers have been able to increase their aftermarket profits. This is creating a wider profit gap with OEMs and is now triggering pushback from airlines. Margins for the supply chain have risen over time The operating margin of our sample of suppliers (31 in total, including engine makers) has moved from 12.5% on average over 1999-2005 to nearly 15.0% over 2011-2016.

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Figure 19 charts how operating margins have trended since 1999 between Airbus and Boeing on the one hand and engine makers and suppliers on the other. We note two key takeaways:

■ Margins are very similar on average for engine makers and other equipment suppliers (see more on this below);

■ The gap in margin between the airframers and their suppliers has increased from the level of the early 2000s (c.5.5%) to about 8.5% since 2010 on average.

Figure 19: Operating margins – airframers vs suppliers in % of revenues, including exceptionals

20.0% 18.0% 16.0% 15.0% 14.0% 12.0% 10.0% 10.0% 8.0% 5.0% 6.0%

0.0% 4.0% 2.0%

-5.0% 0.0%

2011 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Gap suppliers / airframers - rhs Airframers (Airbus+Boeing) Engine makers (5) Suppliers (26)

Source: Company data, Credit Suisse estimates

The samples used for this calculation include:

■ Airframers: Airbus, Boeing; ■ Engine makers: GE Aviation, MTU, Rolls-Royce - Aerospace, Safran - Propulsion, UTC - P&W; ■ Suppliers: Astronics, B/E Aerospace, Curtiss-Wright, Eaton, Esterline, GKN, Goodrich, HEICO, Hexcel, Honeywell, Labinal DSA, Latecoere, LISI, Meggitt, Moog, Parker Hannifin, PCP, Rockwell Collins, Safran - Aircraft Equipment, Spirit Aerosystems, Senior, Smiths Aerospace, Thales Aerospace, Transdigm, Triumph, UTC – UTAS, Woodward, Zodiac, Volvo Aero. We have used segment profit for the suppliers and engine makers. This will slightly overstate the overall profitability of these segments (in particular for some of the US groups), which would probably be lower by a few tens of basis points if allocating some of the central costs. Also, we have not restated margins for capitalised costs at European suppliers, which would have a similar impact. When splitting the suppliers between aerostructures (GKN, Latecoere, Senior, Spirit Aerosystems, Triumph) and the others, it would appear that: 1) the latter enjoy a slightly higher margin than engine makers; and 2) excluding one-offs at one or the other, the margins of aerostructures suppliers were close to those of airframers until the mid-2000s, when a gap started opening in favour of suppliers. Excluding one-offs, aerostructures suppliers would on average generate an operating margin of 10-12% today.

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Figure 20: Operating margin: Airframers vs suppliers by type in % of revenues, including exceptionals

20.0%

15.0%

10.0%

5.0%

0.0%

-5.0%

2015 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2016

2017E 2018E 2019E Airframers (Airbus+Boeing) Engine makers (5) Aerostructures suppliers (5) Other suppliers (21)

Source: Company data, Credit Suisse estimates

We also looked at the operating margins of other airframers (GD – Gulfstream, Textron – Cessna, Dassault Aviation, Embraer and Bombardier). On average, it has decreased from 11% in the early 2000s to about 7-8% today. Until the 2010s, airframers excluding Airbus and Boeing have been posting margins about 500 basis points higher than the two leading commercial aircraft manufacturers. This gap has narrowed since 2010 to 250bp on average. This is largely driven by the deterioration of earnings in regional jets and bizjets. In particular, we believe that the balance was more equal between suppliers and airframers for bizjets as a result of the lower usage of these aircraft.

Figure 21: Operating margins – airframers in % of revenues, operating income, including exceptionals

20.0%

15.0%

10.0%

5.0%

0.0%

-5.0%

2007 2016 1999 2000 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015

2017E 2018E 2019E 2020E

All airframers Airframers (Airbus+Boeing) Other airframers

Source: Company data, Credit Suisse estimates

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Airlines' complaints about aftermarket costs have been rising Airlines have probably come to realise that their efforts to put pressure on OE prices are progressively obliterated by uncontrolled or excessive aftermarket price growth, driven by aircraft equipment makers that they did not choose in the first place and for which they have no (or little) alternative. Airlines have in particular been very vocal against what they denounce as aftermarket lock-up by some suppliers (which in this case include engine OEMs) and alleged price gouging. This is illustrated by the comments made by IATA, and by the EU commission requesting information on engine and aerospace equipment aftermarket. In December 2015 the EU launched a preliminary investigation into some segments of the engine and equipment aftermarket. In March 2016, the airlines trade association, IATA, filed a complaint with the EU focused on "the limited flexibility in negotiations for aftermarket services". The practical consequences (if any) of these investigations will not be known for some time. However, they demonstrate a change in the airlines' stance vis-à-vis aftermarket profitability. We believe that airlines may have started to push airframers to more closely control aftermarket prices, possibly as a condition for future aircraft orders.

Anecdotes point towards some strong aftermarket price increases ELC, an engine lessor, presented at ISTAT Europe (28 September 2016) a chart showing that the list prices for LLPs (Life Limited Parts) on the most popular engines increased by 70-85% between 2006 and 2016. ELC's purpose was to illustrate aftermarket price escalation, which it considered to be excessive. Based on list prices, LLPs for the CFM56-5B have increased at a 6.0-6.5% CAGR over the past 10 years, reaching north of US$3m for a complete set. This is consistent with increases for most engines, such as the CF34-8E or -10E, as illustrated in Figure 22.

Figure 22: Strong increase in list prices for LLPs In US$m, base 100 in 2009

180

160

140

120

100

80

60

40

20

0 CFM56-5B CF34-8E CF34-10E

2007 2009 2014 2016

Source: Credit Suisse research

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Airframers may perceive this margin boost as a subsidy to the Chinese industry We believe that the aftermarket-driven margin boost described above may be seen by Western airframers as a sort of 'subsidy' for the emerging Chinese aerospace industry, with all US and European large equipment suppliers participating in Chinese programmes. We think they may be effectively leveraging the benefits derived from the aftermarket on Western jets to absorb the investments made in Chinese products. This may modify further the relationships of Airbus and Boeing with their supply chain, in a bid by the airframers to protect their technological advantage. At the same time, airframers have also been trying to support the development of some Chinese suppliers as a means to increase competition in the global supplier arena. However, they must do so: 1) without unbalancing their own market in the long term (i.e. by doing too much to support the emergence of a coordinated Chinese industry); and 2) while protecting Western military needs and maintaining a lead in this area vs China (with significant pass-through between civil and military aerospace technologies).

A slow start for China in aerospace We do not believe that Chinese competition in commercial aerospace will present a meaningful challenge to the Western aerospace industry in the short term. So far, China's programmes have not been very successful (e.g. the ARJ21 and C919), with technological challenges limiting the actual threat to Airbus and Boeing, in our view. During our June 2016 visit with five Chinese airlines (including the 'Big 3'), they indicated that while they have ordered some aircraft from the Chinese state-owned aerospace manufacturer (COMAC), they have done so in very small quantities (fewer than 15 units each) and have no expected timeframe for entry-into-service. The airlines also indicated that they and their customers are very content with fleets comprised of Western aircraft. Despite issues with the development of both the ARJ21 and C919, we believe that China will produce a competitive aircraft at some point in the future by leveraging its key strengths: 1) its local market (15-20% of current global deliveries), 2) the availability of local strategic industry financing, and 3) lower production costs (despite increasing labour costs).

Current local programmes and projects The ARJ21 was launched in 2001 and finally entered into service with Chengdu airlines in 2016, following many certification issues. So far, COMAC has delivered three aircraft to this airline. At the end of 2016, COMAC indicated that the ARJ21 still needed optimisation for cabin noise reduction, simplification of warning systems, solving a door pressure issue and improved operational capability in heavy rain (FlightGlobal, 21 April 2017). The COMAC C919 was launched in 2008 and its first flight was initially targeted for 2014. In early September 2016, the first flight was announced for late 2016, but has been further delayed and is now expected before mid-2017, while its entry in service is not expected before 2019 (Aviation Week, 15 September 2016). China has also indicated that it plans to create a 50/50 JV with Russia for the development and production of a widebody aircraft (baseline at 280 seats), with entry in service slated for 2025-2027, with a carbonfibre wing, fly-by-wire, etc. It was initially announced in late 2014. COMAC, representing the Chinese interest in this programme, indicated at the Zhuhai Airshow on 2 November 2016 that it would soon start the selection process for the suppliers. United Technologies and Honeywell also indicated that they had contacts with COMAC on this topic (Reuters, 2 November 2016). At the Farnborough airshow in July 2016, COMAC stated that the engines will be supplied by either GE or Rolls-Royce. We see this as an attempt by China to gain experience with composite materials as well as

Global Aerospace & Defence 20 4 May 2017

aircraft design and certification (an area where we think it has been lagging behind Western aerospace manufacturers). During our trip to China in June 2016, we had the opportunity to meet directly with COMAC, and learned that its biggest surprise on the C919 program has been the complexity of integrating an aircraft from its many components. China recently announced the regrouping of its engine assets into one entity (AECC: Aero Engine Corporation of China) tasked with developing commercial and military engines to meet China's needs. While China is quite optimistic about its new engine company, we believe this is among the most difficult challenges the Chinese aerospace industry will confront, and therefore do not see this as a plausible threat to Western OEMs before the end of the next decade.

No more differentiation for Airbus and Boeing from Western engines and equipment All of the equipment that is supplied to Western aircraft manufacturers is also available to Chinese manufacturers (and to other airframers worldwide), including engines, avionics, landing gear, electrical systems, etc. We think that this shift in balance is likely to lead to an evolution in the relationships between Airbus and Boeing and their main suppliers, as detailed later in this report. We note that the presence of Western suppliers is very strong in areas with high aftermarket content. The aftermarket on their existing aircraft may be seen by Airbus and Boeing as a subsidy to the development of Chinese competitors. We note Airbus' COO Fabrice Bregier's comment in La Tribune on 15 June 2016: "One should not believe that China needs other allies than the Western partners and equipment suppliers working very hard for the success of the C919". As a result, we think that Airbus and Boeing will try to stay competitive by regaining control of some technologies to make them proprietary and to reduce the cost of production of their own products. The best engine technology is available to all airframers Recent programmes have demonstrated that these fuel burn gains are available to all airframers in Europe and the US, but also in Canada, Brazil and China. For instance, the LEAP-1C engine that will power the Chinese C919 is very similar to the LEAP-1A for the A320neo (commonality is about 90-95%, according to Airbus). Figure 23 below summarises the various engines developed by CFMI and Pratt&Whitney and their derivatives for other programmes.

Figure 23: New engine programmes – original platforms and derivatives Engine Original platform Airframer Derivative engine Additional platform Airframer CFMI LEAP-1A A320neo Airbus LEAP-1C C919 COMAC Pratt&Whitney PW1100G A320neo Airbus PW1400G MS21 Irkut Pratt&Whitney PW1500G CSeries Bombardier PW1900G E195-E2 Embraer Pratt&Whitney PW1200G MRJ Mitsubishi PW1700G E175-E2 Embraer Source: Company data, Credit Suisse estimates

As a consequence, we argue that engines in themselves can no longer be seen as a technology differentiator by the airframers (beyond integration of the engine to the airframe).

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Almost all Western equipment suppliers are participating in the emergence of the Chinese aerospace industry Figure 24 lists all the Western equipment suppliers involved in the ARJ21 (Chinese regional jet) and the C919 (Chinese equivalent of the A320), either directly or via JVs with local partners. The only notable absences are aerostructures producers, as most of this is done domestically. A similar phenomenon can be observed on the MS-21 from Russia, with more local suppliers (e.g. for the landing gear) and most suppliers working jointly with a local partner.

Figure 24: Western suppliers / partners to ARJ21/C919 and MS-21 ARJ21 C919 MS-21 Engines GE (CF34-10) CFMI (LEAP) UTC (PW1400G) Nacelles GE Nexcelle Bombardier APU UTC Honeywell UTC Landing gear Liebherr Liebherr - Wheels & brakes Liebherr, Meggitt Honeywell Meggitt Brake control system Meggitt Crane Meggitt Tires Goodyear Michelin - Electrical system UTC UTC UTC, Zodiac Wiring systems GKN Safran - Evacuation system Zodiac Zodiac Zodiac Avionics Rockwell Collins GE Rockwell Collins Cockpit control system Eaton Eaton - Fuel system Parker Hannifin Parker Hannifin Zodiac Exterior lighting UTC UTC - Anti-ice system Liebherr Liebherr UTC Fly-by-wire system Honeywell Honeywell UTC Cabin management system Safran Rockwell Collins - Air management system Liebherr Liebherr UTC Water & waste system Zodiac Zodiac Zodiac Hydraulic system Parker Hannifin Parker Hannifin Eaton Fire detection UTC UTC UTC Oxygen system B/E Aerospace Zodiac Zodiac Cabin interior FACC FACC Zodiac Galleys FACC Zodiac Zodiac Lavatories FACC FACC Zodiac Crew seats Zodiac Zodiac Zodiac Source: Company data, Credit Suisse research

We believe that large Western equipment suppliers see the emergence of a Chinese airframer as a potential source of new business and an opportunity to reduce the relative weight and influence of Airbus and Boeing – as long as they can manage their IP concerns. For instance, the CEO of GKN recently stated that "China is very keen to build its own aircraft and we would like to gain a share of the market. It is a long hard road but they will get there and GKN would like to help them in their success" (The Telegraph, 21 August 2016).

Chinese partnerships with Western airframers and M&A China's key weaknesses as it looks to build up its aerospace industry (lack of technology maturity and weak fleet support) are also being addressed through partnerships with Airbus, Boeing, Bombardier, Embraer and Russia. As discussed in more detail later in this report, Western airframers appear to be leveraging these partnerships to generate some competition in cabin interiors.

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In 2006, Airbus agreed to the creation of a final assembly line for the A320 family in Tianjin, with around 300 deliveries made since 2009. Airbus has stated that the creation of an A330 completion center in Tianjin in a JV with its Chinese partners will open up opportunities for local entities to supply seats and cabin interior elements for installation on the aircraft, which will be flown empty from France to Tianjin. In September 2015, Boeing and COMAC announced a plan for a completion center (interior installation, painting and delivery to Chinese customers) in China for the 737. It will open in Zhoushan. No timetable is available. China has also developed what appears as a structured approach to M&A in the sector, with acquisitions in galleys, seats and other elements of the cabin interior, as shown in Figure 25.

Figure 25: Acquisition of cabin interiors suppliers by AVIC Company Products in the cabin Location AVIC ownership Year of purchase Avic Hubei ALI-Jiatai Economy class seats China 100% FACC Overhead bins, ceiling, lining, monuments Austria 55.5% 2009 AIM Altitude Galleys, Interiors UK 100% 2016 Thompson Aero Seating Business class seats UK 100% 2016 Source: Credit Suisse research

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Technology disruptions may help airframers reshape the balance with the supply chain We see airframers shifting their focus from design innovation to process innovation. In our view, they would concentrate less on reducing operating costs going forward (pilot and labour in the 1980s, fuel in the 2000s) than on cutting ownership costs (via the reduction of production costs and better control of the aftermarket). This shift would potentially offer airframers an opportunity to both: 1) continue reducing aircraft costs and absorb price pressure from airlines; and 2) possibly regain some control over aftermarket revenues and profits and thus reshape the balance with their supply chain. New technologies (in particular automation, 3D printing and digitalisation) are in our opinion the enablers of this – in a departure from the situation that has endured for the last 30 years. The end of a fuel-driven technology cycle? As a key element of airlines' operating costs, fuel efficiency will obviously remain important for the operators and for the industry. However, in our opinion, it is possible that the relative weight of fuel efficiency in the aircraft value proposition may decrease, at least from the airframers' point of view, following 15 years of fuel-driven technology investments. We expect fuel efficiency to remain a focus for engine OEMs, but the availability of engine technologies to all airframers may make this less of a differentiator for Airbus and Boeing.

2000s-early 2010s: aircraft design influenced by high oil prices Airframers have typically launched new programmes when they managed to obtain a 15% decrease in operating costs vs the previous generation of aircraft. This 15% is generally attained via the combination of a number of factors: increasing the number of passengers in a given cabin space, improving the payload, range or airfield capacity of the aircraft (as for the A321 today) and reducing purchasing, operation and maintenance costs. Aircraft designed from the beginning of the 2000s to the early 2010s (787, A350, A320neo, 737MAX, CSeries) all share the same main design goal: improving fuel efficiency vs the previous generation as a reaction to oil price rises. This has generally been accomplished through engine technology and increased use of composite materials. This design strategy is in our view largely explained by the change in the oil price environment over that period, with the underlying view in the late 1990s and 2000s that global oil production was fated to decline and a sharp and permanent rise in oil prices would follow. As illustrated in Figure 26 (which shows Brent from 1970 to 2016), the oil price traded in a 20-40 US$/bbl range between 1985 and 2000, after which it rose to exceed 120 US$/bbl twice in the course of a few years. The improvement in fuel burn also conveniently reduces CO2 emissions (which are a direct function of the amount of fuel burnt). This period after 2000 also coincided with the demise of four-engine aircraft such as the 747, A340 and A380. We think that a combination of the higher oil price, the fragmentation of international air travel and the change in ETOPS rules has made these aircraft less attractive.

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Figure 26: Aircraft programme launches and oil price Year of programme launch, Brent in US$ / BBL

160 A320neo 737MAX

A330neo 140 777X 120

A350 100 757 787 A340 / 80 737Classic A330 777 v2 A310 737NG 747-400 A380 60 767 777 A340 v2 A320 MD-80 40 737 A300 20 747 MD-11

0

1976 1998 1965 1966 1967 1968 1969 1970 1972 1973 1974 1975 1977 1979 1980 1981 1982 1983 1984 1986 1987 1988 1989 1990 1991 1993 1994 1995 1996 1997 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016

Source: Company data, Thomson Reuters, Credit Suisse research

2015 and beyond: the industry may be anticipating a change in the oil supply balance A commonly held view in the aerospace industry (also shared by BP in its latest outlook report) is that the rise of shale oil and the return of Iran on the world oil market are possibly driving a strategic change in oil supply levels, compounding trends in demand that will see the progressive switch to electrical cars. This in turn is seen as potentially limiting oil price increases in the foreseeable future, making over-investment in fuel burn technologies less critical relative to other factors. Consensus amongst airlines and OEMs appears to be that oil prices are likely to stabilise at levels between 50 and 70 US$/bbl, at least for a few years. The debate is more open for the mid-term, with some aerospace industry players expecting the oil price to rise back to US$100 or more and others expecting it to remain below US$50.

Figure 27: Supply of oil crude oil in millions of daily BBL – to December 2016

12,000 40,000

35,000 10,000 30,000 8,000 25,000

6,000 20,000

15,000 4,000 10,000 2,000 5,000

0 0 01/01/1991 01/04/1994 01/07/1997 01/10/2000 01/01/2004 01/04/2007 01/07/2010 01/10/2013

US Saudi Arabia OPEC - RHS

Source: Thomson Reuters

Global Aerospace & Defence 25 4 May 2017

Fuel vs other direct operating costs This assumption of a possibly structurally lower oil price reduces (but does not eliminate) the relevance for the airframers of focusing on technologies to reduce fuel consumption as a way to cut aircraft costs. As a consequence it makes other areas stand out, in our opinion. Direct operating costs (DOCs) for US airlines are dominated by fuel costs (33% at the end of Q3 16, with a peak at 58% in 2008), marginally higher than in the 1990s. The relative decrease in fuel costs has led to a relative increase in the proportion of costs represented by other categories. We believe in particular that it makes the cost of ownership and the cost of maintenance stand out:

■ The cost of ownership of flight equipment (aircraft and their engines) bottomed out in 2011 (12%) and was at 22% on average in the 1990s. It accounted for 17% of DOCs in Q3 16.

■ Maintenance costs have totalled 22% of DOCs in Q3 16 and have fluctuated in an 18- 27% range since 1990.

Figure 28: Direct operating costs breakdown in % Figure 29: Direct operating costs in US$bn in % of total DOCs – all US carriers – 1990 - Q3 2016 in US$bn, – all US carriers – 1990 - Q3 2016

100% 28 90% 80% 21 70% 60% 50% 14 40% 30% 7 20% 10%

0% 0

2000 2001 2002 2003 1990 1991 1992 1993 1995 1996 1997 1998 2005 2006 2007 2008 2010 2011 2012 2013 2015 2016

2011 2015 1990 1991 1992 1993 1995 1996 1997 1998 2000 2001 2002 2003 2005 2006 2007 2008 2010 2012 2013 2016

Fuel Pilots Maintenance Rentals D&A/flight equipment Other costs Fuel Pilots Maintenance Rentals D&A/flight equipment Other costs

Source: US Department of Transportation (DoT) data Source: DoT data

Effectively, we could be approaching the limits of fuel efficiency improvements, barring major technological leaps involving structural changes in aircraft design. In its Vision 2050 report (January 2011), IATA illustrated the progress made in energy efficiency (i.e. how much energy each new aircraft type is consuming per passenger kilometer) thus far. IATA indicated that significant new progress to reduce fuel consumption could be achieved by changing aircraft design and configurations. We think that this also shows that the upside that can be derived from new engine technology is more limited now, given the level of efficiency already reached.

New engine technologies but more challenging to implement There will be continued engine performance improvements (new materials, refinement to architectures, etc.) but they are more difficult to achieve and the higher sophistication of these engines typically comes with higher prices, more complexity and heavier maintenance costs, partly offsetting the benefits of the lower fuel price.

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We note a decrease in the mentions of new engine technologies and a lack of obvious enthusiasm from airframers for disrupting engine types such as open rotors (Fabrice Brégier, the COO of Airbus, expressed what we perceived as some veiled doubts on open rotors in an interview in la Tribune published on 15 June 2016). We believe that the technology for open rotors is still far from ready (owing to issues around noise and vibrations) and we also think that they would face significant regulatory challenges and trigger major infrastructure modifications (e.g. it is not clear how numerous open rotor aircraft could be operated in current airports). We also believe that aircraft innovation cannot be too extreme and requires both main OEMs to follow a similar path to ensure wide-ranging acceptance.

Fuel efficiency is not driven only by engine technologies Engine technologies have been a key driver of fuel burn improvements, together with the use of composite materials. We see the latter continuing to expand in aircraft manufacturing. Systems to better manage the flow of air traffic also offer significant upside to fuel burn improvement. Composite material to expand The use of composite materials to make aircraft lighter is likely to continue and expand in the aircraft and the engines. This will include CMCs (Composite Matrix Ceramics) in engines' hot sections, for instance, allowing engines to run at hotter temperatures and be more fuel efficient. The development of composites to the fuselage of short haul aircraft will, however, require that maintenance challenges are solved, as these are more prone to ground handling damage than widebodies.

Figure 30: Composite materials as a % of structural weight at first flight

60%

787 A350 50%

Cseries 40% A400M E170/190 30% ERJ145 A380 20% A340 A320 A330 777 A340-500 10% A310 767 A300-600 MD11 737 747-100 MD80 L1011 757 747-400 MD90 0% 1960 1970 1980 1990 2000 2010 2020

Source: Company data, Credit Suisse research

We also see new metallic materials continuing to be developed for the aerospace industry, through lighter alloys or new production technologies such as 3D-printing, for instance.

New cockpit technology Cockpit efficiency has also been a key driver. New flight technologies introduced since the 1980s (fly-by-wire, for instance) have reduced the workload in the cockpit and as a result the number of technical people needed to fly an aircraft (eliminating the need for a flight engineer), thereby reducing employment costs for airlines.

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Other technology improvements will drive fuel cost improvements outside the immediate realm of airframers; e.g., smarter navigation and landing systems (ADS-B, for instance) and new air traffic management systems (SESAR in Europe, NexGen in the US). New production technologies also disruptive for the aerospace industry We believe that disruptive technologies will help reduce the production costs of aircraft, pushing OE costs down. We have looked at: 1) automation and robotics, 2) additive manufacturing and 3) digitalisation (industry 4.0), and how they are adopted throughout the supply chain, from airframers and engine makers to Tier 2/3 suppliers. We also believe that these evolutions in production technologies create opportunities for Airbus and Boeing to alter the competitive landscape in their favour. In particular, they could lead to some in-sourcing and better IP control. This may in turn disrupt the current profit balance existing in the aerospace industry, and bring it back over time to a more favourable state for the airframers vs their suppliers.

Disruptor 1 – Manufacturing automation and robotics We see industrial automation and robotics as a structural positive for airframers and aerostructures manufacturers. Slow historical penetration of automation in aerospace The penetration of automation has historically been held back in aerospace by the low volumes of production, high levels of customisation and long lead times that prevail in this industry. It has been largely centered on drilling and riveting (largely repetitive), while assembly of aerostructures remains a highly labour-intensive activity, with many customisation tasks. Airbus has stated that automated tasks in the automotive industry typically last for 1.5 minutes and take about one month to programme; a typical task in aircraft production will last for hours, representing a daunting programming challenge. We note that some of the major technological advances made by German specialist Kuka have been in conjunction with the German Aerospace Center (DLR). Changes coming from increased flexibility of automation Progress in industrial automation technologies and robotics, however, is set to allow increased flexibility in production and reduce the difficulties faced in programming (cf. CS Global Cap Goods report on the Hannover Messe published on 29 April 2016 - More questions than answers from Hannover). We expect automation to spread to the final assembly lines of all aircraft manufacturers, even if it is unlikely to reach the level of penetration of the automotive industry for the foreseeable future. We already observe a number of moves in this direction, with automated assembly lines being developed (by final assembly line specialist Ascent, for instance). Airbus is considering using robots to carry out some heavy duty tasks on its assembly lines and assist human workers in some difficult tasks, while Boeing is introducing more automated riveting in its facilities (MTM). Benefits for the aerospace industry This enhanced flexibility in production allows more tasks to be automated (reducing errors and improving quality) while taking into account the variability of the products and customisation requests. A key feature of new automation equipment is its versatility, allowing it (or part of it) to be used for various different programmes rather than being programme-specific, as is largely the case today. This technology is needed both to increase production rates and reduce unit costs.

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Fixed costs would decrease, with more capital but lower labour costs for the production of the same volumes (more capital dollar per output, but less labour dollar per output). Effectively, shorter cycles mean fewer man-hours for the production of one unit of output. It also helps contain the need for more floor space to accommodate increases in production rates. Production costs are typically split as follows: 55-60% for material costs, 20-25% for staff and 15-20% in overhead costs. Automation can reduce the labour cost per units produced as well as reduce the material costs portion through the decrease in non-quality costs (waste of material, absence of errors, etc.). Faster production cycles would also help reduce WCR (improving inventory turns). Several examples mentioned in the press (for instance, Ascent automatisation of the wing assembly for a bizjet, in Aerospace Manufacturing, August / September 2016) refer to cycles being halved owing to the implementation of automated assembly. The costs of these solutions are likely to decrease as a result of more automation offerings being put on the market. This will make them more affordable and likely further increase their penetration. However, given the financial burden of the existing tooling for current programmes, we would expect these solutions are concentrated on new aircraft and upgrades only. We see this as a long-term process spreading over the next decade (essentially corresponding to the development cycle of one aircraft). During our 4 April 2017 visit to Airbus factories in Hamburg, we were shown activities that will be automated in the new assembly line due to start in 2018, for the drilling of the fuselage sections at the moment of their junction, with a 7-axis robot. Airbus expects this to save 50% of the manual work on the station and to allow workers to be reallocated to more value-added tasks. Another aspect of automation is Airbus' attempt to use drones to visually inspect planes (specifically, the upper part of the aircraft) and check them for quality issues (scratches or painting flaws, for instance). This allows Airbus to significantly reduce the downtime of aircraft, cutting inspections from two hours to 10-15 minutes, while also improving the safety and comfort of the operators. The example of Electroimpact's project on 777X Electroimpact has won a large number of the contracts for the automation of the assembly of the 777X programme. Aerospace Manufacturing indicates that the IP on the machine heads used for this programme will stay with Boeing. Competitors to the airframers will have to either buy the underlying machines from Electroimpact and develop another design for the heads or purchase similar machines from rival assembly specialists. China is also embracing automation Labour costs in China have been rising steadily and we would expect them to continue increasing. They will most likely remain below Western labour costs, but the gap should shrink, together with Chinese competitiveness. As a result, we also see China embracing automation and robotics, with the advantage of not having to manage an existing production asset base. This makes Western efforts on automation even more important. We believe that this Chinese expansion in industrial automation will leverage various recent acquisitions. In April 2016, AVIC bought Aritex, a Spanish specialist in final assembly lines and their related tooling, including automated drilling and riveting. The Chinese appliance maker Midea has just purchased Kuka, the German robotics and systems firm, which has numerous projects and activities in the aerospace industry (on the new 777X facilities for Boeing, for instance).

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Disruptor 2 – Additive manufacturing We believe that additive manufacturing fits naturally into the production process of the aerospace industry; its flexibility and speed match well with the sector's low volume series and high customisation. Single parts that replace a combination of several different parts can also be designed and produced, allowing significant weight savings. In Hamburg, Airbus showed us a new part that is 45% lighter than its current equivalent. The aerospace industry has seen slow additive manufacturing penetration… until recently Additive manufacturing is currently used for rapid prototyping of new parts and the production of some low-risk parts. We believe rapid prototyping could cut costs and development cycles, as it has done in the automotive industry. For example, Ford has stated that additive manufacturing has reduced the cost and time taken to produce the prototype of an intake manifold from US$500k and four months, respectively, to US$3k and four days (ComputerWorld, 17 May 2016). The high cost of materials currently is a key reason behind the slow penetration of this process, which essentially cancels out the decrease in the buy-to-fly ratio (to only 5-10% of the amount of raw material purchased to generate one finished part versus traditional production methods). Rolls-Royce has used additive manufacturing to produce a small quantity of the 1.5m diameter front-bearing housing for the Trent XWB-97 (the A350-1000 engine), which led to a 30% reduction in the development time needed to manufacture this titanium part. However, it will not be used for full-scale production, as the technology is not cost effective yet. Addressing the main hurdles to growth in the sector We believe the 3D printing industry is addressing the two main hurdles it faces in expanding in aerospace by:

■ Demonstrating that parts manufactured with 3D printers are as reliable and safe as parts made via traditional forging, casting, CNC machining or injection moulding; and ■ Improving its cost competitiveness. As a result, we believe 3D printing will continue to expand in mainstream aerospace production. However, as it modifies the way materials are used, it will need to demonstrate their reliability (for safety purposes) and we believe the adoption of 3D printing will be slower than that of automation in the aerospace industry. The industry is actively addressing this issue, with quality-assurance software products such as the PrintRite3D® from Sigma Labs. We find that engine manufacturers are the most active in this field, as detailed later in this report. Benefits for the aerospace industry One key difference with traditional techniques is the variation in the cost curve. Tooling costs lead to high unit costs for low volumes, declining as production increases. 3D printing has a near-flat cost curve, largely independent of the number of units produced after the initial capex has been spent. We would then expect additive manufacturing equipment to gradually replace other capex in the industry, cutting production costs, and, above all, reducing cycles and inventories, in our view. Another potential attraction of additive manufacturing for aircraft OEMs is the possibility to insource some of the production of parts rather than have them produced outside. This would help the OEMs gain better control over the technology they need for their products and thus address the competition from emerging OEMs.

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We also see additive manufacturing expanding in aftermarket (for instance to support maintenance in remote areas). It may also allow for more customisation of OE parts, in non-flight-critical areas, in particular. These technologies may be able to lower the breakeven point of a programme, with lower NRCs (non-recurring costs) to absorb. As a result, this may allow OEMs to launch more specialised/niche aircraft types. The example of Textron Aviation Textron is a leader in the shift towards automated aerospace manufacturing, as exemplified by the robot-based manufacturing cells found in Textron’s aviation plants. During our visit to the Textron Aviation plant in Wichita in late 2015 (see our report Aviation meeting - Strong productivity efforts should boost margins, 8 December 2015), Kuka robots were found drilling holes in a light jet bulkhead; these robots can drill 2,000 holes in <10% of the time it takes to do the same task manually. About 10% of the drilling at the site we visited was carried out by robots, but we expect this ratio to expand significantly in the years ahead. New jets such as the Longitude will be produced from Day 1 with a much higher degree of automation than prior model launches, which should reduce the time it takes for the production of the jet to reach the mature part of its cost curve. Moreover, Textron does much of the system integration on robots. This can reduce the cost of the robot manufacturing cell implementation by 75% (to ~US$0.3m), as well as enable Textron to easily expand the usage of automation into other segments such as Bell Helicopters. Historically, a barrier to automation penetration within Aerospace has been the low volumes involved relative to, for instance, the automotive industry – this reduced the ROI on the robot investment. Rendering the robots more mobile and flexible can reduce this problem though, as one robot can work on several different aircraft during a shift and hence be more fully utilised. The example of Boeing and Norsk Titanium for the 787 Boeing announced on 10 April 2017 that Norsk Titanium would supply 3D-printed structural parts for the 787, which would eventually save an estimated US$2-3m per aircraft, according to Norsk (Thomson Reuters, 10 April).

Disruptor 3 – Digitalisation We expect significant changes to be driven in the A&D industry by the increased use of digitalisation and cloud computing. In particular, the resulting control and leverage of IP by airframers will likely allow them to alter the balance of power in the industry, in our view. Digitalisation has always been a feature of the aerospace industry We believe that the aerospace and defence industry has always been at the forefront of digitalisation, for instance through the development and use of CAD/CAM tools such as Dassault Systemes' CATIA. Dassault Systemes was sponsored at launch by Dassault Aviation (it started as an internal effort in 1977 before being incorporated in 1981) and a majority of its customers came from the aerospace and defence world, before it expanded into other areas. In fact, many internet technologies originate with the US DoD. Therefore it only seems fair that the most recent developments in digitalisation of the industry would find their place in the sector. In the 1990s, the 777 was the first aircraft built directly from a digital mock-up. Dassault Aviation's Falcon 7X was the first aircraft designed in the 2000s with a virtual plateau, where all suppliers were first regrouped on Dassault's premises before returning to their own locations and connecting to a single integrated virtual mock-up from there.

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Changes it brings to the industry Digitalisation covers several technologies, including big data, advanced analytics, man- machine interfaces, digital-to-physical transfer and cloud computing. It is impacting how technologies are used and how business models evolve. Instead of discussing digitalisation trends and issues for these technologies as a whole (for instance questions around standards and open environments), we focus here on how digitalisation impacts several specific areas: products and services offering, design, manufacturing and 'the internet of things', all connected via a common cloud, to use the classification presented by Rolls-Royce at its recent Capital Market Day: ■ Products and services: Data can be opened to partners or third parties (e.g., Rolls- Royce has established a JV with Singapore Airlines to use its flight analytics data); new offerings can be developed, with Rolls-Royce giving the example of autonomous ships (one might expect autonomous aircraft to follow in the future and that air traffic control will become a strategic asset); ■ Design: The increase in computer performance allows for ever more sophisticated design, which can be modified and prototyped in a matter of days rather than months thanks to additive manufacturing. The digital mock-ups can be extended to include real-rendering virtual reality systems, such as the cabin virtual mock-up shown to us by Airbus in the A350 cabin configuration centre on 4 April 2017 (with a whole cabin in 3D matching the actual look of the airline's choices down to the smallest detail). ■ Manufacturing: The use of cloud computing should help improve the efficiency of manufacturing and ensure, for instance, seamless links with the supply chain. ■ Internet of Things: Tracing parts and their use, for example. Benefits for the aerospace industry Digitalisation could benefit the aerospace industry in many ways, including:

■ Reduction in cycle times for development, production and support; ■ Innovative offerings; ■ Quality improvements; ■ Knowledge build-up; and ■ Control of IP (intellectual property). Development cycles could be shortened as digital mock-ups, production systems and documentation can be integrated seamlessly across the supply chain. Aircraft development currently spans more than five years for a brand new programme and 3-4 years for an upgrade. Digitalisation can potentially shorten this, leading to a significant reduction in non-recurring costs and therefore OE costs and aircraft prices. Digitalisation for instance ties into a more automated production system and the 3D-printing of some parts. New offerings can be developed by the OEMs, for instance by leveraging the Internet of Things to track spare parts and inventory levels or refining health management systems for engines and main aircraft equipment. For instance, on a 737-800 (current generation), there are about 1,000 flight data parameters measured today, according to Aircraft Commerce (March 2017). On 737MAX8, this number rises to 15,000 data points to monitor. Leveraging it or even simply making some sense of this data trove requires new tools and creates new opportunities. Digitalisation is also helping to improve quality by reducing the number of interfaces and the risks they generate and by having better control of quality across the supply chain, making sure processes are aligned and robust at all levels. Digital continuity from design to operation of the aircraft simplifies the whole process and makes it more robust. It offers the tools to ensure that the maturity of supplier-furnished equipment is not lagging behind.

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This is a key area that Airbus representatives flagged when we visited the A320 FAL in Hamburg in April. It can also allow corporates to build a knowledge database with the tools to access and leverage it, offsetting some of the consequences of the retirement of an ageing workforce (a key factor for Western aerospace companies). It can also be used to more easily train the younger workforce. More digitalisation (and cloud computing in particular) will also likely come with more control on IP for OEMs. They could be in a position to better track use of the digital information by suppliers, better allocate and trace its ownership and even reflect that on aftermarket and support offerings (through either preventing the use of this information or controlling it more tightly). The internet of corporations Overall, the pace of change resulting from digitalisation is increasing exponentially, with an impact on decision making (owing to faster and better information gathering and accelerated implementation of any decision). It also raises the question of interactions with the Tier 1 suppliers / engine OEMs and their own cloud offerings, which they will want to keep segregated from the airframers' while collaborating with them. As the former CEO of Embraer put it in editorial published in Aviation Week (3 February 2017): "Will the competition of companies evolve to become a competition of networks of companies? Will there be a vertical integration of the aviation supply chain as a result of one party having control of all, or most, data and information?" We believe this will allow airframers to select suppliers that will accept participating in their own platform and to compel them to share some of the IP created in this environment. The example of Airbus and Palantir In January, Airbus disclosed that it has been working with Palantir on the final assembly of the A350, helping to reduce the cost of production using data analytics. Airbus has been using Palantir on seven other projects but will add more in the future (FT, 19 January 2017).

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Consequence 1 – Disruptions to the supply chain We expect a strategic effort from the airframers to reduce the margin gap with their supply chain, via increased pressure on both OE and the aftermarket. This may go through some disintermediation following a reassessment of the role of the supply chain as described in the previous section of this report, made possible by disruptive technologies and a shift in focus towards process innovation rather than product innovation. As a result, we expect suppliers to continue to invest in order to maintain their relevance to the OEMs, putting some pressure on their cash and earnings. It will also encourage consolidation, when not opposed by the airframers. We cannot see a better example of this than the recent comment made by the CEO of United Technologies (the world's largest aircraft equipment supplier): "The dynamic that's changed in the marketplace is [that] any of the sub-suppliers to the OEMs are going to get tremendous pricing pressure because of the margins that we make versus the margins that they make. (…) For our margins to get above 20%, we become a target." Greg Hayes, UTC's CEO at Barclays Select Industrial Conference, 22 February 2017. In this context, we think that aerostructures suppliers may be the most at risk. The pressure on Cabin Interiors has been rising for a while and it could increase further, but its direct access to airlines and independence from airframers can help to contain it. Engine makers are likely to be able to contain the risk and pass most of the pressure on to their own supply chain, in our opinion. However, we note that it is difficult to find short-term consequences that have not been impacting the supply chain already, such as increasing R&D and pressure to cut costs and increase capex and improve operational reliability. An airframer effort to rebalance the relationship with the supply chain We expect a change in the way contracting is done in the industry, with more control sought by airframers to better contain OE and aftermarket costs and repatriate some margin from their suppliers. We effectively see automation, 3D printing and digitalisation as the enablers of this. Pressure on the supply chain economics In our view, the change that we expect in the relationship between airframers and their supply chain will translate into:

■ Continued cost cutting;

■ Evolving contracting policies;

■ The award of some contracts away from traditional sources;

■ A reduction in outsourcing levels;

■ The airframers' opposition to certain concentration moves;

■ The leveraging of cloud computing by OEMs to better control IP. We also believe that a dampening factor is the need for airframers to maintain a low level of industrial risk and avoid introducing too many new partners on a given programme, as illustrated by the impact faulty suppliers have had on the development and ramp-up of 787, A320neo and A350. As a result, changes will likely be gradual, spread across several years.

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Continued cost cutting We expect cost-cutting plans at Airbus and Boeing to continue, with rising price pressure on suppliers, aiding the airframers' efforts to reduce their prices, especially in a low- inflation world. Airbus is implementing its SCOPe+ plan for the A320, calling for a reduction of 10% of the supplier costs for the A320 vs the 2015 reference. The ways and means to reach this target include incremental developments, redesign of parts, review of costs with an increase in volumes to >50 aircraft per month, introduction of double sourcing where needed and a shift from BFE to SFE on some parts. Boeing's PFS 2.0 (Partnering For Success) has been relentlessly pursued, with suppliers mentioning demands for immediate cuts of some 15% to prices in return for future business on new programmes. Safran for instance attributed the margin reduction it faced in H2 2015 in cabling systems to this pressure. New contracting policies Recent months have seen comments surface on changes to contracting policies by Boeing. The most visible has been the loss of a small aftermarket contract by Spirit, not renewed by Boeing. We understand that these discussions include caps being introduced on aftermarket escalation and OE multipliers and some royalty payments being imposed on the suppliers for the use of Boeing's IP. Suppliers with strong positions have typically reacted by offering an increase in OE prices to offset the cut to their aftermarket earnings. Less favourable payment terms have also been mentioned, with Meggitt attributing its disappointing WCR performance in H1 16 to this source. Our channel checks have also flagged changes at Airbus, with adjustments to GTAs (General Terms Agreements) to add performance incentives to existing contracts (probably a consequence of the A320neo and A350 supplier issues in 2015-16). At the Speednews conference in September 2016, Aernnova (a EUR650m aerostructures supplier headquartered in Spain) mentioned the "re-alignment" of contractual conditions imposed by airframers, to include competitiveness clauses, for instance. Our channel checks suggest that OEMs (airframers and engine makers) have moved in recent years to prevent others from utilising OEM IP for free to produce their own. Note that they no longer supply their detailed drawings for free to suppliers or MRO providers. Contract awards to new entrants / smaller suppliers Boeing has also elected to award contracts on new programme to new entrants or smaller suppliers, displacing large established suppliers. A clear example of that has been the 777X landing gear going to Canadian Heroux Devtek instead of the incumbent UTC. Boeing has also been pushing new entrants in the cabin, from China (seats from AVIC in 2012) or Turkey (lavatories and shells for business class seats in 2015). Airbus is working with Chinese partners to develop a supply chain to support its recently launched A330 completion centre in Tianjin. The group has been working with AIM (a UK-based company taken over by AVIC) and FACC (an Austria-based supplier, partly owned by AVIC). Reduction in outsourcing We believe that airframers may also decide to reduce outsourcing in the future, in a bid to reduce industrial risks (in particular at Boeing after the 787 troubles) and to keep control of some differentiating elements versus the emerging competition. For instance, Boeing has decided to insource the production of the wings of the 777X, while they had been outsourced to Mitsubishi for the 787.

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Insourcing could also be seen as a way to control some of the aftermarket and increase the capacity of the airframer to capture a higher share of the profits generated by the aircraft. Opposition to concentration Both Airbus and Boeing have made it clear that they oppose some consolidation moves in the supply chain, which would in their view stifle competition and reduce innovation. Airbus's CEO openly opposed the Honeywell/UTC merger, together with Embraer and Bombardier (FT, 25 February 2016). Boeing has been less publicly vocal on concentration topics, but Reuters reported (30 August 30, 2015) reported that the group was using the "assignability clause" of its contracts to block deals (a clause allowing it to forbid the transfer of the target's contracts to a new owner). Leveraging cloud computing and Industry 4.0 to regain control on IP The digital continuity allowed by cloud computing would enable the OEMs to control the whole chain from conception to delivery and how any participating party would interact with their data (with the fascinating question of data ownership in particular for the one created in the cloud). We believe that the inclusion of programmes in clouds/platforms under the airframers' control will reshape the relationships with the supply chain. We expect airframers / OEMs to select in the future suppliers ready to relinquish some control on their data in return for programme access. Aftermarket winter is coming We expect the coming years to preside over a weakening of some aftermarket business models. Some segments are better sheltered than others, due to their very high level of concentration, a very large non-displaceable installed base and very high level of IP (engines for instance). Others will see the pressure rising, all the more so that Chinese competition gradually slowly becomes organised. We do not expect a hard break but rather a slow process spanning over the next decade, progressively eroding some of the margin lead of the supply chain. Given its specific business model, Transdigm could be a key target for this pressure, in our view. However, we believe that its proprietary product positions could make the group less vulnerable than others in the industry.

Potential changes to existing situations We expect airframers to modify the contracting policies (and possibly even existing contracts) with their suppliers and reduce the amount of customisation (in particular via the standardisation of cabin retrofits). It may even be possible that airframers actively try to limit the pool of available aftermarket (accelerating the replacement of older aircraft with less aftermarket-intensive aircraft), something potentially facilitated by the introduction of the A320neo and 737MAX. Contract modifications We observe that airframers have started to request contract modifications from suppliers and change the economics of the aftermarket, under pressure from airlines to reduce the full lifecycle costs of their products. Based on our channel checks, they appear to include:

■ Caps being added to contracts to prevent excessive aftermarket pricing escalation; ■ Forced reduction in multipliers allowed between OE and aftermarket prices; ■ Payment of royalties from aftermarket revenues.

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We believe that this evolution is more a question of when rather than if, with new programmes likely to face significant contracting changes. These modifications may even be enforced on existing contracts, depending on the negotiating position between the airframer and the supplier. These are on top of the performance conditions imposed in GTAs, as mentioned above, which relates more to OE activities than to aftermarket. Reducing the size of the aftermarket Some may even believe that OEMs are consciously working on reducing some of the aftermarket revenues (which are returning gross margins above 90% on some products flagged by some suppliers). They would achieve this through: 1) the improvement in reliability of the aircraft and its equipment and 2) maintaining a high level of retirement of the older part of the fleet.

■ Improvement in reliability: this reduces the number of maintenance events, but it is usually offset by an increase in the shop visit content. For example, changing LLPs (which account for more than half of the material costs in a large shop visit) in engines: from 10,000-15,000 flights to up to 30,000 now.

■ Replacement of the older part of the fleet: this is of course beneficial to the OEM, which makes nearly all of its profits on the OE sale. We note that reducing the cost of aftermarket is beneficial to airlines and is likely to receive their support.

Figure 31: OEM initiatives in aerostructures & materials Initiative Activity New commercial terms "- Unilateral price reductions and revised payment terms - ""no fly"" list for suppliers that don't participate" Part redesigns "- Value engineering - Material substitution" New processes "- Shift to lower cost processes - Leverage new processes" Selective vertical integration "- Expand role in profitable product segments - Assume system integration role - Gain access to lucrative aftermarket revenue" Aggregation & dual sourcing "- Aggregate fragmented segments (e.g. fasteners, interior parts) - Shift to dual sourcing" Capture revert "- Where possible, capture revert from suppliers - Work with supply chain integrators to close loop on material" Source: AeroDynamic Advisory

Reducing the costs of cabin retrofits At the Speednews conference in Toulouse in September 2016, several speakers mentioned the pressure that OEMs are putting on cabin retrofitters. They see cutting this cost as a key element to facilitate and expedite the transition from one operator to another, in particular for larger widebodies. This includes pre-certifying a number of configurations and their equipment (including economy class seats) and offering them in a catalog, thus removing the need to obtain a new STC (supplemental-type certificate) for each new operator (saving time and money). We understand that this STC work has traditionally been a substantial contributor to the profits of a retrofit contract.

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Onsite 3D printing for aftermarket We are cautious on the prospects for onsite printing of parts for the aftermarket. We think this could be a risk for aftermarket suppliers, as we think it could be challenging to ensure that parts printed under such circumstances have been produced according to the proper processes (which would require fully qualified employees and certifications for production processes) to avoid flight safety risks. This in effect limits the near-term prospects to non- critical low-value parts only, in our view.

Who is at risk? We think that companies with business models that are geared towards aftermarket face higher pressure. These include component manufacturers (fuel systems, electrical systems, avionics, etc.), cabin interior specialists, engine makers and wheels & brakes suppliers, to name a few. We also believe that aerostructures and cabling are less exposed to this risk given how marginal their aftermarket revenues are. The next elements to assess are: 1) the level of IP owned by the supplier, 2) the level of concentration of the related segment, to get a sense of the OEM's ability to replace an existing supplier (on a current programme or on new ones), as well as 3) the size of the existing installed base that will need to be serviced until the aircraft are retired. Some suppliers may try to compensate for this by increasing OE prices, but we believe that airframers are also actively engaged in pushing OE prices down (essential to continuing to sell new aircraft and take older aircraft out of service and resisting the price pressure from airlines). The expected increased pressure on costs and calls for increased R&D will cascade down from Tier 1 suppliers into the supply chain and probably start to impact first Tier 2 and then Tier 3 suppliers. Within our coverage, this could have a negative impact on Meggitt (Underperform, TP: 430p), for example. We nonetheless believe that the process will take time to have a material impact, as most of the pressure will come from new programmes or contract renewals.

Figure 32: Disruption risk by segment 3D printing Automation Digitalisation Examples of key Tier 1s & Tier 2s Aerostructures and parts - - - Spirit, GKN, Senior, Latecoere, Daher, Triumph, MHI, IHI, Figeac Aerospace, Orbital ATK, Sonaca, PCP, ATI, Hexcel Cabin equipment - = - Rockwell Collins, Zodiac, FACC, Astronics, Heico, Jamco Seats - - = Rockwell Collins, Zodiac, Recaro Engines and parts + = + GE, Rolls-Royce, United Technologies, Safran, MTU, Barnes, Woodward, Meggitt, Heico, Esterline, PCP, ATI Avionics and parts = = - Rockwell Collins, Honeywell, Thales, GE, Esterline Flight systems (fuel, etc.) and parts - = - Safran, Zodiac, Eaton, Parker Hannifin, Honeywell, United Technologies, Heico, Curtiss-Wright, Esterline, Moog Landing systems, wheels & brakes - - = Safran, United Technologies, Heroux Devtek, Meggitt Source: Credit Suisse research Size matters As a result of the above, we expect continued concentration of the supply chain at various levels. For a supplier, an increase in its size allows it to diversify its clients, programmes and products, thus reducing the risk of marginalisation by an airframer and reducing the impact of any exclusion from a programme. It also allows the supplier to build its own digital platform and share its costs on a larger base of products while leveraging it on a larger products base.

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Transdigm – we view its proprietary product positions as less vulnerable to pricing pressure We have long viewed Transdigm (TDG.N, Outperform, TP: US$301) as a strong M&A- driven growth story and the best publicly traded cash return vehicle in our A&D coverage. The M&A story appears far from done, the cash return aspect is intact, and in this environment where OEMs could pressure pricing, we see TDG as more insulated than suppliers that own less IP, at least for now. Transdigm has repeatedly stressed that it has seen minimal disintermediation or systemic change from recent actions taken by Boeing, which continues to target better pricing and spares participation from suppliers. This is because TDG’s proprietary product positions are generally less vulnerable to the pricing pressure that those with less IP have begun to confront. Transdigm believes it stays true to its negotiating position, and while it will flex where needed, it will not compromise the business model. So far it has not seen significant changes in terms in its agreements. That said, we think the pressure being applied to some smaller suppliers potentially could make them more willing sellers. We also prefer TDG’s higher mix of aftermarket profit, making it less vulnerable to the OE cycle, and its EBITDA performance continues to be strong as a result of continuous productivity efforts and tight cost controls. In sum, while we think Transdigm will eventually see some impact from the parts disintermediation strategy that is slowly being imposed by OEMs, we expect this to have a very gradual impact over many years, if not a decade or more. Risk to aerostructures suppliers We consider aerostructures to be an area of high risk for the supply chain when it comes to pressure from the airframers on OE pricing and contracts. For Airbus, Structure & Airframe purchases amounted to EUR5.0bn in 2015 (accounting for 15% of external purchase costs).

Figure 33: Airbus external sourcing by material category in EURm, 2015

Not assigned Product related services 3% Structure & Airframe 8% 15%

Equipment & Systems 14% Propulsion systems 30%

Indirect material Production material 22% 8%

Source: Company data

Threat 1 – displacement where suppliers' IP is limited We believe that some aerostructures work is facing a threat of displacement by 3D printing and automation when it has only limited IP and is easily replicable. This is particularly true for build-to-print work, where the IP is owned by the OEM. The supplier would then have little differentiation power and could be easily moved to less labour-intensive competitors, unless it invests in new technologies and reduces prices.

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We think that smaller aerostructures elements are more likely to be affected first by additive manufacturing (brackets, for instance). Automation is likely to impact the assembly of larger parts. We also think this displacement move will be centred on metallic aerostructure production, even if automation is increasing in composite assemblies. We believe that composites have already largely embraced that automation effort on the production side, as this has been critical for the cost effectiveness of its ramp-up on new programmes. As a result of this displacement, we would expect some suppliers to capture additional work, offering more flexibility and lower costs. They could be located in low-cost countries or have already embraced automation on a greater scale. They could also be alternative suppliers, such as PMA manufacturers trying to become more mainstream (see our HEICO report dated 25 August 2016: Value proposition continues to gain traction).

Threat 2 – insourcing by airframers This work could also be insourced by the airframers, as it would require less labour to produce these parts. The main question would then be whether the OEM would want to spend the related capital itself or would prefer to leave it to the supply chain. The decision will probably involve assessing the industrial performance of the suppliers on the relevant part and the competitiveness risk of leaving the work outside the company. Airbus – possible status quo on aerostructure insourcing for the time being Airbus had been contemplating outsourcing its aerostructure activities since the early 2000s (through disposal or listing of its related assets). A first move was made with the sale of 70% of Socata to Daher in 2008, but the push was suspended after the 2009 crisis. Then, the ramp-up of the A350 and the difficulties associated to it showed that control of this activity was execution-critical. It would appear that the status quo is likely for this business for the time being. It may be revisited by Airbus at the end of the decade, once production has stabilised, but the technology disruption may have permanently changed the parameters and it is possible that Airbus keeps control of these assets. We consider that it would then be a question of the potential return generated (via a disposal, in terms of additional margin, for instance via synergies or lower capital needed for a new programme launch) versus the operational risk taken. Boeing insourcing of the 777X wings Boeing has decided to insource the wings for the 777X. On the 787, the wings had been outsourced to Mitsubishi Heavy Industries. As a result, Boeing will invest US$1.0bn for the production facility of the wings of the 777X. This includes autoclaves for the wing parts, automated fibre placement machines, automated trimming and drilling machines, etc. The wing ribs will initially be manufactured internally, but may be outsourced at a later stage (Seattle Times, 19 May 2016). Boeing automated assembly of the 777X fuselage Boeing has decided to switch the assembly of the 777X fuselage to an automated process using KUKA robots, instead of the hand-riveting of the current programmes. The system is being tested, with the aim of being used for the current 777 units ahead of the switch to the 777x. The stated aim is to have the system ready by the end of 2016 and to switch the production over the following 12 months. This is expected to reduce costs and improve the quality of the build (Aviation Week, 1 July 2016).

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Figure 34: Boeing's twin aisle supply chain approach Aircraft system 777 787 777-X Wings Insourced most manufacturing Outsourced to Japan Aircraft Development Co Insourced at new composite wing factory in Everett Fuselage Outsourced to Japan Aircraft Development Co Outsourced to four risk sharing partners; later Outsourced to Japan Aircraft Development Co insourced Nacelle Insourced systems integration and most Outsourced systems integration and Insourced systems integration; outsourced manufacturing manufacturing to Goodrich manufacturing Flight controls Insourced systems integration; outsourced Outsourced to Moog and other Tier 1 integrators Insourced systems integration; outsourced manufacturing manufacturing Landing gear Insourced systems integration; outsourced Outsourced systems integration and Insourced systems integration; outsourced manufacturing to Goodrich manufacturing to Safran manufacturing to Heroux Devtek

Source: AeroDynamic Advisory

Spirit – the next cleansheet programme to be the key We think concerns around long-term aerostructure supply chain disintermediation have made investors cautious, although Spirit (SPR.N, Outperform, TP: US$74) has continued to deliver strong operating results and is driving meaningful improvement in cash generation to support a robust (and fairly recent) capital deployment strategy. We think real/significant changes to the OEM-Tier 1 relationship will begin to materialise with the next new (cleansheet) aircraft programmes, where the OEM will have the necessary leverage to drive improvements to both terms (pricing) and efficiencies. SPR will have to prove its best-value proposition, and its multiple could be constrained as the new platform takes shape, depending on which outcome appears more likely. Here, again, the financial impact will likely take a decade or more to materialise unless existing contract adjustments become part of the negotiations with Boeing. That said, the impact on multiples is already here and could remain despite the likelihood of that gradual impact being several years out. GE insourcing plans As detailed in our Diversified Industrials team report GE Aviation Meetings; LEAP ramp-up on track so far; EBIT growth outlook still solid (30 October 2016), GE commented that it has allowed too much margin to be captured by suppliers that have used its expertise and training, and it is now seeking to retain much more of this knowledge and capture a higher share of supply chain profits. Our US team expects pricing pressure on Aviation's 5,000- wide global supplier count to increase considerably. Over 25 years (a typical engine life span), this insourcing could be worth US$8-10bn, equivalent to 100-200bps of margin per annum.

Consequences for the aerostructure supply chain We see two main possible outcomes for the suppliers of aerostructures: either the adoption of automation and additive manufacturing as well, which will require a significant amount of capital and, in some cases, make obsolete some older equipment; or the risk of being displaced if no decisive action is taken, as more content is shifted to other suppliers or insourced by the airframers. We think the most likely outcome is an increase in capex and R&D spend in the supply chain, price cuts and consolidation of the lower tiers. Daher's automation of the production of the A350 landing gear doors The French aerostructure group Daher (revenues of EUR1.04bn in 2015, of which about half are in aerostructures) recently launched a EUR20m investment for automating the production of the landing gear doors for the A350 (in composite materials). They have been made manually for the first A350s but increasing them to a rate of 13/month would require automating the process. The workforce of about 100 persons today should not change materially with the automation of the process (Les Echos, 27 June 2016).

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FACC's automation of the production of the 737 winglets FACC, the Austrian aerostructures and cabin interior company (revenues of EUR588m in 2015/16), started investing in automation about two years ago as a way to absorb higher production rates while keeping its footprint and labour costs under control. It bought in particular an automated tape layer for wing parts. This has allowed the group to cut by 50% the number of hours needed for the production of the winglets for the 737 versus where it was 5-6 years ago. This machine is not fully utilised yet, allowing FACC to consider absorbing the expected production rate increases without further material investment. The group has also stated that it is hiring managers from the automotive industry to import their expertise in automation and robotics. Figeac Aero's automation of the production of the LEAP carter The French aerostructures manufacturer has announced a EUR37m investment into an automated production line for the carter of the LEAP engine (Les Echos, 11 October 2016). This will reduce production costs by 20% as well as cut cycle times, with only 60 employees instead of the 100 that would be needed without automation. Annual revenues will amount to EUR35m (1x the capex), with total sales of EUR500m over 10 years (capex = 7.5% of the expected revenues). The automation will span from the machining of the parts, their assembly, surface treatment, as well as the supply of the titanium to the machines and the visual control of the process. Some risks in Cabin Additive manufacturing may change the economics of the cabin interior industry and lead to an increase in the weight of PMA manufacturers in this area as well as create new competition in the aftermarket. We also believe that this is an area where the risk of new entrants is more pronounced, as illustrated by the emergence of new economy class seat manufacturers in recent years and a conscious effort to see Chinese competition emerge. It is, however, also likely that the risk is concentrated on the lower value-added part of the cabin; i.e. anything that is not a differentiator for the end customer of the aircraft.

Risk on the less IP-heavy segments of cabin interiors The development of 3D printing appears to us to be a potential risk for suppliers of cabin interior parts, essentially centred on the most basic elements of the cabin (panels, ceiling, sub- parts of closets or other monuments). For these, the risk is to be displaced in favour of lower- cost competitors or of insourcing by the airframer and to lose aftermarket revenues to PMA manufacturers or print-capability in MRO shops across the world for the non-flight critical parts. In our view, the risk is lower for the IP-heavy part of the market and where the supplier has direct access to and influence on the airline decision process in terms of design. We think that not all airlines will want to rely only on OEM-supplied cabin solutions, which are likely to be very standardised. As a result, producers of seats or galleys / lavatories would be exposed to this risk only on the production of detail spare parts that are not safety-critical (we also note that Zodiac produces PMA of its own, a side-effect in particular of its purchase of Heath Tecna in 2011). For these, the main risk in our view will be the Chinese buying spree in aerospace assets in Europe, which could facilitate the emergence of new organised competition, with a strategic ambition to grow in the business. On a more positive note, we also consider that the largest cabin interior suppliers may leverage these technologies to reduce the costs of their parts, either through the use of additive manufacturing by themselves or by their own supply chain. It could also allow them to reduce the non-quality of their products, an area of concern for airframers in recent years, although this would come with an increase in capex costs and additional R&D expenses, as well as appropriate processes.

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The example of Stratasys' cooperation with Boeing A good example is the cooperation between Boeing and 3D printing specialist Stratasys, with technology demonstrators recently unveiled, capable of printing whole cabin interior parts (using a machine tellingly named "Infinite Build"). Aerospace Manufacturing magazine lists armrests as well as wall and ceiling panels as possibilities for these machines (24 August 2016). The project started about 10 years ago and is still in its demonstration phase. The example of Airbus cooperation with Autodesk Airbus has been cooperating with Autodesk on the bionic 3D printing of a partition wall for the A320. This wall separates the cabin and the galley, and is the structure that will support the cabin crew seats. It will allow a 45% weight saving for similar structural properties.

Potential development of PMA manufacturers into more mainstream alternative suppliers PMAs (generic parts produced by non-OEMs) have until now been expanding in areas where the aftermarket volumes are high enough to make the development of these parts profitable. Provided that additive manufacturing reduces the cost of both design and production of parts, it may lead OEMs to rely on PMA manufacturers to offer alternative sources of supply of parts for both linefit and aftermarket needs. This is probably easier where the IP of the parts rests with the airframer (under build-to-print contracts), as the latter can replace more expensive suppliers with alternatives. We believe that HEICO (HEI.N, Outperform, TP raised to US$85 from US$76), the largest PMA manufacturer, also stands to benefit from this trend. Cabin has been an area of strategic development for the group in recent years. Zodiac estimates that about 10-15% of its aftermarket (i.e. 3-4% of its total sales) are exposed to the PMA threat. Cannibalisation of the aftermarket from second-hand equipment is less of an issue for some parts such as evacuation slides, where age limits mean that the part has to be replaced by a new and not a second-hand part. For some years, Zodiac has been implementing certain measures to counter these threats, such as the launch of Zodiac Services, which allows for a better control of the market's spare parts needs through a co-ordinated approach of the aftermarket needs of its clients. We also note that some of Zodiac's businesses offer their own PMAs to the market (eg, for lavatories). For example, Zodiac Airline Cabin Interiors holds 140 PMA part certificates for lavatories, galleys, overhead bins, and sidewalls.

Emergence of alternative seat manufacturers We believe that Airbus and Boeing are supportive of seeing some new seat makers emerge as an alternative to Zodiac and B/E, which control an estimated 70-75% of the market. We note that several new ventures were launched in the early 2010s, in Europe and the US: Pitch, Expliseat, EnCore, Mirus, etc. China is also developing its activity in this field, via a subsidiary of AVIC, and recently took control of a small but established business-class seat manufacturer based in Ireland, Thompson Aero Seating.

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Figure 35: Example of alternative seat manufacturers beyond Zodiac and B/E Aerospace Creation / start Ownership Location of seat activity Products offered Comment Started as Brice, was purchased by Timco in 2002, which HAECO Swire Hong Kong/US 1968 Economy, premium economy was then purchased by HAECO in 2014 Recaro Private Germany 1971 Economy, premium economy, Revenues of EUR409m in 2015 (EUR300m in 2011) with business class 2,000 employees, SFE option on A320 since 2015, first deliveries in 2016 Stelia Airbus France 1970 Business class, first class World leader for pilot seats, revenues c.EUR150m Economy, premium economy, AvioInteriors Private Italy 1972 business class c.400 employees Economy, premium economy, Geven Private Italy 1984 business class c.200 employees, A320 BFE from 2018 onwards Thompson Aero Seating Private UK 1997 Business class GBP65m revenues in 2015/16, 285 employees, business class seat started in 2003, 2011 entry in service, bought by AVIC in December 2016 Acro Aircraft Seating Private UK 2005 Economy, premium economy 25,000 seats per year, c.GBP30m revenues for 2016E, 150 employees, new products added to Airbus BFE catalog in early 2017 ZIM Flugsitz Private Germany 2007 Economy, premium economy, 2016 revenues EUR48m, 80% output in economy class business class seats, >150 employees Pitch Aircraft Seating Private UK 2010 Economy Launched with Monarch in 2014 Optimares Private Italy 2010 Economy, Business First deliveries in 2013 Expliseat Private France 2011 Economy Titanium seats, in production for ATR as BFE option since 2016 for hot and high conditions EnCore Private US 2011 Economy Offered as SFE option by Boeing since 2016, first undisclosed customers announced in October 2016 Hubei ALI-Jiatai AVIC China 2012e Economy Offered as BFE under conditions by Boeing, first seats delivered in 2016 to 9Air JAMCO Listed Japan 2012 Business class Moved from seat furniture (for SuperFirst class) to full seat offers on A350 catalog Mirus Aircraft Seating Private UK 2015 Economy Composite materials seats, first order announced with AirAsia in April 2016

Source: Company data, Credit Suisse research

The risk of SFE offers is emerging slowly The OEMs are also trying to increase the share of seats sold as SFE (sold to the airline by the airframer rather than by the seat manufacturer). Airbus selected Recaro in 2015 as an SFE option for the A320. Boeing is backing EnCore as an SFE offer for the 737 and, more recently, for the 787. It is largely targeted at airlines and lessors looking for a standardised cabin product with limited impact of any differentiation on the passenger. This is in our view a long-term threat and will essentially materialise through market share shifts and pricing pressure on the economy class segment, which appears to be more and more commoditised. We believe that this threat will only slowly impact the main seat manufacturers. Indeed, we note that it took nearly 10 years from launch for more established companies like ZIM or Acro to generate revenues of EUR40-50m. As a comparison, Zodiac had revenues of EUR1,389m in Seats in 2015/16. B/E Aerospace did not disclose its revenues by sub-segment, but we estimate that in 2016, commercial aircraft seating sales accounted for about US$1.5bn, i.e. broadly on a par with Zodiac. The sector #3 (Recaro) has revenues of more than EUR400m, more than twice those of Stelia (#4).

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Figure 36: Market shares for seat makers Based on estimated 2016E EURm revenues

ZIM Geven Acro Others Thompson 1% 1% 1% 3% 2% AvioInteriors 3% Stelia 4% B/E Recaro 37% 11%

Zodiac 37%

Source: Company data, Credit Suisse estimates

Boeing also announced a collaboration (March 27) with car seat manufacturer Adient and stated that it believed its customers "would benefit from a wider range of options and more reliable, on-time performance in the airplane interiors and seating category". We see a limited direct threat from this, car seat manufacturers having looked at this segment in the past already and been deterred by the heavy regulatory requirements (and accompanying liabilities) of aircraft seating. This is likely to translate into further pressure on the main two cabin interior suppliers, Zodiac and B/E Aerospace (now Rockwell Collins), to deliver on their commitments.

The special relationship between engine OEMs and airframers Engine manufacturers are both OEMs (with IP control and direct access to the airlines that are their customers with a direct contractual relationship) and suppliers (as the aircraft makers specify which engine they use on which platform). We believe that while there is risk to the downside over the very long term, engine OEMs enjoy a special relationship with airframers, which is buffering them from most of the pressure. They can also leverage the disruptive technologies to their advantage.

Shift in costs Engine OEMs as an industry are targeted by airlines as a source of rising costs, as illustrated by the IATA statements mentioned above. Engine maintenance accounts for 7% of total costs for US airlines as measured by the DoT and 41% of their overall maintenance costs (measured on average between 1990 and 2016). Channel checks suggest that airlines and MRO providers are particularly unhappy about annual price escalation on spare parts for engines, which can be in excess of 10% in some instances.

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Figure 37: Engine maintenance costs for US airlines in US$m – Q1 1990 to Q3 2016

55% 10%

9% 50% 8%

45% 7%

6% 40%

5% 35% 4%

30% 3%

Q1 2001 Q1 Q1 1990 Q1 1991 Q1 1992 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q1 2016 Q1

Engines as % of direct maintenance costs Engine maintenance as % of total costs - rhs

Source: DoT data

Airlines are putting pressure on airframers as well to try and contain these engine maintenance costs. This offers airframers an opportunity to try and capture some of the aftermarket profits, one which we believe they try to leverage. Airframers are unlikely to repatriate some of the engine workload as a result of technology disruptions, with specific supply chains and IP control by the engine OEMs. The main change in the relationship has resulted from the launch of upgrades to existing aircraft platforms rather than new ones, shifting part of the development costs to the engine OEMs and putting at risk some of their existing installed base. This has effectively capped engine OEMs' margins and cash flows in recent years and will slow margin progression compared with a situation where these new engines had not been launched and it results in containing the margin gap between airframers and engine makers. Figure 38 shows the new platform launches since 2005 and illustrates that airframers have refrained from major modifications to the existing airframe bodies, limiting significant upgrades to wings. For instance, the modifications of the A320neo vs the A320ceo are only the engines, the engine pylons and adjustments to the related systems.

Figure 38: New platforms launched and major modifications / new systems Launch Platform Airframer Airframe Wing Cabin Avionics & systems Engine 2005 A350 Airbus      2007 CSeries Bombardier      2008 C919 COMAC      2008 MS-21 Irkut      2008 MRJ Mitsubishi      2010 A320neo Airbus      2011 737MAX Boeing      2013 777X Boeing      2013 E-Jet E2 Embraer      2014 A330neo Airbus      Source: Credit Suisse research

We would also expect the potentially structurally lower fuel prices to result in a lower influence of engine makers on airframers' decisions and actions.

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Disruption mitigating disruption for engine OEMs We believe that engine OEMs are passing down the pressure to their own supply chain (cf. GE's comments), including through price cuts. We also believe that they are leveraging the technology disruptions to their own advantage and absorbing some of the cost pressure (and possibly even improving their own profitability). As described above, we see engine manufacturers as well positioned to benefit from additive manufacturing and digitalisation (with a risk of competition with airframers and airlines around frontier definition when it comes to cloud computing and data sharing / ownership). In particular, GE and Rolls-Royce appear very active on both additive manufacturing and digitalisation, GE likely at an advantage given its size and the diversity of its portfolio of activities as well as its financial buying power. United Technologies is also very active in 3D printing through its UTRC (United Technologies Research Center) and works on leveraging digital technologies throughout the group, from elevators to aircraft engines. Safran does not appear to lag behind in 3D printing, with a recently announced partnership with Prodways aiming to develop printable materials and assembly processes for these materials with inorganic compounds, such as ceramics and metals. It reinforces longstanding activities of the group in this field. Safran also subscribed to convertible bonds in Prodways ahead of its upcoming listing. Its digital strategy currently appears less advanced. Aircraft systems and avionics In terms of disruption risks, suppliers of avionics and aircraft systems (fuel, oxygen, electricity, hydraulics, air management) sit between the engine OEMs and the cabin and aerostructures suppliers, in our view. We think that airframers are pushing for increased integration between the aircraft design and its systems. This is a key differentiator with the Chinese and Russian competition, allowing for better operating costs. It will also offer an opportunity for the airframers to gain more control of the IP used for these systems (in particular in the case of data created in OEMs' clouds, as OEMs are likely to demand exclusivity of the design and restrict reuse and export of any IP created). As a result, this offers them an opportunity to share some of the aftermarket in the future (for instance via royalties on the use of the joint IP). Additive manufacturing can add to the risk in these areas as well, particularly in the more mechanical parts of the sector. However, it can also be used by the supplier to absorb the pressure and in that sense appears rather neutral. The impact of automation on aircraft systems appears more limited, in our view. Similarly to engine makers, these suppliers are faced with upgrade plans to existing systems rather than the development of new platforms. This results in an increase in R&D costs for them and the risk of an accelerated renewal of their installed base. But there is still some risk to traditional Tier 1 avionics suppliers. We note that Boeing is teaming with Harris on next-gen avionics for military aircraft, with Boeing doing the integration. Harris and Boeing are developing avionics for current and future military aircraft. Harris will design the hardware and Boeing will integrate it. If this effort proves to be successful on the military side, we wonder if Boeing might attempt to integrate more of the avionics on its future commercial platforms.

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Consequence 2 – New opportunities in the supply chain As a result of the disruptions flagged above, we see opportunities for automation companies, for 3D printing specialists, for PMA manufacturers (in particular HEICO) and for digitalisation specialists (Dassault Systemes and Thales, for instance). The cost pressure and IP risks for the existing supply chain are also likely to lead to further consolidation, in particular for Tier 2 / Tier 3 suppliers. For Industrial Automation companies Today, aerospace accounts for about 5% of the revenues of automation companies, vs about 50% for the automotive industry. In this section, we provide a brief overview and assessment of the potential for industrial automation (IA) players to enable and therefore to benefit from the potential increased penetration in the Aerospace industry.

Background In summary, we see the following key broad benefits to the aerospace industry from automation (as discussed in detail throughout this report):

■ Manufacturing costs: The combination of airframe manufacturers’ increased production volumes and developments in robotics technology have led to a rising number of areas where the economics of automating airplane manufacturing starts to make sense. ■ Development and production cycles: Development of new manufacturing processes that aim to bridge the gap between the digital and the real world can significantly shorten production cycles and reduce non-quality related costs and raw material waste. ■ Digitalisation: Breaking down information silos throughout the manufacturing process and leveraging cloud platforms for data management and analytics to drive: i) future product development, ii) improved operational efficiency of aircraft, and iii) IP management across the value chain from suppliers up to OEMs. On the manufacturing cost improvement and production cycles specifically, we see the following opportunities:

■ Reduced labour costs from increased use of robotics, which can also lead to higher- quality work with more consistent precision and output; ■ Reduced time to market for new ideas/product development cycles through more efficient, digitalised processes; ■ Reduced waste of material as there are fewer iterations before meeting production quality standards; ■ Virtual assembly as part of quality inspection to avoid non-fitting components and associated costs; ■ Additive manufacturing has the potential to reduce production time, material density and component production costs.

Automation & Robotics application Airframers appear well placed to benefit from the continuous technological innovation in discrete automation, and in particular through leveraging improvements in industrial software to increase the flexibility of robotic solutions. We see increased automation of manufacturing processes and technologies allowing the use of new materials as an attractive avenue for OEMs to achieve a rebalancing of power in the supply chain, as discussed in the section of this report on Technology disruption.

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As production volumes in the aerospace industry increase and the technology improves, we see it as likely that the penetration of industrial automation and robotics in the sector will gradually increase and can potentially catch up with even the Automotive industry. This would have a positive impact on the industry as a whole, but in particular on high-end providers, in our view – i.e. ABB and Kuka in Robotics and Siemens and Hexagon in digital manufacturing solutions. Using data from the International Federation of Robotics (IFR), and leveraging our Credit Suisse HOLT database, we have modelled the potential impact from increased penetration of robotics in the Aerospace industry on the overall robotics market. Our scenarios are based on assumptions of how quickly and to what extent the Aerospace industry can converge towards Automotive in terms of the number of industrial robots bought per $1bn of CAPEX spend (2015 data used as a reference).

Figure 39: Aerospace Industrial Robotics Adoption Scenario Analysis

1.6

Industrial robots ('000) per USD bn CAPEX Spend 1.4 Automotive Aerospace 100% catch up in 5 years

1.2 Aerospace 100 % Catch up in 10 years

Aerospace 100 % catch up in 15 years 1 75% of Automotive Robotic Units ('000) per USD bn CAPEX Spend

0.8 Aerospace 75% catch up in 5 years

Aerospace 75% catch up in 10 years

0.6 Aerospace 75% catch up in 15 years

50% of Automotive Robotic Units ('000) per USD 0.4 bn Capex Spend"

Aerospace 50% catch up in 5 years NumberofIndustrial Robots purchased perUSD bn CAPEX spend 0.2 Aerospace 50% catch up in 10 years

Aerospace 50% catch up in 15 years 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years

Source: Credit Suisse HOLT, IFR, Credit Suisse estimates

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Figure 40: Overview of Results on Additional Robot Demand from Aerospace Industry Analysis 2015 2016E 2017E 2018E 2019E 2020E Robots shipped '000 units Global 254 290 322 363 414 469 Additional Robot demand from Aerospace Bull Scenario: 100% '000 Units 1.35 1.59 2.37 4.23 9.07 23.40 catch up in 5 years Additional Robot demand from Aerospace % 0.53% 0.55% 0.74% 1.16% 2.19% 4.98% Additional Robot demand from Aerospace Base Scenario: 75% '000 Units 1.35 1.39 1.56 1.84 2.27 2.92 catch up in 10 years Additional Robot demand from Aerospace % 0.53% 0.48% 0.48% 0.51% 0.55% 0.62% Additional Robot demand from Aerospace Bear Scenario: 50% '000 Units 1.35 1.38 1.53 1.76 2.10 2.61 catch up in 10 years Additional Robot demand from Aerospace % 0.53% 0.47% 0.47% 0.48% 0.51% 0.56% Source: Credit Suisse HOLT, IFR, Credit Suisse estimates

Key takeaways:

■ Increased adoption of robotics in the Aerospace industry has the potential to add from 0.5% to 5% to total annual shipments of industrial robot units globally. ■ As a base case, increased adoption of robotics in the Aerospace industry can by itself create c0.6% annual growth in the global market. ■ Due to the complexity of the Aerospace industry, the value impact is likely to be higher as the increase in shipments will likely be in the high-end segment. ■ In terms of implications for broader industrial automation components demand, we see Robotics as representative of the industrial automation controls layer (PLC, HMI) where there is a somewhat similar penetration potential.

Digitalised Manufacturing Process application We believe that the most substantial impact on aircraft production costs, and consequently OE margins, will come from the reduction in labour and material costs and faster production cycles enabled by digitalising the manufacturing process throughout the supply chain.

Figure 41: Overview of Manufacturing process from Conceptualisation to Assembly Production Cycle Concept Advanced Tooling and Pilot Testing/Pre- Production ramp- Stages Product Design Virtual Assembly Transportation Assembly Development Engineering commissioning production up PLM Software PLM Software PLM Software PLM Software PLM Software PLC PLM Software Robotics CAD CAD CAD CAD CAD CAD CAE CAE CAM Technology 3D Printing Robotics Robotics Metrology Metrology Metrology 3D Printing 3D Printing Reality to Digital

Design/Costing Data Analysis

3D Positioning 3D Inspection Information flow Manufacturing Planning

Compare to CAD - Reengineer

Cloud Ecosystem - Automatic manufacturing feedback loop OEM OEM OEM OEM OEM Party involved Supplier Supplier Supplier Supplier Supplier Supplier Source: Company data, Credit Suisse estimates, Hexagon Manufacturing Intelligence

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We have broken down the digital manufacturing process into its separate phases, emphasising the various technologies used (as illustrated in Figure 41) and provide an overview of each phase below:

■ Concept development. Translate an idea into a virtual/physical model (in automotive, this traditionally has been done with clay models, now also potentially through additive manufacturing/3D printing). The aim of this stage is to project the look and feel of the component. ■ Product Design. Transfer the idea to a Computer-Aided Design (CAD) software suite – this is where product design actually happens. Take the concept from geometry to engineering. This process normally happens in phases. ■ Advanced Engineering. Testing the feasibility of the design, involving simulations of performance; compliance with emissions regulations; cost analysis of manufacturing requirements and material choice; supply chain design; manufacturability of components: weight, cost, performance. ■ Digital twin. Creation of the digital twin – simulate the whole aircraft put together as well as all the individual components. ■ Tooling & Commissioning. Design all tools fixtures, dyes and moulds necessary for the production. There are thousands of components in a car and millions of components in a plane. Needs to reconfigure across the whole supply chain. ■ Pilot testing, pre-production. Using Automotive as a benchmark, this process takes c40 months. Around three months of that is due to waste and hence can be improved upon – we estimate this ratio is higher in Aerospace given the complexity and regulations (hence offering even higher potential for improvement). ■ Taking BMW as an example in the Automotive space: the company undertakes 2-3 iterations of their design before achieving a stable high-quality die/mould that can be used for volume production (it has perfected this process through integrating quality inspection with CAD/Computer-Aided Manufacturing (CAM)). Other OEMs have 5-6 iterations. ■ For each iteration, up to a 1,000 components are produced before a sufficient sample is then quality-tested. Metrology equipment facilitates creation of a digital 3D reconstruction of the component through reverse engineering, which is then reconciled with the original CAD design. If found to be sub-par, the data gathered from the quality inspection is then automatically fed into the Computer-aided Engineering (CAE)/CAM software for the calibration of the manufacturing robots before the next iteration. ■ High-end dies/moulds cost US$150-350k each in the Automotive industry. We expect this to be higher in Aerospace because of the size of the equipment and larger number of components. ■ Production ramp-up. Ramp-up production of components that are now reconciled with their digital twin. ■ Virtual Assembly. In the new Airbus production line in Hamburg, the company has installed 3D tracking and automation technology supplied by Hexagon AB with the purpose of cutting down days of assembly through the use of software platforms that interact with fixture and motion elements to make the process as efficient as possible. ■ Through reverse engineering of all the finished components and creating a digital 3D reconstruction, it is possible to move the physical assembly of the plane into the digital world. The idea is to scan all of the individual components at the suppliers and verify that the virtual reconstruction fits its counterpart on the digital twin (virtual assembly) before shipping the physical parts to the final assembly destination. The vendors cite productivity increases from this process (time saving) of 10-15% and see scope for this to increase further as the technology is diffused throughout the supply chain.

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Potential industrial automation beneficiaries

Figure 42: Relative areas of strength for key global Industrial Automation players Software Control systems (software& hardware) Hardware PLM MES HMI/ SCADA PLC DCS CNC Discrete Process Robotics ABB        Schneider        Siemens        Europe Rotork  IMI  Spectris   Kuka  Emerson    Rockwell     Eaton    US Honeywell   GE    Pentair  Flowserve  Fanuc   Mitsubishi Electric    Japan Yaskawa   Yokogawa  Omron   Supcon   Hollysys  China Weinview  Baosight  Source: Company data, Credit Suisse estimates, Hexagon Manufacturing Intelligence

Product Lifecycle Management (PLM) – Siemens (with Mentor Graphics)

Figure 43: Siemens Innovation Life-Cycle Data Loop

Source: Siemens

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PLM software comprises the traditional CAD/CAM solutions. A growing trend is to also now to integrate Electrical Design Automation (EDA) and CAE solutions in the PLM offering. Post the acquisition of Mentor Graphics, Siemens became the first company to provide a fully integrated design suite in PLM and we therefore see it as one of the most technologically capable candidates to benefit from growth in digitalised manufacturing. Robotics – Increasing market penetration – ABB, KUKA We believe the global high-end robotics vendors are well-positioned to benefit from the expected trend of robotics adoption in Aerospace. Fanuc, ABB, Yaskawa and KUKA are the leading global players in industrial articulated robots space.

Figure 44: Robotics: Global players market shares, Figure 45: Robotics: Global key players organic 2015, units growth benchmarking

225

Fanuc, 25% 200

Others, 33% 175

150

125

100

75

50

Yaskawa, 18% 25 Kuka, 6% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Yaskawa (Robots) Fanuc (Robots) ABB, 18% Kuka (Robots) ABB (Discrete Automation)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

KUKA appears to feature most prominently in the technology demonstrations in aerospace applications we have studied. The recent development of Chinese air-conditioner manufacturer Midea acquiring an >90% stake in the company may affect some of the OEMs' decision making, in our view, as China is developing its airframe manufacturing with the aim of becoming competitive globally. Currently, KUKA has a seven-year ring- fencing agreement and our recent trip to Hannover Messe in April 2017 did not yield any negative feedback on customers' decision making resulting from this development. ABB, in our view, has the most developed application-specific software offerings in robotics and given its Western positioning and footprint is well-positioned to capture a potential demand increase. Quality Inspection – Metrology Players – Hexagon Manufacturing Intelligence Technological improvements: laser scanners, probes and White-Light technologies cut quality inspection time as they facilitate reverse engineering through the gathering of point cloud data, and can also be fitted as a robotic solution on the production line for some components. Incorporating the use of UAVs to inspect previously time-consuming areas (e.g. the top of the fuselage) can improve safety and save time/costs. Through software programs, the point-cloud data is used for the reconstruction of a 3D copy that can then be compared to the original CAD design. Post the acquisition of MSC software, a large producer of CAE solutions, Hexagon is able to seamlessly integrate the knowledge gathered from the quality inspection process and feed it back to the design software. Additive Manufacturing/3D printing – a natural extension of better data analytics and improved software technologies.

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Additive manufacturing helps to create new shapes and new ways of structurally manufacturing the various components/materials. For instance, while before five different parts might have to have been assembled to form one component, today the same thing can be manufactured in one piece. One of the issues that has delayed adoption of 3D printing technologies have been questions around the reliability and safety of printed parts vs. more traditional technologies. As gathering of quality data and its subsequent analysis becomes integrated in the manufacturing process, it should help to demonstrate the reliability of the technology. Sensors and data analytics The number of sensors incorporated into plain components is set to grow from around 1,000 sensors per plane to 15,000 sensors per plane. We see this as a potential source of growth for providers of quality sensors able to work under sometimes extreme conditions onboard a flight. We also see this as a growth driver for providers of data analytics and software solutions that manage to gather actionable insights from these new volumes of data, thereby reducing maintenance costs and improving safety. Aerospace specialists Specialists in aircraft assembly and related tooling (including fastening systems, composite systems and stations and assembly lines) are small non-listed companies, with Electroimpact (US), MTorres (Spain), Ascent (US) and Broetje (Germany) leading the group.

Figure 46: The main suppliers of automated assembly and tooling equipment HQ Comments Electroimpact US 750 employees, privately owned MTorres Spain 700 employees (including non-aerospace), privately owned Ascent Aerospace US part of AIP Aerospace, which has 1,300 employees Broetje Germany 750 employees and EUR144m revenue in 2015, privately owned Aritex China based in Spain, taken over by AVIC in mid-2016 Source: Credit Suisse research, company data

In a 2015 study, Roland Berger consultancy saw an annual market of EUR2bn for aerostructures equipment, with fastening systems accounting for the largest portion, as illustrated in Figure 47.

Figure 47: Composition of the aerostructures equipment market in EURm

Operational services 16%

Fastening systems Small tools 35% 8%

Conveyor systems 4%

Stations / lines 22% Composite systems 15%

Source: Roland Berger in a 2015 study

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Consolidation in automation Consolidation between the various suppliers of this equipment for the aerospace industry is a possibility once a certain degree of maturity has been reached, given the industry structure and the increased complexity and scale of the automation projects being implemented. Indeed, most of the players are a part of small private groups and one is part of a private equity group (Ascent, owned by AIP) – see Figure 46. M&A from the automation generalists is another possible option as a route to market. It could be a way for them to acquire an installed base and leverage the digital part of their offering, as Siemens described in at its US Capital Markets Day on 27 March 2017. We believe airframers will not look to buy into these specialised suppliers, although they are likely to impose IP limitations on some of the innovations (as illustrated by the Electroimpact example with Boeing) and influence some of the deals through the contract structures. Opportunities in 3D printing From an end-market point of view, we see additive manufacturing developing at a slower pace than automation in aerospace. The main reasons are: 1) the cost curve of the technology, which remains too high, and 2) the maturity of the materials used, which is the main stumbling block for widespread adoption of that technology beyond the current areas of production of non-critical parts and prototyping. Companies in our coverage that could stand to benefit from 3D printing development in aerospace include GE (GE.N - Outperform, TP: US$34) and Arconic (ARNC.N - Restricted).

Which segments? We see three main areas for the development of 3D-printed parts in aerospace:

■ Engine parts: We see them as likely to be limited to static parts of the engine for the foreseeable future. The steady increase in temperatures inside the engines makes it difficult to find appropriate materials for rotating parts in the hot section.

■ Cabin parts: We believe the key for the development of this segment is the ability to print large parts, as illustrated by the Boeing / Stratasys panel-printing project and the Airbus / Autodesk bionic partition wall for the A320. Safety and quality issues are the main drivers besides costs for this segment.

■ Aerostructures: We have seen small 3D-printed parts made by companies like GKN and ATI. We believe the size of parts will increase over time but we do not expect very large structures to be printed anytime soon.

The example of GE – a key focus for the group GE has shown considerable interest in additive manufacturing for some time (for background, see our sector initiation report Additive Manufacturing - Early in the AM for Additive Manufacturing – 17 September 2013, when we highlighted the aerospace application of this technology in particular). The group acquired Morris Technologies and Rapid Quality Manufacturing in 2012 (which had 130 employees; Arcam / SLM have 285 / 260 employees, respectively); Morris, though, was an operator of machines rather than a manufacturer. We highlighted GE's application of this technology in our report Additive Manufacturing: GE and the rise of 3D metal production – 25 July 2014, when we visited its site in Cincinnati, Ohio, and we saw further evidence of this in our GE Greenville plant tour in 2015 (GE: Pulling all gross margin levers in Greenville – 10 August 2015).

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GE expects to grow its new additive manufacturing business to US$1bn of sales 'at attractive returns' by 2020. We are forecasting additive manufacturing sales to grow from US$0.3bn in 2017 to US$1.8bn in 2021 while operating profit is seen going from breakeven to US$0.4bn over the same period (this business is expected by management to generate zero EBIT in 2018; so it will not be contributing towards the US$2 EPS target). GE aims to generate US$3-5bn of overall product cost-out over the next decade. Overall, GE claims to have invested US$1.5bn since 2010 in manufacturing and additive technologies. In early September 2016, GE announced plans to acquire two public metal-based additive manufacturing companies, Arcam and SLM Solutions (Cost-out, backward integration, and technical leadership, 6 September 2016), before dropping the offer on SLM after it was rejected by its shareholders. GE announced on 28 October 2016 that it had agreed to purchase 75% of Germany-based Concept Laser Systems for US$599m. Concept Laser has ~200 employees, and makes powder bed-based machines; it focuses on the aerospace, medical and dental industries, and has a presence in the automotive and jewellery sectors. The company was acquired for similar multiples as SLM would have been; its sales (US$100m as of 2016) and profitability are slightly higher than the latter. These acquisitions will report into David Joyce, CEO of GE Aviation, but we would expect that via the GE Store, their technology will be spread throughout the company's Industrial businesses (additive manufacturing is applied across six such businesses today). We also think that if 3D printing can come close to hitting some of GE's expectations for the technology, it could be carved out as its own segment in the next few years. We visited a large GE Additive Manufacturing site in late October 2016, where it was highlighted that cost savings of as much as 60% could be generated by using 3D printing as opposed to traditional techniques for aerospace components. Aside from the much- publicised fuel nozzle example for the LEAP (where production could rise to 35K / year by 2020), other parts such as the servo fuel heater for the GE9X engine will also be 3D printed, the use of which should generate 60% / 40% cost / weight savings, respectively. Overall for GE Aviation, additive manufacturing is targeted to add US$3bn in cost-out in the next 10 years, worth ~100bps of margin per annum. See our report GE Aviation Meetings; LEAP ramp-up on track so far; EBIT growth outlook still solid – 30 October 2016. GE's competitors also clearly see the advantages of applying this technology – Honeywell for instance presented at Arcam's own US Investor Day in March 2016, explaining how it was using Arcam's technology (in metals and polymers) to reduce component costs, optimise design, and shorten its supply chain and engineering development cycle times in its Aerospace business (citing the example of a transition duct).

The example of Arconic As highlighted in our 12 December 2016 report (Don't Get Lost In Transition – Medium Term Growth Outlook is Solid / Valuation Attractive), Alcoa's spin-off Arconic is an industry leader in 3D printing. It works with both Airbus and Boeing in that field. Arconic announced in April 2016 an agreement with Airbus to sell 3D-printed titanium parts for the fuselage and engine pylon parts. We note this contract is similar to the deal announced with Boeing in which the company will provide titanium landing gear components for the 737MAX and aluminium-lithium for the cargo floor of the 777X. ARNC uses two separate processes to manufacture 3D-printed parts. The standard process involves the use of 3D-printing to make the full final product (which involves relatively minimal finishing / heat treatment) and the second hybrid process is called Ampliforge, which Arconic developed in 2015. Ampliforge uses 3D printing to develop a near-net shape and then is finished utilising more traditional manufacturing processes. This process is currently being tested in Pittsburgh and in the UK.

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These developments significantly reduce the buy-to-fly ratio of the material and allow for more efficient production of complicated, low and more importantly high load-bearing parts. We believe the use of 3D-printing / Ampliforge is critical for Arconic to gain market share as OEMs aggressively seek to reduce buy-to-fly ratios and leverage new composite designs. We note that for titanium the buy-to-fly ratio can be as high as 90% and Boeing noted that while titanium usage increases with the increased amount of composite use, the high buy-to-fly ratio puts titanium in the cross-hairs of cost reduction with potential for displacement unless the yield loss improves. As detailed in this report, aerospace OEMs are transitioning to a more mature part of the cycle following significant technological upgrades made over the past decade and thus the focus has shifted from performance enhancements and risk taking on new design / materials towards total cost optimisation. This is likely to put more pressure on suppliers and in our view creates more distinction between the commodity and more advanced downstream players. We believe Arconic is well positioned to win in the new market place given its significant R&D effort and its global sourcing capabilities. We also fully acknowledge the general aerospace plate workhorse grades are becoming more commoditised with increased completion in Europe and now China, albeit to a lesser extent. Opportunities for PMA parts manufacturers PMA manufacturers may be uniquely positioned as a natural second-source option to benefit from OEM supply chain efforts. We believe HEICO in particular looks well positioned.

HEICO benefiting from these OE initiatives We think that HEICO's FSG branch in particular could become a partner in the potential disintermediation efforts coming from the primes that are trying to become more vertical or participate more in the aftermarket profit stream. HEICO (HEI.N, Outperform, TP raised to US$85 from US$76) has noted that the opportunity to do more work with OEMs is a "fertile area". In July, HEICO's Inertial Aerospace Services subsidiary entered into a licence agreement with Northrop Grumman where it will repair and overhaul select inertial reference units, and will receive Northrop Grumman's parts, inventory and test equipment for all Northrop-licensed products. Previously, Inertial was competing with Northrop Grumman in the marketplace, but as Northrop Grumman was looking to exit the overhaul business for its own parts, it licensed HEICO (exclusively) to perform that work. While HEICO will continue to do its traditional business, management believes this is a great example of the opportunity for HEICO and OEMs to work together to support airlines and reduce operational costs. Importantly, HEICO noted significant opportunities to reach similar arrangements with other OEMs as its reputation grows, both on the commercial and military side. We upgraded our rating on the stock from Neutral to Outperform in late 2016 – see Favorable strategic positioning and M&A upside drive upgrade to Outperform (15 December 2016). Opportunities in digitalisation Digitalisation offers many investment opportunities along numerous lines, including PLM, cloud computing, data analytics, artificial intelligence and cybersecurity. As with any new technology with fast innovation cycles, many will fail and few will succeed. We expect continued M&A activity in this domain, with both new listings and takeovers (originating in particular from large operators keen to diversify their technological base – such as Thales in our coverage). The development of cloud-based platforms implies strengthening cybersecurity around these. This is beneficial to large defence groups such as Thales, BAE Systems and Raytheon, even if it is diluted in their overall revenues (5-10% of overall revenues). We expect these groups to continue investing in these activities, both organically and through acquisitions.

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We highlight here a few established names carrying less risk but looking well placed to boost their prospects owing to digitalisation: Dassault Systemes (DAST.PA - Outperform, TP: EUR85) and Thales (TCFP.PA - Outperform, TP: EUR102).

Dassault Systemes – at the heart of the digital agenda Dassault Systemes was founded in 1981 to design products in 3D through the spin-off of a team of engineers from Dassault Aviation. Today, we think Dassault is a key enabler of digital transformation and will continue to play an important role in the evolution of the aerospace industry. Dassault has its heritage in 3D design and over the past three decades has been instrumental in driving efficiencies for a broad range of industries, including automotive and aerospace. Every 5-10 years, Dassault has introduced major innovation to the market. This started with basic 3D modelling to bring automation to the design process, moving to full digital mock-ups to provide lifelike visualisations and then to PLM (Product lifecyle management), extending the reach of the product into simulation and manufacturing. The latest version of the product is the "3D Experience", which directly enables digital transformation. In 2016, licence revenues from this platform increased by 30%. Dassault Systemes notes that in some instances the clients of the platform bring their own suppliers and partners to Dassault Systemes' products as a result.

Figure 48: Dassault Systemes has a history of innovation

Business Experience Platfrom Product Lifecycle Management

Digital Mock-up Design

1981 1989 1999 2012 2016

Source: Dassault Systemes

The 3D Experience platform The 3D Experience is a suite of products that work together to provide an end-to-end platform throughout an organisation. This includes harnessing all aspects of 'digital technology'. At the front end, it includes information tools that can gather product intelligence from the Internet/ social media. This information can be used to help formulate new product initiatives; these ideas can then be fully designed, visualised, simulated and digitally tested; and then the designs can be used directly in the manufacturing process. We see a number of major benefits of this platform. First, this creates a consistent data backbone that runs through the organisation. This creates a "single source of truth", which avoids the problem of duplication and tracking variations. It also provides a data model that can be re-used in multiple departments, improving efficiency and time to market significantly.

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Figure 49: The 3D Experience

Source: Dassault Systemes

How is Dassault relevant to aerospace? Dassault's products can be used in a broad range of industries. However, given the close relationship between Dassault Systemes and Dassault Aviation, it is no surprise that aerospace is one of the core verticals for Dassault Systemes.

Figure 50: FY16 Software revenue in EURm

Business services 9% Diversification industries* Industrial equipment 31% 16%

Aerospace and defense 13%

Transportation and mobility 31% Source: Company data, *Architecture, Engineering and construction; Consumer goods and retail; Consumer packaged goods and retail; Energy, Process and Utilities; Finance business service; High tech; Life sciences; Marine and offshore; Natural resources

We also think it is worth highlighting that this new platform is fully open and deliverable in a cloud environment. This enables different departments to access the same data, but significantly, it also enables partners and the supply chain ecosystem to use the platform. The open nature of the platform provides a secure environment for open collaboration and the sharing of ideas and because access can be controlled, it is a way of monitoring and protecting intellectual property rights. We think this platform may tie directly into the vision that airframers have to get back control of their IP and leverage it for profit.

Thales – Digital is a key growth driver for the medium term Thales has developed a strategy around digitalisation, which it presented with its FY16 results in February. It is organised around four core digital technologies (big data, cyber- security, connectivity and artificial intelligence), leveraging its existing strengths (the group effectively designs sensors, which capture data and systems that process and distribute these, with high reliability and real-time requirements). We believe this positions the group well to benefit from the digitalisation trend, with a significant installed base of systems.

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The group employs 10,000 system engineers and 7,500 software engineers. We expect Thales to continue spend on R&D (and as a result hire new engineers) in these areas to feed future organic growth.

Figure 51: 27% of Thales' workforce is in digital engineering in number of employees, 2016

Systems engineers 15%

Software engineers 12%

Hardware engineers Other employees 8% 65%

Source: Company data

For instance, the group is investing in a new generation of connectivity-based rail signalling (ETCS Level 3) for deployment after 2020, which may eventually lead to autonomous trains. Thales is also leveraging its cybersecurity expertise on its other business lines, for instance when it is selling its IFEC systems (in-flight entertainment and connectivity). Given the strong financial situation of the group (EUR2.4bn net cash at the end of 2016), we think M&A is also likely to play a role in reinforcing the group's position. In 2016, Thales bought Vormetric in software-based data protection, complementing its existing hardware-based data protection businesses (US$400m for expected revenues of US$75m). We would not be surprised to see acquisitions in data analytics or artificial intelligence, each probably carrying a large price tag for small revenues but strong growth potential. Each deal will have to be assessed on its own merits, but the strategy articulated by Thales and its acquisition track record offer a good starting point. The group announced on 28 April 2017 the acquisition of Guavus in the US, for a USD215m consideration (with Thales indicating it will should have revenues of USD30min 2017E). This company specialises in real-time big data analytics, in particular focused on the telecommunications and cable network operator market in the US. We expect more similar deals to happen in the future. Thales expects to deploy the Guavus platform developed over the last two years on its own vertical markets, such as defence, cybersecurity and air traffic management, with the first products out in a matter of months after the completion of the deal. Besides selling the Guavus products in its markets, the acquisition is also aimed at helping Thales increase sales of its own digital products. The group stated that it is paying a multiple of about 4.0x sales on 2017E expectations (i.e. an implied USD120m) and 2.5x sales on the maximum payout if the sales targets are reached (implying a revenue target of USD90m, at an unspecified date). They also stated that they expect Guavus' EBIT to be marginally negative in 2017E and to be at Thales average by 2020E (i.e. 10-11%).

Leveraging large physical installed bases We note a strategy followed by many large industrial conglomerates (such as GE and Siemens) to leverage their digital offering on their existing physical installed base, to enhance the customer experience and generate additional revenues for themselves, as well as reduce costs for both parties. This raises the question of future operating standards and probably gives the first comers a significant advantage on followers.

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Siemens (SIEGn.DE – Neutral, TP: EUR135) pushes to link its digital offering (from PLM tools to its MindSphere open environment for IoT) to its industrial activities, including automation and 3D-printing. See our 27 March report: Further insights into the Digital Strategy. Similarly, GE (GE.N - Outperform, TP: US$34) has made significant efforts to expand its Digital offering in recent years, particularly around its Predix offering, which aims to be an industrial operating system. We estimate its 'pure' Aviation Digital sales comprise a few hundred million dollars today. The company is partnering with airlines such as Qantas and China Eastern, on Asset analytics, Operations optimisation, Digitalised fleet records, and Flight analytics. GE claims that over 10,000 aircraft with ~100 airlines are GE Aviation Digital Solutions customers. The biggest potential new addressable market yielded by Predix is likely to be the 'Intelligent Airport'.

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Consequence 3 – Long-term boost to margins and cash for the airframers As a result of these disruptions, we expect the profitability gap between airframers and their suppliers to reduce over time, most likely beyond the turn of the decade (as new technologies mature and new programmes are launched). This would be positive for airframers' valuation, with higher profits and lower cyclicality (as some of the increased profits would come from services / aftermarket revenues). We believe this may help support multiples for airframers at the end of the decade, once they reach peak production levels. Airframers reducing the margin gap with suppliers Margin expansion for airframers into the teens We see three main drivers for airframers to reduce the margin gap with their suppliers:

■ Improving their own operational performance (on both production and development costs);

■ Cutting costs originating from their suppliers (purchases account for 70-75% of costs);

■ Capturing some aftermarket / services profits. We measure the existing underlying margin gap at 800bp today, with a small decrease by the end of the decade (explained largely by the FX boost received by Airbus). We believe airframers as an industry could target a reduction of 200-250bp of this gap in the long run, returning to the levels of the early 2000s, as illustrated on Figure 52. Boeing's stated "aspirational margin goal" for instance is mid-teens. This would bring the airframers' margin to c.12-13% collectively.

Figure 52: Operating margins – airframers vs suppliers – looking ahead in % of revenues, operating income, including exceptionals

20.0% 18.0% 16.0% 15.0% 14.0% 12.0% 10.0% 10.0% 8.0% 5.0% 6.0%

0.0% 4.0% 2.0%

-5.0% 0.0%

2011 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Gap suppliers / airframers - rhs Airframers (A+B) Engine makers (5) Suppliers (26)

Source: Company data, Credit Suisse estimates

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We would expect the compounded supplier margin (including engine makers) rate to expand by 100bp by the end of the decade. Indeed, on the positive side, volumes will ramp up on new programmes, while their start-up costs will shrink, with further positive effects of disruptive technologies on unit costs. R&D costs will also recede at engine makers, even if a shift to upgrades (rather than new programmes) limits the reduction. This can be expected to be offset partially by lower margins on new aftermarket (at the start of their price escalation and faced with some airframers pressure), and the retirement of the older and more profitable part of the installed base.

How achievable can this target be? Even when restating Airbus's past profits for currency impacts, as an industry airframers have never reached such a level and we believe it would only happen progressively, as new programmes are introduced. The technology disruptions arising will change both production and processes and offer airframers the opportunity to alter the balance in their favour, which has not been possible in the past. Overall, in our view the main obstacles likely to be faced by airframers on their way to closing this margin gap are:

■ Resistance from the supply chain, with some execution risk as a result (see below execution risk on the current ramp-up);

■ Price pressure from airlines as they reshape their procurement policies and reduce their costs;

■ Execution challenges on the implementation of the disruptive technologies on new programmes. We note that suppliers can still be expected to capture a disproportionate share of the aftermarket revenues, as they will be the actual producers of most of the parts. As a result, the gap should not disappear completely. Some areas in the supply chain appear better positioned than others to contain the pressure – where IP content is high (engines), where the relation with airlines is not totally reliant on airframers (cabin, engine), where aftermarket is protected by a large non- displaceable installed base (engines, systems) and where technology disruptions can be leveraged to their own profit (engines). Risk to airframers from a contentious ramp-up The pressure on Tier 1 suppliers also means that they are likely to push back on the planned production ramp-up and the investments it requires. This is illustrated in Figure 53 shown at the September 2016 Speednews conference. According to this survey by Roland Berger consultancy, 40% of the Tier 1 suppliers indicate that they believe a downturn will come in the next 3-5 years (compared with only 16% of the Tier 2s). We think this makes them more reluctant to invest in the required capacity to meet the production goals of the airframers. We believe this view may prevent some Tier 1s from investing and it could be a key risk to the delivery ramp-up for Airbus and Boeing. Industrial and financial consequences have been demonstrated by the delays for the A350 and the A320neo, both impacted by a lack of investments coupled with a lack of maturity of the industrial processes (by Zodiac in lavatories for the A350 and by Pratt & Whitney in fan blades for the PW1000G for the A320neo). We believe Airbus and Boeing will most likely watch merging companies (B/E Aerospace / Rockwell Collins and Zodiac Aerospace / Safran) and pay particular attention that they do not cut capex to support synergies and cash-flow targets.

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Figure 53: Tier 1 suppliers appear less confident than others in the cycle Question: How long do you think that the current buoyant market conditions in the civil aerospace sector will continue?

50%

45%

40%

35%

30%

25%

20%

15%

10%

5%

0% Gradual rate rises will be well-managed by the OEMs in The present cycle has some way to run (10-20% or more We are near the top of the cycle (within 10% in volume response to future changes in demand as the industry increase in volume terms), after which there will be a terms) and a downturn will come in the next 3-5 years continues on a long-term super cycle downturn in >5 years' time

OEM Tier 1 Tier 2

Source: Roland Berger, survey presented in September 2016

Cost reductions for airframers Overall, airframers appear to be in a good position to leverage disruptive technologies and reduce production costs (including at suppliers), non-quality costs and development times, which should help them to increase cash and earnings.

Reduction of direct production costs We estimate the net direct cash cost reduction potential resulting from the shift to automated assembly at a range of 50-100bp for airframers. This is based on the following assumptions:

■ Assembly work is 10% of the cost of producing an aircraft;

■ Labour costs currently account for 30% of the costs of assembly;

■ Cycle times are reduced by 30% to 50%, translating into an equivalent reduction in the man hours needed to perform the assembly. This reduction is concentrated in the stations where the automation is implemented, covering only a limited part of the production costs. This vision is based on a mature industrial setting, assuming that all programmes have been migrated to it, which will require years to achieve.

Reduction of non-quality costs The decrease of non-quality costs could further reduce production costs for OEMs by 100- 150bp, on our estimates, via the elimination of extra inspections, scrap of faulty parts, etc. Making sure that the supply chain embraces automation as well (something which appears to be the case) should allow Airbus to reduce the risk imported from its supply chain (which triggered execution issues in 2016 with the A320neo and the A350). In the supply chain, these non-quality costs currently range from 1.5% to 2.0% of sales at FACC to 5-6% of sales for Zodiac.

Global Aerospace & Defence 64 4 May 2017

Reduction of development costs Shortening development cycles could lead to significant savings, which could be up to 10- 15% of the total development costs, on our estimates. This would correspond to reducing the development time by 20-25% and concentrating development activities in a shorter time frame. Launching the A320neo cost Airbus about EUR1bn while the group flagged a cost of EUR2bn for the A330neo. We estimate the cost of the 737MAX at US$1.5-2.0bn. The development costs of the A350 have exceeded EUR15bn and those of the A380 probably topped EUR20bn, while those of the 787 are said to be beyond US$20bn. Capturing some of the suppliers' aftermarket profits We expect the airframers to try to capture some of the aftermarket profits, particularly via the evolution of contract terms and the use of cloud computing.

Evolution in contract terms Changes implemented to contract terms between OEMs and their suppliers are likely to result in suppliers being less able to raise aftermarket pricing (a key demand from airlines) while giving the airframers the opportunity to impose some royalties on the use of their intellectual property. Suppliers can be expected to push back, but with the risk of seeing challengers replace them on new programmes, especially in areas where the airframer can hand out simple build-to-print contracts and keep control of the design and integration of the equipment. The impact is likely to be gradual and spread over a generation of products, in our view.

Cloud-based digital continuity to help capture aftermarket flows Digital continuity offered by the use of these OEM-controlled clouds could help the airframers capture a larger share of aftermarket and some of the associated profits. We can envisage each OEM developing its own cloud as an ecosystem where suppliers would need to participate to be allowed on a programme and accept joint ownership of some degree of any IP created in this cloud. It would also require the owner / operator of the aircraft to plug into the said cloud and share data with the cloud sponsor, which they have been reluctant to do until now (usually through JVs). This is effectively offering the OEMs a way to boost ancillary revenues via such partnerships, in particular with large operators / alliances.

A better sense of aftermarket trends Airbus and Boeing have each purchased a leading parts distributor (respectively Satair in 2011 and Aviall in 2006). This should allow them to have better insight into aftermarket pricing and trends. Technology disruptions positive for the airframers' valuation We believe the technology disruptions that we have highlighted in this report are positive for the valuation of airframers and supportive of an expansion of their multiples compared with previous cycles. It may help to reduce their discount to their suppliers.

Global Aerospace & Defence 65 4 May 2017

Structurally better profitability supportive of multiples expansion A reduced cyclicality of earnings should benefit valuation, even if absolute levels of earnings remain driven primarily by volumes and FX. Higher aftermarket revenues for the airframers and stronger underlying margins would mean more sustainability of profitability over cycles, which we think should result in better valuations and lower multiples volatility from peak to trough. The main drivers of this improvement in valuation include:

■ Margin protection and maybe even margin expansion;

■ Cash-flow benefits;

■ Lower earnings volatility;

■ A more flexible cost structure. Margin protection and maybe even margin expansion Capturing a higher share of services profits and reducing costs should eventually help airframers to resist margin pressure from airlines and new competitors and improve their profitability. The implementation of these new technologies will initially translate into higher costs, as illustrated by the increase in HQ costs at Airbus resulting from the ongoing digitalisation effort. Cash-flow benefits Improved earnings will of course increase the generation of operational cash. It will come with some capex, but lower than it could have been (with lighter structures needed for new assembly lines, for instance). It will also reduce the WCR needs by reducing the production cycle, to some extent. Shorter development cycles will also help reduce the cash needs of the business. Lower earnings volatility Improving the quality of the production process (for instance by using automation) will reduce the volatility of earnings for airframers (a typical example being the "one-offs" booked by Airbus on programme slippages). A more flexible cost structure We believe that increased automation will also allow the airframers to: 1) lower their fixed costs in terms of labour, and 2) increase the flexibility of their production tool. This will in turn mean lower cyclicality, as it will increase the airframers' ability to adjust production to fluctuations in demand and shift around backlogs with a shorter notice (aircraft customisation currently starts 9 months before delivery for the A320).

Closing the valuation gap to the suppliers Closing the gap with suppliers in terms of operating margin would help the OEMs to close the gap in terms of valuation. Suppliers excluding aerostructures and engines are currently trading on a 2019E adjusted EV/EBIT of c.12.0x, while airframers trade on c.8.0x on average, with Airbus at 7.3x and Boeing at 10.5x.

Global Aerospace & Defence 66 4 May 2017

Figure 54: Adjusted EV/EBIT for suppliers – 28 April 2017 2015 2016 2017E 2018E 2019E Esterline 7.6x 15.0x 15.0x 12.2x 10.6x L-3 14.9x 14.8x 15.0x 13.9x 12.7x Meggitt 19.7x 16.3x 14.4x 13.0x 12.5x Moog 13.6x 13.8x 14.9x 12.9x 11.8x Orbital ATK 12.4x 12.3x 12.6x 11.5x 10.4x Rockwell Collins 13.3x 12.9x 16.5x 13.2x 12.0x Rolls-Royce 11.3x 18.3x 16.1x 11.2x 8.2x Safran 15.3x 13.1x 14.1x 11.3x 9.3x Spirit Aerosystems 8.3x 10.9x 8.0x 7.2x 6.3x Transdigm 17.8x 18.4x 15.0x 13.7x 12.5x Triumph 10.1x -2.7x 10.9x 7.9x 6.9x Woodward 13.1x 18.4x 17.1x 14.1x 12.8x Zodiac Aerospace 34.0x 29.0x 37.4x 16.7x 11.6x Average 14.7x 14.7x 15.9x 12.2x 10.6x Average excl. aerostructures & engines 16.3x 16.8x 17.5x 13.5x 11.9x Source: Company data, Credit Suisse estimates

Figure 55: Adjusted EV/EBIT for prime contractors and airframers – 28 April 2017 2015 2016 2017E 2018E 2019E Airbus Group 12.2x 11.8x 14.9x 10.4x 7.3x BAE Systems 12.2x 12.1x 12.4x 11.7x 11.6x Boeing 12.8x 18.5x 13.4x 12.0x 10.5x Dassault Aviation 11.5x 15.5x 7.8x 5.9x 5.5x GD 10.9x 14.8x 14.4x 13.2x 12.0x Huntington Ingalls 8.8x 10.8x 11.4x 10.8x 9.7x Lockheed Martin 15.2x 15.9x 16.0x 13.9x 12.4x Northrop Grumman 13.1x 14.6x 14.8x 13.3x 11.9x Raytheon 13.4x 13.4x 14.1x 12.4x 10.8x Thales 10.6x 12.7x 12.7x 10.6x 9.1x Average 12.1x 14.0x 13.2x 11.4x 10.1x Source: Company data, Credit Suisse estimates

Boeing – intensely focused on costs We believe that Boeing (BA.N – Neutral, TP: US$200) has begun to question the traditional lag in its margins versus those for its suppliers, catalysed perhaps by the losses it incurred on the 787 programme, where BA bore much of the risk and overruns despite strong efforts to share these costs with the supply chain. Management is specifically looking for double-digit margins (company-wide) by 2018E, with "mid-teens" within five years. To put this into perspective, a mid-teens margin in 2020 would translate into a 74% increase in core EPS versus our current forecast. We detail this reasoning in the Boeing-specific section later in this report. Airbus valuation should eventually reflect better underlying profitability We expect Airbus (AIR.PA – Outperform) to benefit in the long run from an improvement in trade terms relative to the sector. This underpins the increase in our target price to EUR100 (from EUR76). See the Airbus section of this report for more details.

Global Aerospace & Defence 67 4 May 2017

Credit Suisse HOLT® view of the sector's valuation Economic P/E multiples have expanded in all three segments over the past 12 months. Engine Makers in particular have seen a sharp re-rating, while Airframers' valuation has expanded despite the absence of significant earnings improvement. Suppliers continue to trade at a discount.

Figure 56: Economic P/E x

45

40

35

30

25

20

15

10

5

April 96 April 15 April April 97 April 98 April 99 April 00 April 01 April 02 April 03 April 04 April 05 April 06 April 07 April 08 April 09 April 10 April 11 April 12 April 13 April 14 April 16 April 17 April

Airframers Engine Makers Suppliers

Source: Credit Suisse HOLT

Global Aerospace & Defence 68 4 May 2017

Europe/France Aerospace & Defense

Airbus Group (AIR.PA) Rating OUTPERFORM Price (28 Apr 17, €) 74.23 Target price (€) (from 76.00) 100.00 Market Cap (€ m) 57,373.3 Valuing the potential of sustainably higher margins Enterprise value (€ m) 62,508.2 Target price is for 12 months. ■ A free cash flow story to 2020E: Airbus should generate nearly EUR18bn

Research Analysts of cumulative free cash flow (FCF) over 2017E-20E, with a strong pick-up in

Olivier Brochet 2018E and even more in 2019E, on our estimates. This should be driven by 44 20 7888 8508 the increase in output and a favourable mix on the A320, a reduced cash [email protected] drain from the A350 and the improvement in the US$ hedge rate. A400M will Specialist Sales: Andrew Bell be a larger-than-anticipated drag on cash flow in 2017E-18E, but this may 44 20 7888 0479 [email protected] start to reverse in 2019E. We would expect this cash generation to support share buybacks once execution is normalised on A320neo and A400M negotiations are finalised. Provided the A320neo's PW1100G engine beats the group’s delivery targets for 2017 (lower than Pratt’s own targets), there is room for beating the FCF guidance, in our view (“similar to 2016”). ■ The opportunity of technology disruptions: Automation, 3D printing and digitalisation offer Airbus the opportunity to increase its underlying profitability (capturing some margin from suppliers, increasing flexibility and reducing fixed costs). This would help the group extend its margin expansion and FCF generation beyond 2020E. ■ Catalysts and Risks: Paris airshow briefing: 21 June; H1 earnings: 27 July. The main risks include a drop in USD vs the EUR, persistence of difficulties at Pratt & Whitney with the A320neo engine, renewed trouble for the A400M, or a major geopolitical event. ■ Valuation: We increase our target price to EUR100 per share (from EUR76). We have switched from a 2018E SOTP to a 2020E SOTP. To value Airbus' commercial aircraft activities, we use an adjusted EV/EBIT multiple of 10.0x, given the prospect of sustainably higher and less volatile profitability beyond 2020E as a result of the technology disruptions we have investigated. Our valuation also includes a EUR1bn contingency charge in case of potential new issues with the A400M. We have increased by EUR70-100m the digitalisation / innovation costs we include in HQ, to reflect the investment under way (about -1/2% on EPS over 2017E-20E excluding capital gains in 2017). Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E 12/19E Revenue (€ m) 66,581.0 71,088.3 77,823.0 83,150.3 EBITDA (€ m) 6,249.0 6,697.3 8,528.5 10,691.8 Adjusted net income (€ m) 2,562.00 2,730.95 3,822.96 5,262.39 CS EPS (adj.) (€) 3.31 4.02 4.91 6.76 Prev. EPS (€) - 3.76 4.93 6.71 ROIC (%) -40.8 -43.0 -66.8 -86.2 P/E (adj.) (x) 22.4 18.5 15.1 11.0 P/E rel. (%) 147.3 127.0 115.1 90.9 The price relative chart measures performance against the EV/EBITDA (x) 10.0 9.3 7.1 5.3

CAC 40 INDEX which closed at 5267.3 on 28/04/17 Dividend (12/17E, €) 1.62 Net debt/equity (12/17E,%) -262.1 On 28/04/17 the spot exchange rate was €1/Eu 1.- Dividend yield (12/17E,%) 2.2 Net debt (12/17E, € m) -11,369.0 Eu.92/US$1

BV/share (12/17E, €) 5.6 IC (12/17E, € m) -7,031.9 Performance 1M 3M 12M Free float (%) 73.6 EV/IC (12/17E, (x) -8.9 Absolute (%) 4.1 17.6 36.8 Source: Company data, Thomson Reuters, Credit Suisse estimates

Relative (%) 0.9 7.4 17.9

Global Aerospace & Defence 69 4 May 2017

Airbus Group (AIR.PA) Price (28 Apr 2017): €74.23; Rating: OUTPERFORM; Target Price: (from €76.00) €100.00; Analyst: Olivier Brochet Income statement (€ m) 12/16A 12/17E 12/18E 12/19E Company Background Revenue 66,581 71,088 77,823 83,150 Airbus is one of the two global manufacturers of large commercial EBITDA 6,249 6,697 8,528 10,692 aircraft, ranging from 150 seats (A320) to 500+ (A380). Its newest Depr. & amort. (2,294) (2,465) (2,749) (2,930) programme is the A350, which entered into service in late 2015. EBIT 3,955 4,233 5,780 7,761 Defence revenues account for c.20% of sales. Net interest exp. (275) (267) (245) (200) Associates - - - - Blue/Grey Sky Scenario PBT 1,291 4,372 5,384 7,412 Income taxes (291) (1,246) (1,561) (2,149) Profit after tax 1,000 3,126 3,823 5,262 Minorities (5) -0 -0 -0 Preferred dividends - - - - Associates & other 1,567 (395) 0 0 Net profit 2,562 2,731 3,823 5,262 Other NPAT adjustments (1,567) 395 (0) 0 Reported net income 995 3,126 3,823 5,262 Cash flow (€ m) 12/16A 12/17E 12/18E 12/19E EBIT 3,955 4,233 5,780 7,761 Net interest (275) (267) (245) (200) Cash taxes paid - - - - Change in working capital 1,245 (1,044) 603 118 Other cash and non-cash items (556) 1,028 171 879 Cash flow from operations 4,369 3,950 6,308 8,559 CAPEX (2,805) (2,714) (2,606) (2,697) Free cashflow to the firm 3,181 1,653 3,781 6,220 Acquisitions (120) 0 0 0 Divestments 803 906 0 251 Other investment/(outflows) 1,037 (839) (271) (243) Cash flow from investments (1,085) (2,646) (2,876) (2,689) Net share issue/(repurchase) 60 0 0 0 Dividends paid (1,012) (1,047) (1,254) (1,610) Issuance (retirement) of debt 1,572 0 0 0 Our Blue Sky Scenario (€) (from 99.00) 114.00 Cashflow from financing (116) (1,047) (1,254) (1,610) We used a 2020E SOTP without de-rating the Airbus mutiple for Changes in net cash/debt 1,059 213 2,177 4,261 commercial aircraft (EV/EBIT of 12.0x), implying further upside on deliveries for at least two years beyond 2020E (for instance on A320 Net debt at start (10,097) (11,156) (11,369) (13,546) and A350) and continued improvement on margin. Change in net debt (1,059) (213) (2,177) (4,261) Net debt at end (11,156) (11,369) (13,546) (17,807) Our Grey Sky Scenario (€) (from 43.00) 58.00 Balance sheet (€ m) 12/16A 12/17E 12/18E 12/19E It would assume that the on-going ramp-up in deliveries is Assets interrupted, triggering a de-rating to peak multiples (EV/EBIT of 7.0x Total current assets 56,096 57,883 63,559 70,486 2018E instead of the 10.0x 2020E in our core scenario). Total assets 111,133 113,662 118,591 124,322 Liabilities Share price performance Total current liabilities 56,692 58,563 60,420 62,111 Total liabilities 107,481 109,324 111,184 112,907 Total equity and liabilities 111,133 113,661 118,591 124,322 Per share 12/16A 12/17E 12/18E 12/19E No. of shares (wtd avg.) (mn) 779 778 778 778 CS EPS (adj.) (€) 3.31 4.02 4.91 6.76 Dividend (€) 1.35 1.62 2.08 3.06 Free cash flow per share (€) 4.08 2.12 4.86 7.99 Key ratios and valuation 12/16A 12/17E 12/18E 12/19E Growth/Margin (%) Sales growth (%) 3.3 6.8 9.5 6.8 EBIT growth (%) (3.7) 7.0 36.6 34.3 Net income growth (%) (3.5) 6.6 40.0 37.7 EPS growth (%) (2.0) 21.5 22.3 37.7 EBITDA margin (%) 9.4 9.4 11.0 12.9 The price relative chart measures performance against the CAC 40 INDEX EBIT margin (%) 5.9 6.0 7.4 9.3 which closed at 5267.3 on 28/04/17 Pretax profit margin (%) 1.9 6.2 6.9 8.9 On 28/04/17 the spot exchange rate was €1/Eu 1.- Eu.92/US$1 Net income margin (%) 3.8 3.8 4.9 6.3 Valuation 12/16A 12/17E 12/18E 12/19E EV/Sales (x) 0.9 0.9 0.8 0.7 EV/EBITDA (x) 10.0 9.3 7.1 5.3 EV/EBIT (x) 15.8 14.8 10.5 7.3 Dividend yield (%) 1.82 2.18 2.80 4.12 P/E (x) 22.4 18.5 15.1 11.0 Credit ratios (%) 12/16A 12/17E 12/18E 12/19E Net debt/equity (%) (305.5) (262.1) (182.9) (156.0) Net debt to EBITDA (x) (1.8) (1.7) (1.6) (1.7) Interest coverage ratio (x) 14.4 15.8 23.6 38.9

Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates

Global Aerospace & Defence 70 4 May 2017

Cash and margin upside for Airbus Airbus Group spent about EUR79bn in capex and R&D between 2002 and 2016, an average of EUR5.3bn per annum. Saving 10% of that amount (through cost cutting and cycle reduction) would boost annual cash generation by c.EUR500m, compared with cumulative FCF generation of EUR23.9bn over 2002-2016 (pre-aircraft financing and M&A) and an annual average of EUR1.6bn. It would represent a 7% increase vs our current 2020E expectation for FCF.

Figure 57: Airbus - Capex and R&D, FCF and EBIT (reported) in EURm - group

10,000

8,000

6,000

4,000

2,000

0

-2,000

2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013 2014 2015 2016

2017E 2018E 2019E 2020E

Capex R&D FCF EBIT - reported

Source: Company data, Credit Suisse estimates

Cumulative EBIT (reported) for the group comes to just above EUR27bn over 2002-2016, i.e. EUR1.8bn per annum. At the Airbus level (commercial aircraft activities), the average reported EBIT comes to EUR1.1bn. We expect the cumulative group EBIT over 2017E- 2020E to be of a similar order of magnitude as for the 2002-2016 period. Reducing the R&D costs of Airbus (commercial aircraft) by 10% would boost the earnings by c.EUR200m per annum (+19% vs the 2002-2016 average and 3% vs 2018E-2020E earnings), adding 20bp to our 2020E EBIT margin forecast. We expect them to stabilise at around EUR2.2bn for the foreseeable future, and include at this level the launch of a new programme upgrade (most likely a new version of the A350, in our opinion). Reducing costs and increasing aftermarket profits at Airbus (commercial aircraft) by a combined net impact of c.200bp would increase the group's reported margin to above 13% (3.1% in 2016 and 11.1% estimated for 2020E – 10.9% for the company-supplied consensus). This would be closing over half of the current margin gap with the supply chain. Using 2020E as a theoretical reference, this would represent a c.20% boost to our current EBIT expectations. We expect the positive impact to progressively materialise only in the next decade, but this gives a sense of the earnings expansion that could be generated.

Global Aerospace & Defence 71 4 May 2017

Figure 58: Airbus – EBIT reported and R&D Figure 59: Airbus – EBIT margin reported and R&D in EURm – commercial aircraft activities in % of revenues – commercial aircraft activities

10,000 1,000 12.0%

900 10.0% 8,000 800 8.0% 700 6,000 6.0% 600 4.0% 4,000 500 2.0% 400 2,000 0.0% 300 -2.0% 200 0 100 -4.0%

-2,000 0 -6.0%

2004 2007 2002 2003 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016

2015 2016 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

2017E 2018E 2019E 2020E

2017E 2018E 2019E 2020E

EBIT - reported R&D Deliveries - rhs EBIT margin R&D as % of sales

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

As a side note, this margin ambition would be further boosted by a last leg of FX benefits beyond 2020, as hedge rates in the hedgebook align with forward rates (assuming US$ spot rates of 1.05, it should stabilise at 1.16 by 2022, a 4 cent improvement vs 2020E). We calculate that this would add another c.EUR600m to EBIT and 70bp to EBIT margin on a 2020E basis. A key factor for Airbus' long-term valuation Airbus currently trades on an adjusted EV/EBIT of 10.4x 2018E, in line with the average of 10.3x over 2004-2016 and mid-range between highs and lows of respectively 15.6x (2007) and 3.8x (2008). On our 2020E forecasts, it trades on 5.9x EV/EBIT, a >40% discount to its historical average. The stock trades on a 2018E adjusted P/E of 15.1x, 5% lower than its 2004-16 average of 15.9x. A key element for Airbus' valuation between now and the end of the decade will be its ability to maintain its profitability beyond 2020 and to reduce its margin volatility in down cycles. Effectively, the main question would now be: is Airbus soon going to be trading at a peak multiple (implying a significant de-rating vs the current level) or can these multiples be sustained (or even expanded)? If the group can convince of its ability to 1/ sustain its margin, 2/ reduce its volatility between highs and lows, and 3/ limit its decrease in the event of a downturn, we would expect the peak multiple to be higher. Assuming that it can boost its underlying margin by 200-300bp as envisaged above, we think that Airbus could 1/ sustain an adjusted EV/EBIT multiple of 10.0x as long as production is holding and 2/ warrant a peak EV/EBIT multiple of 7.0x rather than the level of c.4.0-5.0x seen in 2008-2009 (taking into account that 2008 and 2009 were impacted by the financial crisis and by internal execution issues and assuming that FX would not materially move from current levels). Boeing's EV/EBIT multiple hit 8.9x in 2008 (near the lowest point of 2004-2016, with 8.0x in 2012 in the wake of 787 issues).

Global Aerospace & Defence 72 4 May 2017

Figure 60: Airbus – EV/EBIT adjusted (x) Figure 61: Airbus – P/E adjusted (x)

18.0x 35.0x

16.0x 30.0x 14.0x 25.0x 12.0x

10.0x 20.0x

8.0x 15.0x

6.0x 10.0x 4.0x

5.0x 2.0x

0.0x 0.0x 2004 2006 2008 2010 2012 2014 2016 2018E 2020E 2004 2006 2008 2010 2012 2014 2016 2018E 2020E

EV/EBIT adjusted (x) Average 2004-2016 P/E adjusted Average 2004-2016

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Target price increased to EUR100 We switch from a 2018E SOTP to a 2020E SOTP using an adjusted EV/EBIT multiple of 10.0x on our 2020 estimates for the Commercial Aircraft business, as detailed above. We use a sample of A&D peers for the Helicopters business, with a 20% discount to reflect the lower profitability and the difficulties on the SuperPuma programme. We use a defence & space EV/EBIT multiple of 12.5x for Airbus Defence & Space EBIT excluding the JV contribution (valued at a defence & space P/E discounted by 10%, given the high growth profile for MBDA in particular). We adjust the enterprise value for a number of elements:

■ Net debt (including the Airbus convertible bond to be converted into Dassault Aviation shares);

■ The launch aids;

■ The pension deficit, net of tax;

■ A small residual customer financing position;

■ A further EUR1.0bn contingency charge on the A400M to cover for possibly unsuccessful negotiations with the customers, net of tax;

■ The value of the residual 10% Dassault stake (at its conversion price, matching the convertible counted as debt). We have tweaked our earnings estimates after Q1 to account for an increase in HQ costs over 2017E-2020E related to the digitalisation effort and innovation endeavours. This takes our HQ charge to -EUR350m per annum vs EUR250/280m previously. We have also reflected the latest hedge rates in our model, with a marginal improvement in 2019E- 2020E and a marginal negative impact on 2017E. This is broadly in line with our FCF expectations.

Global Aerospace & Defence 73 4 May 2017

Figure 62: 2020E SOTP in EURm and EUR per share Sales EBIT EBIT Implied EV/EBIT Implied EV per % of total Comment adjusted margin EV/sales multiple EV share equity (%) (x) (x) value Airbus 70,172 7,810 11.1% 1.1x 10.0x 78,105 100.4 77% @10.0x sustained EV/EBIT multiple Airbus Helicopters 8,038 555 6.9% 0.7x 10.0x 5,548 7.1 6% A&D primes 2018E multiple, 20% discount Airbus Defence & Space (excl. JVs) 9,299 766 8.2% 1.0x 12.5x 9,559 12.3 9% defence & space 2018E multiple HQ, other & Eliminations -1,449 -350 24.2% 2.5x 10.2x -3,573 -4.6 -4% Enterprise value 86,060 8,781 10.2% 1.0x 10.2x 89,638 115.2 89% Add: JV contributions (MBDA, ASL) 187 14.2x 2,651 3.4 3% Defence peers P/E, 20% discount Entreprise value (incl. JVs) 8,968 10.4% 10.3x 92,289 118.6 92% Add: net cash 21,714 27.9 22% including Dassault convertible Less: refundable advances -6,080 -7.8 -6% Less: pension deficit -7,039 -9.0 -7% net of tax Less: customer financing -420 -0.5 0% Less: A400M contingency -750 -1.0 -1% EUR1.0bn pre-tax additional charge Add: Dassault Aviation stake 1,079 1.4 1% at EUR1,307 conversion price Less: minorities 30 0.0 0% Equity value 100,823 129.6 Discounted equity value 77,475 99.6 2.5y discount @ 10% Number of shares 778 Note: Defence & Space stocks include Orbital ATK, GD, L-3, Lockheed Martin, Northrop Grumman, Raytheon, Rockwell Collins, MacDonald Dettwiler (all CS estimates) and OHB (IBES consensus). A&D primes include Boeing, Bombardier, GD, Lockheed Martin, Northrop Grumman (all CS estimates) Source: IBES, Credit Suisse estimates

Figure 63: EV/EBIT - Airbus vs A&D prime Figure 64: EV/EBIT – Airbus vs defence & space contractors sample

16.0x 18.0x

14.0x 16.0x

14.0x 12.0x

12.0x 10.0x 10.0x 8.0x 8.0x 6.0x 6.0x 4.0x 4.0x

2.0x 2.0x

0.0x 0.0x

2004 2008 2015 2005 2006 2007 2009 2010 2011 2012 2013 2014 2016

2006 2010 2004 2005 2007 2008 2009 2011 2012 2013 2014 2015 2016

2017E 2018E 2019E

2019E 2017E 2018E

Average Defence & Space Airbus Average A&D prime contractors Airbus

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Global Aerospace & Defence 74 4 May 2017

Using company-provided consensus data (Figure 65) instead of our own forecasts for EBIT and FCF generation, we calculate that the 2020E SOTP would come to EUR87 per share. Our 2017E EBIT numbers are 3% ahead of consensus, as a result of 1/ our deliveries expectations (17 aircraft higher) and 2/ a view that escalation should have a positive impact in H2 as PPI indexes have trended better.

Figure 65: CS forecasts vs consensus in EURm and EUR per share Reported CS Consensus CS vs consensus (%) 2015 2016 2017E 2018E 2019E 2020E 2017E 2018E 2019E 2020E 2017E 2018E 2019E 2020E Airbus Group Revenues 64,450 66,581 71,088 77,823 83,150 86,060 68,000 738,000 79,500 82,700 5% -89% 5% 4% EBIT 4,062 2,258 4,790 5,780 7,761 8,968 4,000 5,300 6,700 8,100 20% 9% 16% 11% EBIT adjusted 4,108 3,955 4,233 5,780 7,761 8,968 4,100 5,300 6,700 8,200 3% 9% 16% 9% Margin % 6.4% 5.9% 6.0% 7.4% 9.3% 10.4% 6.0% 0.7% 8.4% 9.9% Net income 2,696 995 3,126 3,823 5,262 6,161 2,600 3,500 4,600 5,600 20% 9% 14% 10% EPS adjusted 3.38 3.31 3.51 4.91 6.76 7.92 3.4 4.6 6.0 7.3 3% 7% 13% 8% DPS 1.30 1.35 1.62 2.08 3.06 3.58 1.49 1.87 2.33 2.79 8% 11% 31% FCF (pre-M&A+a/c financing) 1,325 1,408 1,397 3,781 5,969 6,631 1,300 2,500 4,200 5,500 7% 51% 42% 21% FCF/EBIT adjusted conversion 32% 36% 33% 65% 77% 74% 32% 47% 63% 67% Airbus Deliveries 635 688 741 792 859 892 724 784 835 857 2% 1% 3% 4% Revenues 45,854 49,237 55,806 62,453 67,636 70,172 52,000 56,900 62,800 66,200 7% 10% 8% 6% EBIT adjusted 2,766 2,811 3,314 4,763 6,683 7,810 3,200 4,300 5,700 7,200 4% 11% 17% 8% Margin in % 6.0% 5.7% 5.9% 7.6% 9.9% 11.1% 6.2% 7.6% 9.1% 10.9% Airbus Helicopters / Defence & Space / Others & HQ - implied Revenues 18,596 17,344 15,282 15,370 15,514 15,887 16,000 681,100 16,700 16,500 -4% -98% -7% -4% EBIT adjusted 1,342 1,144 919 1,017 1,079 1,158 900 1,000 1,000 1,000 2% 2% 8% 16% Margin in % 7.2% 6.6% 6.0% 6.6% 7.0% 7.3% 5.6% 0.1% 6.0% 6.1% FCF/adj. net income conversion 50% 55% 51% 99% 113% 108% 49% 71% 91% 97% Source: Company data for historical data and consensus, Credit Suisse estimates

Figure 66: EPS revisions 2012-2020E in EUR per share

9

8

7

6

5

4

3

2

1

0 07/01/2009 07/01/2010 07/01/2011 07/01/2012 07/01/2013 07/01/2014 07/01/2015 07/01/2016 07/01/2017

2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Source: Thomson Reuters

Global Aerospace & Defence 75 4 May 2017

Figure 67: Divisional data in EURm 2013 2014 2015 2016 2017E 2018E 2019E 2020E Airbus deliveries (# of aircraft) A320ceo 493 490 491 477 345 137 12 0 A320neo 0 68 239 484 657 690 A330/A340 108 108 103 66 68 36 6 6 A330neo 0 27 60 60 A350 1 14 49 74 96 112 124 A380 25 30 27 28 15 12 12 12 Total 626 629 635 688 741 792 859 892 US$ rates US$ spot rate 1.33 1.33 1.11 1.11 1.05 1.05 1.05 1.05 US$ achieved hedge rate 1.37 1.35 1.34 1.32 1.31 1.25 1.21 1.19 Revenues Airbus 39,494 42,280 45,854 49,237 55,806 62,453 67,636 70,172 Airbus Helicopters 6,297 6,524 6,786 6,652 7,121 7,383 7,698 8,038 Airbus Defence & Space 13,121 13,025 13,080 11,854 9,330 9,243 9,198 9,299 Other & HQ -1,345 -1,116 -1,270 -1,162 -1,170 -1,256 -1,382 -1,449 Total Airbus Group 57,567 60,713 64,450 66,581 71,088 77,823 83,150 86,060 EBIT adjusted Airbus 2,214 2,529 2,766 2,811 3,314 4,763 6,683 7,810 Airbus Helicopters 397 413 427 350 386 426 474 555 Airbus Defence & Space 911 920 1,051 1,002 883 941 955 952 Other & HQ 15 204 -136 -208 -350 -350 -350 -350 Total Airbus Group 3,537 4,066 4,108 3,955 4,233 5,780 7,761 8,968 Growth 15% 1% -4% 7% 37% 34% 16% EBIT margin - adjusted Airbus 5.6% 6.0% 6.0% 5.7% 5.9% 7.6% 9.9% 11.1% Airbus Helicopters 6.3% 6.3% 6.3% 5.3% 5.4% 5.8% 6.2% 6.9% Airbus Defence & Space 6.9% 7.1% 8.0% 8.5% 9.5% 10.2% 10.4% 10.2% Total Airbus Group 6.1% 6.7% 6.4% 5.9% 6.0% 7.4% 9.3% 10.4% Adjustments Adjustments -913 -26 256 -1,687 557 0 0 0 As a % of revenues -1.6% 0.0% 0.4% -2.5% 0.8% 0.0% 0.0% 0.0% EBIT reported Airbus 1,593 2,671 2,287 1,543 3,314 4,763 6,683 7,810 Airbus Helicopters 397 413 427 308 386 426 474 555 Airbus Defence & Space 659 409 736 -93 883 941 955 952 Other & HQ -25 547 612 500 207 -350 -350 -350 Total Airbus Group 2,624 4,040 4,062 2,258 4,790 5,780 7,761 8,968 EBIT margin - reported Airbus 4.0% 6.3% 5.0% 3.1% 5.9% 7.6% 9.9% 11.1% Airbus Helicopters 6.3% 6.3% 6.3% 4.6% 5.4% 5.8% 6.2% 6.9% Airbus Defence & Space 5.0% 3.1% 5.6% -0.8% 9.5% 10.2% 10.4% 10.2% Total Airbus Group 4.6% 6.7% 6.3% 3.4% 6.7% 7.4% 9.3% 10.4% R&D Expensed R&D -3,118 -3,391 -3,460 -2,970 -2,915 -2,954 -2,934 -2,939 Capitalised R&D -421 -118 -85 -85 -260 -160 -140 -80 Self-funded cash R&D -3,576 -3,509 -3,545 -3,055 -3,175 -3,114 -3,074 -3,019 Source: Company data, Credit Suisse estimates

Global Aerospace & Defence 76 4 May 2017

Americas/United States Aerospace & Defense

Boeing (BA) Rating NEUTRAL Price (28-Apr-17, US$) 184.83 Target price (US$) 200.00 52-week price range (US$) 184.83 - 122.70

Market cap (US$ m) 111,559.87 Looking to narrow margin gap to suppliers Target price is for 12 months.

■ Thesis: We think the ultimate question for investors today is whether Research Analysts Boeing's free cash flow can grow meaningfully beyond 2017. Boeing is clearly

Robert Spingarn cheaper than peers on 2017 FCF, which is $14/share in our model, implying a 212 538 1895 yield of almost 8%. On this number alone, BA shares trade at a ~30% discount [email protected] to the other large cap names in A&D (in the 5% range). While we think the Jose Caiado 212 325 6771 cycle could fade a bit, though not collapse, and we believe we are being more [email protected] realistic on margin expansion, our forecast still yields enough growth to support Justin Harnett our TP, given the current relative valuation discount. We think near-term 212 325 3193 numbers are achievable, and with defense stocks near all-time highs and the [email protected] market seeking more traditional-economy stocks under the Trump

administration, we see scope for investors to pay a 7% yield for BA’s 2017 free cash flow, and recently increased our target price to $200 on that basis. ■ Pursuing new efficiencies through the supply chain: We believe that Boeing has finally begun to question the traditional lag in its margins versus those for its suppliers. The catalyst for this appears to be the deep and unexpected losses on the 787 program, where BA bore much of the risk and overruns despite strong efforts to share these costs with the supply chain. As a result, we think the upcoming decade will see a migration from a focus on design evolution (for lower operating costs) to manufacturing innovation (for lower production costs and sales prices). ■ Longer-term earnings upside could be meaningful: With this new, intense focus on cost and greater factory productivity, BA is looking at every inch of the enterprise for efficiencies. The company has characterised the initiative as playing offense, meaning that this is margin-enhancing rather than margin- defending. Management is specifically looking for double-digit margins (company-wide) by this year, with "mid-teens" within five years. To put this into perspective, a mid-teens margin in 2020 would translate to an almost 50% increase in core earnings versus our current forecast, which assumes core margins rise to the low double digits (~11.5%) by 2020E. Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E 12/19E EPS (CS adj.) (US$) 7.26 9.30 10.40 12.00 Prev. EPS (US$) - - - - P/E (x) 25.5 19.9 17.8 15.4 P/E rel. (%) 127.1 109.2 109.6 104.7 Revenue (US$ m) 94,571.0 92,475.2 95,734.1 99,531.2 EBITDA (US$ m) 7,374.0 10,336.6 10,950.2 11,604.3 OCFPS (US$) 16.37 17.81 19.27 22.02 P/OCF (x) 9.5 10.4 9.6 8.4 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 EV/EBITDA (current) 15.5 11.0 10.4 9.8 Daily May02, 2016 - Apr28, 2017, 05/02/16 = US$134.01 Net debt (US$ m) 1,151 2,809 3,810 4,290

ROIC (%) 241.26 723.51 -547.42 -204.24 Quarterly EPS Q1 Q2 Q3 Q4 2016A 1.74 -0.44 3.51 2.46 Number of shares (m) 603.58 IC (current, US$ m) 2,028.00 2017E 2.01 2.13 2.40 2.78 BV/share (Next Qtr., US$) 85.8 EV/IC (x) 33.3 2018E 2.44 2.41 2.70 2.86 Net debt (Next Qtr., US$ m) 4,203.8 Dividend (current, US$) 5.68

Net debt/tot eq (Next Qtr.,%) -576.0 Dividend yield (%) - Source: Company data, Thomson Reuters, Credit Suisse estimates

Global Aerospace & Defence 77 4 May 2017

Boeing (BA) Price (28 Apr 2017): US$184.83; Rating: NEUTRAL; Target Price: US$200.00; Analyst: Robert Spingarn Income Statement 12/16A 12/17E 12/18E 12/19E Per share 12/16A 12/17E 12/18E 12/19E Revenue (US$ m) 94,571.0 92,475.2 95,734.1 99,531.2 No. of shares (wtd avg) 641 607 568 529 EBITDA 7,374 10,337 10,950 11,604 CS adj. EPS 7.26 9.30 10.40 12.00 Depr. & amort. (1,910) (1,929) (2,010) (2,016) Prev. EPS (US$) - - - - EBIT (US$) 5,464 8,408 8,940 9,588 Dividend (US$) 4.36 5.68 6.25 6.87 Net interest exp (306) (315) (304) (304) Dividend payout ratio 60.07 61.05 60.06 57.25 Associates - - - - Free cash flow per share 12.30 14.00 15.05 17.31 Other adj. 40 22 0 0 Earnings 12/16A 12/17E 12/18E 12/19E PBT (US$) 5,198 8,115 8,636 9,284 Sales growth (%) (1.6) (2.2) 3.5 4.0 Income taxes (544) (2,472) (2,731) (2,938) EBIT growth (%) (29.4) 53.9 6.3 7.3 Profit after tax 4,655 5,644 5,905 6,346 Net profit growth (%) (13.3) 21.2 4.6 7.5 Minorities - - - - EPS growth (%) (5.9) 28.2 11.8 15.4 Preferred dividends - - - - EBITDA margin (%) 7.8 11.2 11.4 11.7 Associates & other 0 0 0 0 EBIT margin (%) 5.8 9.1 9.3 9.6 Net profit (US$) 4,655 5,644 5,905 6,346 Pretax margin (%) 5.5 8.8 9.0 9.3 Other NPAT adjustments 0 0 0 0 Net margin (%) 4.9 6.1 6.2 6.4 Reported net income 4,655 5,644 5,905 6,346 Valuation 12/16A 12/17E 12/18E 12/19E Cash Flow 12/16A 12/17E 12/18E 12/19E EV/Sales (x) 1.19 1.24 1.21 1.16 EBIT 5,464 8,408 8,940 9,588 EV/EBITDA (x) 15.5 11.0 10.4 9.8 Net interest (306) (315) (304) (304) EV/EBIT (x) 20.6 13.6 12.9 12.1 Cash taxes paid - - - - P/E (x) 25.5 19.9 17.8 15.4 Change in working capital 3,045 2,246 2,124 2,380 Price to book (x) 2.3 2.1 1.8 1.6 Other cash & non-cash items 2,296 464 179 (23) Asset turnover 1.1 1.1 1.2 1.2 Cash flow from operations 10,499 10,803 10,939 11,642 Returns 12/16A 12/17E 12/18E 12/19E CAPEX (2,613) (2,312) (2,393) (2,488) Free cashflow to the firm 7,886 8,491 8,545 9,153 ROE stated-return on (%) 9.4 10.8 10.6 10.8 ROIC (%) 2.4 7.2 (5.5) (2.0) Aquisitions (297) 0 0 0 Divestments 38 9 0 0 Interest burden (%) 0.95 0.97 0.97 0.97 Other investment/(outflows) (508) 195 0 0 Tax rate (%) 10.5 30.5 31.6 31.6 Cash flow from investments (3,380) (2,108) (2,393) (2,488) Financial leverage (%) 0.20 0.18 0.17 0.16 Net share issue(/repurchase) (7,001) (7,000) (6,000) (6,000) Gearing 12/16A 12/17E 12/18E 12/19E Dividends paid (2,756) (3,431) (3,547) (3,633) Net debt/equity (%) 131.2 (140.4) (77.3) (57.2) Issuance (retirement) of debt (34) 3 0 0 Net Debt to EBITDA (x) 0.2 0.3 0.3 0.4 Other 216 55 0 (0) Interest coverage ratio (X) 17.9 26.7 29.4 31.6 Cashflow from financing activities (9,575) (10,373) (9,547) (9,633) Quarterly EPS Q1 Q2 Q3 Q4 Effect of exchange rates (33) 20 0 0 2016A 1.74 -0.44 3.51 2.46 Changes in Net Cash/Debt (2,489) (1,658) (1,001) (480) 2017E 2.01 2.13 2.40 2.78 Net debt at start (1,338) 1,151 2,809 3,810 2018E 2.44 2.41 2.70 2.86 Change in net debt 2,489 1,658 1,001 480 Net debt at end 1,151 2,809 3,810 4,290 Share price performance Balance Sheet (US$) 12/16A 12/17E 12/18E 12/19E Assets Cash & cash equivalents 8,801 7,155 6,154 5,674 Account receivables 8,832 8,600 9,956 11,347 Inventory 43,199 40,950 38,421 34,805 Other current assets 1,656 1,501 1,393 1,322 Total current assets 62,488 58,206 55,924 53,147 Total fixed assets 12,807 13,230 13,613 14,085 Intangible assets and goodwill 7,864 7,838 7,838 7,838 Investment securities 1,317 1,319 1,319 1,319 Other assets 5,521 4,171 4,498 4,863 Total assets 89,997 84,764 83,193 81,252 Liabilities Accounts payables 11,190 9,733 9,943 10,306 Short-term debt 384 0 0 0 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 Other short term liabilities 38,560 38,511 39,773 40,887 Daily May02, 2016 - Apr28, 2017, 05/02/16 = US$134.01 Total current liabilities 50,134 48,244 49,716 51,192 Long-term debt 9,568 9,964 9,964 9,964 Other liabilities 29,418 28,557 28,440 27,595 Total liabilities 89,120 86,764 88,120 88,751 Shareholder equity 817 (2,061) (4,987) (7,559) Minority interests 60 60 60 60 Total liabilities and equity 89,997 84,764 83,193 81,252 Net debt 1,151 2,809 3,810 4,290

Source: Company data, Thomson Reuters, Credit Suisse estimates

Global Aerospace & Defence 78 4 May 2017

Looking to narrow margin gap to suppliers We believe that Boeing has finally begun to question the traditional lag in its margins versus those for its suppliers. The catalyst for this appears to be the deep and unexpected losses on the 787 program where BA bore much of the risk and overruns despite strong efforts to share these costs with the supply chain. While we have no doubt that suppliers endured financial pain as well, BA is left with nearly US$30bn in deferred production (non- recurring) cost that might have been half that level or lower under different circumstances. Consequently, we believe that Boeing's Partnering for Success (PfS) program was devised to recoup some of these costs. The methodology was to exchange lower OE unit prices from suppliers in return for greater opportunities on new and future aircraft. Going forward, we would expect Boeing to de-prioritize those suppliers who refuse(d) to participate in a meaningful way. As a result, we think the upcoming decade will see a migration from a focus on design evolution (for lower operating costs) to manufacturing innovation (for lower production costs and sales prices). As an example, BA's whole T-X bid is based on production affordability, and leveraging 'Black Diamond' and massive amounts of automation to lower production costs. In military avionics, they have been partnering with Harris on next-gen programmes, with BA acting as integrator. Among suppliers, Rockwell Collins has been a key beneficiary of the program as one of the first to sign on. As a result, while COL already had made great content inroads on the 787 cockpit, it then was able to win further business on KC-46, 737MAX and 777X. We think COL may win similar content on MoM/NMA if and when it is announced. Many suppliers have since complained that the terms for Partnering for Success have been heavily biased in BA's favor. Still, many have no choice but to comply in some manner or risk alienating one of the two largest OEMs in aerospace. At some point, when candidate aircraft from new entrants become worthwhile projects, suppliers may accrue some more leverage with Boeing. In the meantime, we think BA is enjoying its newfound negotiating leverage, which appears to have encouraged it to seek a new round of OEM component price decreases as well as participation in a supplier's aftermarket stream, perhaps through royalties. This is the new cost of winning content on new programs, and so we may not see how well this new blueprint works until we get to the MoM or 797, or whatever the next airplane will be called. Mid-teens aspirational margin target With this new intense focus on cost and greater factory productivity, BA is looking at every inch of the enterprise for efficiencies. The company has characterised the initiative as playing offense, meaning that this is margin-enhancing rather than margin-defending. Management is specifically looking for double-digit margins (company-wide) by next year, with "mid-teens" within five years. Boeing also announced a strategic effort to grab more services activity and hired former GE Aviation executive Kevin McAllister in late 2016 to lead this drive.

Global Aerospace & Defence 79 4 May 2017

Figure 68: Boeing – increased focus on margin expansion

Mid teens

Double digt 10.0%

2013-2015 near-term focus Aspirational goal

Source: Boeing Potential upside to earnings To put this into perspective, a mid-teen margin in 2020 would translate to an almost 50% increase in core earnings versus our current forecast, which assumes core margins rise to the low double digits (~11.5%) by 2020. In Boeing's factories, the efficiencies come from a variety of initiatives, but the key ones are improved flow (to reduce travel time, man-hours and WIP), and automation, which also improves labor time and WIP. And of course, both benefit capacity. Further, Boeing is making no secret about adjusting its make/buy strategy in certain areas, primarily critical path technologies. As a result, it recently completed its new Composite Wing Center on the Everett campus, which will house construction of 777X wings. This is a significant departure from 787, where the composite wings were outsourced (to Mitsubishi in Japan). Boeing views capabilities such as composite structure fabrication and assembly as critical path items and centers of excellence that it wants to control. For all of the issues that affected 787 during its 3+ year delay, we think Boeing has made a very concerted effort to learn from past missteps and act accordingly and decisively. Supply chain focus This brings us to the supply chain, where Boeing has become more aggressive about reopening contracts to improve both terms (pricing) and efficiencies, often in exchange for greater share on future programs. When there is no meeting of the minds, unexpected changes can occur (e.g. Heroux-Devtek winning the 777X landing gear). These are the actions behind Partnering for Success, and they are migrating into a newly energised initiative by Boeing to capture more of the lifecycle revenues from its programs by tapping into the aftermarket. Boeing notes that while it has roughly 50% of the installed fleet, it only sees ~6% of the aftermarket revenues. It wants to increase its market share in two areas.

■ First, it believes it can supply more "high-value" aftermarket parts, especially where it controls more IP. Boeing has characterised some of these opportunities as a "win-win" for itself and its suppliers, though we're not sure all of the latter would agree. Still, we think Boeing likely has the upper hand here, as long as it does not overplay it.

■ Second, it sees on-board data analytics as another value stream, realised through subscriptions sold to its airline customers to help manage maintenance activity and save fuel. In order to do this, BA has reconfigured Gold-care, which is no longer simply a "nose-to-tail" maintenance offering, but now allows for customisation. Gold-care today covers 60 airlines and 2,200 aircraft. Boeing has 3,200 aircraft subscribing to some form of its data analytics package (as of mid-2016).

Global Aerospace & Defence 80 4 May 2017

Americas/United States Aerospace & Defense

Heico Corp (HEI) Rating OUTPERFORM Price (28-Apr-17, US$) 71.07 Target price (US$) (from 76.00) 85.00 52-week price range (US$) 71.69 - 48.42 Favourable strategic positioning among suppliers; Market cap (US$ m) 6,055.19 Target price is for 12 months. unique way to gain exposure to PMA

Research Analysts ■ Estimate & TP revisions: Our EPS estimates adjust slightly to

Robert Spingarn $2.10/$2.25/$2.50 to reflect the recent 5-for-4 stock split, effective April 19, 212 538 1895 which resulted in the issuance of ~17m new HEI shares, as well as modest [email protected] revisions to our operating margin forecasts. Our TP rises to US$85 (from Jose Caiado 212 325 6771 US$76) to reflect greater expected acquisition potential and a higher rate of [email protected] margin expansion in our DCF model. Justin Harnett ■ We have long admired HEICO's business model, including (1) consistently 212 325 3193 reliable free cash flow generation; (2) an active M&A strategy that typically [email protected] enables HEI to exceed guidance; (3) a desirable focus on high-margin

aftermarket business; and (4) potential second-sourcing opportunities with the original equipment manufacturers (OEMs). ■ The latter point, which pertains to HEICO's leading position as the world's largest PMA (parts manufacturing authority) parts supplier, plays directly to the theme of this report. PMA manufacturers are naturally insulated from OEM efforts to capture more of the aftermarket annuity enjoyed by their component suppliers. HEI may begin to see interest from OEMs looking to a natural second-source of certain parts for OE use, and could therefore become a potential partner to OEMs in their disintermediation efforts. ■ HEI management has previously described the opportunity to do more work with OEMs as a "fertile area". In July 2016, HEICO's Inertial Aerospace Services subsidiary entered into an exclusive license agreement with Northrop Grumman (NOC) where it will repair and overhaul select inertial reference units, and will receive Northrop Grumman's related parts, inventory and test equipment. Previously, Inertial was competing with NOC in the marketplace. At the time, HEICO noted significant opportunities to reach similar arrangements with other OEMs, including on the commercial side. ■ Risks: Deterioration in air traffic growth, declines in airline capacity, M&A integration. Share price performance Financial and valuation metrics

Year 10/16A 10/17E 10/18E 10/19E EPS (CS adj.) (US$) 2.29 2.10 2.25 2.50 Prev. EPS (US$) 1.83 1.99 2.21 2.47 P/E (x) 31.0 33.8 31.6 28.5 P/E rel. (%) 154.9 186.0 195.2 193.5 Revenue (US$ m) 1,376.3 1,471.6 1,596.9 1,733.4 EBITDA (US$ m) 325.6 351.2 387.7 425.6 OCFPS (US$) 3.66 3.23 3.27 3.60 P/OCF (x) 14.8 22.0 21.7 19.7 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 EV/EBITDA (current) 19.7 18.3 16.6 15.1 Daily May02, 2016 - Apr28, 2017, 05/02/16 = US$49.512 Net debt (US$ m) 415 210 -14 -262

ROIC (%) 11.64 12.97 14.67 16.52 Quarterly EPS Q1 Q2 Q3 Q4 2016A 0.46 0.57 0.62 0.65 Number of shares (m) 85.20 IC (current, US$ m) 1,562.49 2017E 0.59 0.50 0.51 0.51 BV/share (Next Qtr., US$) 12.1 EV/IC (x) 4.1 2018E 0.49 0.54 0.56 0.66 Net debt (Next Qtr., US$ m) 315.0 Dividend (current, US$) -

Net debt/tot eq (Next Qtr.,%) 25.5 Dividend yield (%) - Source: Company data, Thomson Reuters, Credit Suisse estimates

Global Aerospace & Defence 81 4 May 2017

Heico Corp (HEI) Price (28 Apr 2017): US$71.07; Rating: OUTPERFORM; Target Price: (from US$76.00) US$85.00; Analyst: Robert Spingarn Income Statement 10/16A 10/17E 10/18E 10/19E Company Background Revenue (US$ m) 1,376.3 1,471.6 1,596.9 1,733.4 HEICO Corporation, through its subsidiaries manufatures Federal EBITDA 326 351 388 426 Aviation Administration (FAA) approved jet engine and aircraft Depr. & amort. (60) (63) (69) (75) component replacement parts, other than the original equipment EBIT (US$) 265 288 319 351 manufacturers (OEMS) and their subcontractors. Net interest exp (8) (8) (8) (8) PBT (US$) 257 281 311 343 Blue/Grey Sky Scenario Income taxes (81) (87) (96) (106) Profit after tax 176 194 215 237 Minorities (20) (21) (20) (20) Reported net income (US$) 156 173 195 217 Other NPAT adjustments 0 0 0 0 Adjusted net income 156 173 195 217 Cash Flow 10/16A 10/17E 10/18E 10/19E EBIT 265 288 319 351 Net interest (8) (8) (8) (8) Change in working capital 9 6 0 1 CAPEX (31) (38) (32) (35) Free cashflow to the firm 218 228 252 278 Aquisitions - - - - Divestments - - - - Cash flow from investments (298) (38) (32) (35) Cashflow from financing activities (34) (23) (28) (30) Changes in Net Cash/Debt (81) 205 224 248 Balance Sheet (US$) 10/16A 10/17E 10/18E 10/19E Assets Cash & cash equivalents 43 197 371 569 Total current assets 584 713 886 1,083 Total assets 2,039 2,029 2,171 2,334 Liabilities Total current liabilities 214 197 197 197 Total liabilities 892 707 657 607 Our Blue Sky Scenario (US$) (from 83.20) 95.00 Total liabilities and equity 2,039 2,029 2,171 2,335 Our Blue Sky valuation of $95 is also based on a DCF model (8.5% Net debt 415 210 (14) (262) WACC, 13% revenue growth, assuming an even more robust M&A pipeline). Our Blue Sky scenario assumes an extremely active M&A Per share 10/16A 10/17E 10/18E 10/19E strategy which should continue to drive upside to guidance, with an No. of shares (wtd avg) 68 82 87 87 elevated focus on high-margin aftermarket businesses, a quick CS adj. EPS 2.29 2.10 2.25 2.50 recovery in the South America market boosting FSG sales, and an Prev. EPS (US$) 1.83 1.99 2.21 2.47 increase in defense spending. Dividend (US$) 0.16 0.21 0.26 0.29 Free cash flow per share 3.20 2.77 2.91 3.20 Earnings 10/16A 10/17E 10/18E 10/19E Our Grey Sky Scenario (US$) (from 64.00) 65.00 Sales growth (%) 15.8 6.9 8.5 8.5 Our Grey Sky valuation of $65 is based on our DCF methodology EBIT growth (%) 15.5 8.5 10.8 10.1 (8.5% WACC, 6% revenue growth, assuming modest acquisitions). Net profit growth (%) 17.1 10.6 12.7 11.4 Our Grey Sky scenario assumes some deterioration in air traffic EPS growth (%) 16.5 (8.3) 6.9 11.2 growth, slower aftermarket growth, reduced M&A activity due to EBITDA margin (%) 23.7 23.9 24.3 24.6 elevated valuations, an ongoing drag in the South America market EBIT margin (%) 19.3 19.6 20.0 20.3 hurting FSG organic sales, and somewhat moderated defense Pretax margin (%) 18.7 19.1 19.5 19.8 spending. Net margin (%) 11.3 11.7 12.2 12.5 Share price performance Valuation 10/16A 10/17E 10/18E 10/19E EV/Sales (x) 4.70 4.26 3.78 3.34 EV/EBITDA (x) 19.7 18.3 16.6 15.1 EV/EBIT (x) 24.4 21.8 18.9 16.5 P/E (x) 31.0 33.8 31.6 28.5 Price to book (x) 5.0 5.2 4.7 4.1 Asset turnover 0.7 0.7 0.7 0.7 Returns 10/16A 10/17E 10/18E 10/19E ROE stated-return on (%) 17.6 16.5 16.0 15.4 ROIC (%) 11.6 13.0 14.7 16.5 Gearing 10/16A 10/17E 10/18E 10/19E Net debt/equity (%) 36.2 15.9 (0.9) (15.1) Interest coverage ratio (X) 32.1 36.6 40.5 44.6

Quarterly EPS Q1 Q2 Q3 Q4 2016A 0.46 0.57 0.62 0.65 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 2017E 0.59 0.50 0.51 0.51 Daily May02, 2016 - Apr28, 2017, 05/02/16 = US$49.512 2018E 0.49 0.54 0.56 0.66

Source: Company data, Thomson Reuters, Credit Suisse estimates

Global Aerospace & Defence 82 4 May 2017

Europe/France Computer Services & IT Consulting

Dassault Systemes (DAST.PA) Rating OUTPERFORM Price (28 Apr 17, €) 81.93 Target price (€) 85.00 Market Cap (€ m) 21,152.4

Enterprise value (€ m) 18,927.9 A digital enabler Target price is for 12 months.

■ Long-term value creation: We see Dassault as a market-leading provider of Research Analysts PLM solutions that is at the heart of digital transformation. Its new product

Charles Brennan CFA suite, the 3D Experience, is specifically designed to create an end-to-end 44 20 7883 4705 data model that can be used throughout an organisation. Meanwhile, the [email protected] platform is designed to take advantage of cloud capabilities, enabling easy William Lunn 44 20 7883 3959 collaboration throughout the enterprise and across the supply chain. These [email protected] technologies are relevant to all industries, including aerospace.

■ Doubling its addressable market: Dassault has a long-term approach to improving the group's competitive market position, creating a runway for sustained premium rates of growth. In particular, the group has been acquiring assets that extend its reach from the traditional engineering towards manufacturing and marketing to create an end-to-end suite. Based on management estimates, this has more than doubled the group's addressable market from $10bn to $24bn. We think this could enable the group to achieve its 2019 EPS target of €3.50, implying a 2017-19 CAGR of c15%. ■ Valuation: Headline valuation metrics at Dassault look full, but we continue to believe the earnings power is higher than the stated EPS. In particular, we estimate Dassault will generate margins of 31.4% in FY17E, somewhat below the medium-term 35% target. Meanwhile, we forecast a net cash position at the end of FY17E that is broadly equivalent to 10% of the market cap. Assuming margin recovery and more efficient use of the balance, we can easily justify EPS 15% higher than current EPS forecasts. Given the group's market-leading position and financial optionality, we reiterate our Outperform rating. The main risk to our target price is currency moves, especially JPY and slippage in the 3D experience roll-out, which has suffered from short- term sales execution issues. Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E 12/19E Revenue (€ m) 3,065.6 3,343.6 3,621.6 3,923.3 EBITDA (€ m) 999.7 1,084.5 1,197.0 1,325.5 Adjusted net income (€ m) 640.30 704.20 782.07 867.50 CS EPS (adj.) (€) 2.49 2.74 3.04 3.37 Prev. EPS (€) - - - - ROIC (%) 31.2 38.2 45.6 55.7 P/E (adj.) (x) 32.9 29.9 27.0 24.3 P/E rel. (%) 216.2 205.9 205.4 201.3 The price relative chart measures performance against the EV/EBITDA (x) 19.7 17.5 15.2 13.2

CAC 40 INDEX which closed at 5267.3 on 28/04/17 Dividend (12/17E, €) 0.55 Net debt/equity (12/17E,%) -52.3 On 28/04/17 the spot exchange rate was €1/Eu 1.- Dividend yield (12/17E,%) 0.7 Net debt (12/17E, € m) -2,224.6 Eu.92/US$1

BV/share (12/17E, €) 16.7 IC (12/17E, € m) 2,026.1 Performance 1M 3M 12M Free float (%) 40.0 EV/IC (12/17E, (x) 9.3 Absolute (%) 1.0 14.1 18.8 Source: Company data, Thomson Reuters, Credit Suisse estimates

Relative (%) -2.2 3.9 -0.1

Global Aerospace & Defence 83 4 May 2017

Dassault Systemes (DAST.PA) Price (28 Apr 2017): €81.93; Rating: OUTPERFORM; Target Price: €85.00; Analyst: Charles Brennan Income statement (€ m) 12/16A 12/17E 12/18E 12/19E Company Background Revenue 3,066 3,344 3,622 3,923 Dassault Systemes SA develops 3D and Product Lifecycle EBITDA 1,000 1,085 1,197 1,326 Management software solutions powered by 3D. It's software Depr. & amort. (207) (184) (172) (172) applications address a range of products, from consumer goods, EBIT 958 1,049 1,165 1,294 machine parts and semiconductors to automobiles, aircraft, ships & Net interest exp. (11) 16 14 14 factories. Associates - - - - PBT 953 1,058 1,179 1,308 Blue/Grey Sky Scenario Income taxes (209) (277) (328) (371) Profit after tax 744 781 851 937 Minorities (5) (3) (2) (2) Preferred dividends - - - - Associates & other (98) (74) (67) (67) Net profit 640 704 782 868 Other NPAT adjustments (193) (150) (133) (133) Reported net income 447 554 649 735 Cash flow (€ m) 12/16A 12/17E 12/18E 12/19E EBIT 958 1,049 1,165 1,294 Net interest (11) 16 14 14 Cash taxes paid - - - - Change in working capital 0 0 0 0 Other cash and non-cash items (326) (123) (286) (329) Cash flow from operations 622 942 893 979 CAPEX (56) (63) (60) (60) Free cashflow to the firm 565 879 833 919 Acquisitions (246) 0 0 0 Divestments - - - - Other investment/(outflows) 3 (3) 0 0 Cash flow from investments (299) (66) (60) (60) Net share issue/(repurchase) (101) 8 0 0 Dividends paid (102) (140) (140) (140) Issuance (retirement) of debt 0 0 0 0 Cashflow from financing (202) (131) (140) (140) Our Blue Sky Scenario (€) 90.00 Changes in net cash/debt 135 738 693 779 Our most bullish scenario assumes a 10.0% increase in FY17 adjusted EPS, and a P/E re-rating to 30x. This is in line with the Net debt at start (1,351) (1,486) (2,225) (2,918) trailing 12m high, and results in a blue sky target of €90, Change in net debt (135) (738) (693) (779) representing a futher 6% upside to our current target price of €85. Net debt at end (1,486) (2,225) (2,918) (3,697) Balance sheet (€ m) 12/16A 12/17E 12/18E 12/19E Our Grey Sky Scenario (€) 62.00 Assets Our most bearish scenario assumes a -10.0% reduction in FY17 Total current assets 3,570 4,218 4,841 5,550 adjusted EPS, and a P/E de-rating to 25x. This is in line with the Total assets 6,943 7,457 7,969 8,566 trailing 12m low, and results in a grey sky target of €62, representing Liabilities a futher -27% downside to our current target price of €85.0. Total current liabilities 1,466 1,625 1,625 1,625 Total liabilities 3,060 3,207 3,207 3,207 Share price performance Total equity and liabilities 6,943 7,457 7,969 8,566 Per share 12/16A 12/17E 12/18E 12/19E No. of shares (wtd avg.) (mn) 257 257 257 257 CS EPS (adj.) (€) 2.49 2.74 3.04 3.37 Dividend (€) 0.55 0.55 0.55 0.55 Free cash flow per share (€) 2.20 3.42 3.24 3.57 Key ratios and valuation 12/16A 12/17E 12/18E 12/19E Growth/Margin (%) Sales growth (%) 6.6 9.1 8.3 8.3 EBIT growth (%) 8.2 9.5 11.1 11.0 Net income growth (%) 11.0 10.0 11.1 10.9 EPS growth (%) 10.6 10.0 11.1 10.9 EBITDA margin (%) 32.6 32.4 33.1 33.8 EBIT margin (%) 31.2 31.4 32.2 33.0 Pretax profit margin (%) 31.1 31.7 32.6 33.3 The price relative chart measures performance against the CAC 40 INDEX Net income margin (%) 20.9 21.1 21.6 22.1 which closed at 5267.3 on 28/04/17 Valuation 12/16A 12/17E 12/18E 12/19E On 28/04/17 the spot exchange rate was €1/Eu 1.- Eu.92/US$1 EV/Sales (x) 6.4 5.7 5.0 4.4 EV/EBITDA (x) 19.7 17.5 15.2 13.2 EV/EBIT (x) 20.5 18.0 15.7 13.5 Dividend yield (%) 0.67 0.67 0.67 0.67 P/E (x) 32.9 29.9 27.0 24.3 Credit ratios (%) 12/16A 12/17E 12/18E 12/19E Net debt/equity (%) (38.3) (52.3) (61.3) (69.0) Net debt to EBITDA (x) (1.5) (2.1) (2.4) (2.8) Interest coverage ratio (x) 91.2 (64.7) (83.2) (92.4)

Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates

Global Aerospace & Defence 84 4 May 2017

Europe/France Aerospace & Defense

Thales (TCFP.PA) Rating OUTPERFORM Price (28 Apr 17, €) 96.52 Target price (€) 102.00 Market Cap (€ m) 20,433.7 Solid in digital Enterprise value (€ m) 18,049.0 Target price is for 12 months. ■ The right products in the right markets: Thales should enjoy an organic

Research Analysts growth acceleration, in particular driven by its defence activities but also in

Olivier Brochet IFE, satellites, avionics, rail signaling, etc. In Europe, the group appears well 44 20 7888 8508 positioned to capture a significant share of the upcoming defence budget [email protected] upside, with local implantations covering 90% of the gap to the 2% NATO Specialist Sales: Andrew Bell spending goal (See Attractive defence exposure, 1 February 2017). The 44 20 7888 0479 [email protected] group continues to invest in R&D to prepare growth for beyond 2020E (with for instance an ETCS Level 3 system for autonomous trains). ■ Margin upside: This growth acceleration is supportive of further margin expansion beyond the current target of 9.5-10% for 2017-2018. We see 12% as possible, as detailed in The next best-in-class? (25 July 2016). ■ Strong in digital: Thales appears to us well positioned in cybersecurity, data analytics and artificial intelligence. We would expect the group to make further acquisitions in these areas (following Vormetric in cyber in 2016, Guavus in real time big data in April 2017), with net cash of EUR2.4bn at the end of 2016 and an EBIT / FCF conversion of >60% on average for 2017E- 2020E. ■ Catalysts and Risks: H1 results on 26 July, IFRS15 impact detailed post summer. Risks: slowdown of orders in international markets; strengthening of the EUR/US$ rate; programme slippage; and significant IFRS 15 impact on revenue recognition. ■ Valuation: Our target price of EUR102 per share is based on the average of a 2018 SOTP (EUR98) and 2021 SOTP (EUR105). We include a 10% premium to the valuation of the Defence & Security businesses to reflect the potential organic growth boost resulting from higher defence spending in European countries where Thales is well represented. The stock currently trades on an adjusted EV/EBIT of 10.6x 2018E, while its adjusted P/E is 17.1x 2018E. Its 2018E FCF yield comes to 6.5%, vs 7.0% on average over 2004-16. Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E Revenue (€ m) 14,884.8 15,857.7 16,860.9 EBITDA (€ m) 1,738.6 2,118.4 2,430.5 Adjusted net income (€ m) 896.80 1,021.43 1,201.91 CS EPS (adj.) (€) 4.20 4.79 5.63 Prev. EPS (€) - - - ROIC (%) 36.6 38.4 43.9 P/E (adj.) (x) 23.0 20.2 17.1 P/E rel. (%) 150.7 138.6 130.5 The price relative chart measures performance against the EV/EBITDA (x) 10.6 8.5 7.1

CAC 40 INDEX which closed at 5267.3 on 28/04/17 Dividend (12/17E, €) 1.82 Net debt/equity (12/17E,%) -43.6 On 28/04/17 the spot exchange rate was €1/Eu 1.- Dividend yield (12/17E,%) 1.9 Net debt (12/17E, € m) -2,384.8 Eu.92/US$1

BV/share (12/17E, €) 24.6 IC (12/17E, € m) 3,084.3 Performance 1M 3M 12M Free float (%) 46.1 EV/IC (12/17E, (x) 5.9 Absolute (%) 6.5 9.7 28.2 Source: Company data, Thomson Reuters, Credit Suisse estimates

Relative (%) 3.3 -0.5 9.3

Global Aerospace & Defence 85 4 May 2017

Thales (TCFP.PA) Price (28 Apr 2017): €96.52; Rating: OUTPERFORM; Target Price: €102.00; Analyst: Olivier Brochet Income statement (€ m) 12/16A 12/17E 12/18E Company Background Revenue 14,885 15,858 16,861 Thales is involved in aerospace & defence electronics (radars, EBITDA 1,739 2,118 2,430 avionics, satellites, etc), as well as in rail signalling. Defence Depr. & amort. (385) (560) (623) accounts for 55%+ of its revenues, with France being its largest EBIT 1,354 1,558 1,808 market (EUR2bn+ sales). Net interest exp. 6 8 10 Associates 120 132 138 Blue/Grey Sky Scenario PBT 1,284 1,438 1,690 Income taxes (372) (381) (448) Profit after tax 912 1,057 1,242 Minorities (68) (55) (60) Preferred dividends - - - Associates & other 53 19 20 Net profit 897 1,021 1,202 Other NPAT adjustments 50 (58) (57) Reported net income 946 964 1,145 Cash flow (€ m) 12/16A 12/17E 12/18E EBIT 1,354 1,558 1,808 Net interest (8) (32) (30) Cash taxes paid (99) (155) (206) Change in working capital (63) (492) (257) Other cash and non-cash items 154 349 403 Cash flow from operations 1,338 1,228 1,717 CAPEX (480) (519) (563) Free cashflow to the firm 954 824 1,271 Acquisitions (391) 0 0 Divestments 8 15 17 Other investment/(outflows) 35 (0) (0) Cash flow from investments (828) (504) (547) Net share issue/(repurchase) 46 0 0 Dividends paid (297) (361) (403) Issuance (retirement) of debt - - - Our Blue Sky Scenario (€) 109.00 Cashflow from financing (343) (411) (457) A blue sky valuation would be reflective of Thales reaching 12.5% of Changes in net cash/debt 158 313 714 margin in 2021, essentially equivalent to the group being the best-in- class in each of its segments. It would imply in our view that organic Net debt at start (1,914) (2,072) (2,385) growth accelerates further (with revenues coming 10% higher than Change in net debt (158) (313) (714) currently forecast) thanks to continued strong order intake. This Net debt at end (2,072) (2,385) (3,099) would yield a value of EUR109 per share (using a 2021 valuation). Balance sheet (€ m) 12/16A 12/17E 12/18E Assets Our Grey Sky Scenario (€) 74.00 Total current assets 14,066 15,684 17,341 A grey sky valuation may be a case of Thales' operating margin Total assets 22,690 24,463 25,874 reaching a 10% ceiling, with organic growth reversing after 2018 and Liabilities Aerospace revenues coming 15% lower than expected. We Total current liabilities 13,310 14,480 15,149 estimate that the group's valuation would then come to EUR74 per Total liabilities 17,824 18,994 19,663 share (based on a 2018 valuation). Total equity and liabilities 22,690 24,463 25,874 Per share 12/16A 12/17E 12/18E Share price performance No. of shares (wtd avg.) (mn) 213 213 213 CS EPS (adj.) (€) 4.20 4.79 5.63 Dividend (€) 1.60 1.82 2.14 Free cash flow per share (€) 4.47 3.86 5.96 Key ratios and valuation 12/16A 12/17E 12/18E Growth/Margin (%) Sales growth (%) 5.8 6.5 6.3 EBIT growth (%) 11.3 15.1 16.0 Net income growth (%) 10.9 13.9 17.7 EPS growth (%) 9.6 13.9 17.7 EBITDA margin (%) 11.7 13.4 14.4 EBIT margin (%) 9.1 9.8 10.7 Pretax profit margin (%) 8.6 9.1 10.0 Net income margin (%) 6.0 6.4 7.1 Valuation 12/16A 12/17E 12/18E The price relative chart measures performance against the CAC 40 INDEX EV/Sales (x) 1.2 1.1 1.0 which closed at 5267.3 on 28/04/17 EV/EBITDA (x) 10.6 8.5 7.1 On 28/04/17 the spot exchange rate was €1/Eu 1.- Eu.92/US$1 EV/EBIT (x) 13.6 11.6 9.6 Dividend yield (%) 1.66 1.89 2.22 P/E (x) 23.0 20.2 17.1 Credit ratios (%) 12/16A 12/17E 12/18E Net debt/equity (%) (42.6) (43.6) (49.9) Net debt to EBITDA (x) (1.2) (1.1) (1.3) Interest coverage ratio (x) (214.9) (207.7) (188.9)

Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates

Global Aerospace & Defence 86 4 May 2017

Americas/United States Non Ferrous Metals

Arconic, Inc. (ARNC) Rating RESTRICTED [V] Price (28-Apr-17, US$) 27.33 Target price (US$) 52-week price range (US$) 30.55 - 17.34 Leveraging Metallurgy and Process Know How to Market cap (US$ m) 11,978.51 Target price is for 12 months. Drive Shipset Growth in Challenging Market [V] = Stock Considered Volatile (see Disclosure Appendix)

Arconic has been able to achieve meaningful shipset revenue growth in Research Analysts

next generation jet engine and airframe applications through aggressive Curt Woodworth, CFA R&D allocation, leveraging expertise in metallurgy, and making strategic 212 325 5117 [email protected] acquisitions to expand product breadth and increase vertical integration. The Serena Rocha Calejon sea-change in OEM philosophy towards capturing more of the value through the 212 325 3482 channel clearly will affect ARNC, which we believe in recent history has [email protected] underperformed peers in commercial terms.

The incoming new leadership at ARNC will need to address the commercial sales function at EPS and drive better contract terms over the coming cycle. ARNC has long-term agreements with many OEMs and the heavy lifting with respect to commercial terms and content wins for next generation aircraft and jet engines is essentially finalised and now the focus is on operational execution and leverage to the broader cyclical trend in the market. Closing the gap with EPS segment peer Precision Castparts (PCC) margins is vital. ■ Can Arconic Close the Gap with PCC? Historically PCC generated EBITDA margins near 25-30% with the most recent year reported in 2015 at 27%. Alcoa's EPS segment had EBITDA margins of 20.8% in 2016. While ARNC has a relatively small large structural castings business at La Porte (~$300mm), the EPS segment is a global leader in medium-sized castings and fasteners. We believe EPS should be able to close the gap with PCC to within 100-150bp, with recovery at Firth Rixson as the key driver. ■ Thesis and Risks: We expect multiple expansion over the next year as margins start to recover and upside scenarios become more realistic from both management actions and cycle dynamics. The key risk is potential cyclical slowing in aerospace. Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E 12/19E EPS (CS adj.) (US$) 0.96 1.15 1.31 1.51 Prev. EPS (US$) - - - - P/E (x) 28.4 23.8 20.9 18.1 P/E rel. (%) 141.8 130.9 128.7 123.1 Revenue (US$ m) 12,394.0 12,130.0 12,560.2 13,186.9 EBITDA (US$ m) 1,702.0 1,846.6 1,952.6 2,088.1 OCFPS (US$) 1.93 2.24 2.22 2.37 P/OCF (x) 9.6 12.2 12.3 11.5 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 EV/EBITDA (current) 10.3 9.5 9.0 8.4 Daily May02, 2016 - Apr28, 2017, 05/02/16 = Net debt (US$ m) 6,217 4,636 4,199 3,730 US$24.64855776 ROIC (%) -17.87 9.65 8.69 9.25

Quarterly EPS Q1 Q2 Q3 Q4 Number of shares (m) 438.29 IC (current, US$ m) 11,358.00 2016A 0.25 0.23 0.11 0.12 BV/share (Next Qtr., US$) 12.2 EV/IC (x) 1.6 2017E 0.33 0.26 0.28 0.28 Net debt (Next Qtr., US$ m) 4,794.4 Dividend (current, US$) 0.24 2018E 0.28 0.36 0.34 0.33 Net debt/tot eq (Next Qtr.,%) 85.1 Dividend yield (%) -

Source: Company data, Thomson Reuters, Credit Suisse estimates

Global Aerospace & Defence 87 4 May 2017

Arconic, Inc. (ARNC) Price (28 Apr 2017): US$27.33; Rating: RESTRICTED [V]; Target Price: ; Analyst: Curt Woodworth Income Statement 12/16A 12/17E 12/18E 12/19E Per share 12/16A 12/17E 12/18E 12/19E Revenue (US$ m) 12,394.0 12,130.0 12,560.2 13,186.9 No. of shares (wtd avg) 453 469 495 495 EBITDA 1,702 1,847 1,953 2,088 CS adj. EPS 0.96 1.15 1.31 1.51 Depr. & amort. (535) (530) (535) (542) Prev. EPS (US$) - - - - EBIT (US$) 974 1,274 1,417 1,546 Dividend (US$) 0.00 0.24 0.24 0.24 Net interest exp (499) (410) (330) (310) Dividend payout ratio 0.00 20.90 18.31 15.90 Associates - - - - Free cash flow per share (0.56) 1.25 1.12 1.19 Other adj. 0 0 0 0 Earnings 12/16A 12/17E 12/18E 12/19E PBT (US$) 475 864 1,087 1,236 Sales growth (%) (0.2) (2.1) 3.5 5.0 Income taxes (1,465) (172) (370) (420) EBIT growth (%) 12.3 30.8 11.3 9.1 Profit after tax (990) 691 718 816 Net profit growth (%) 69.5 20.3 18.2 13.7 Minorities - - - - EPS growth (%) 78.4 19.3 14.1 15.2 Preferred dividends - - - - EBITDA margin (%) 13.7 15.2 15.5 15.8 Associates & other 1,495 (84) 0 0 EBIT margin (%) 7.9 10.5 11.3 11.7 Net profit (US$) 505 607 718 816 Pretax margin (%) 3.8 7.1 8.7 9.4 Other NPAT adjustments (1,495) 84 (0) 0 Net margin (%) 4.1 5.0 5.7 6.2 Reported net income (990) 691 718 816 Valuation 12/16A 12/17E 12/18E 12/19E Cash Flow 12/16A 12/17E 12/18E 12/19E EV/Sales (x) 1.47 1.37 1.29 1.19 EBIT 974 1,274 1,417 1,546 EV/EBITDA (x) 10.3 9.5 9.0 8.4 Net interest (499) (410) (330) (310) EV/EBIT (x) 18.7 13.0 11.4 10.2 Cash taxes paid - - - - P/E (x) 28.4 23.8 20.9 18.1 Change in working capital 2,756 (70) (52) (85) Price to book (x) 2.4 2.2 2.1 1.9 Other cash & non-cash items (2,358) 256 65 21 Asset turnover 0.6 0.6 0.6 0.6 Cash flow from operations 873 1,050 1,101 1,173 Returns 12/16A 12/17E 12/18E 12/19E CAPEX (1,125) (464) (545) (585) Free cashflow to the firm (252) 586 556 588 ROE stated-return on (%) (11.5) 12.5 11.5 11.8 ROIC (%) (0.2) 0.1 0.1 0.1 Aquisitions - - - - Divestments 0 (10) 0 0 Interest burden (%) 0.49 0.68 0.77 0.80 Other investment/(outflows) 368 1,142 0 0 Tax rate (%) 308.4 19.9 34.0 34.0 Cash flow from investments (757) 668 (545) (585) Financial leverage (%) 1.58 1.28 1.16 1.04 Net share issue(/repurchase) 0 0 0 0 Gearing 12/16A 12/17E 12/18E 12/19E Dividends paid 0 (130) (119) (119) Net debt/equity (%) 120.9 78.2 63.9 51.0 Issuance (retirement) of debt 0 (492) 0 0 Net Debt to EBITDA (x) 3.7 2.5 2.2 1.8 Other 1,136 481 0 0 Interest coverage ratio (X) 2.0 3.1 4.3 5.0 Cashflow from financing activities 1,136 (141) (119) (119) Quarterly EPS Q1 Q2 Q3 Q4 Effect of exchange rates (7) 4 0 0 2016A 0.25 0.23 0.11 0.12 Changes in Net Cash/Debt 1,245 1,581 438 469 2017E 0.33 0.26 0.28 0.28 Net debt at start 7,462 6,217 4,636 4,199 2018E 0.28 0.36 0.34 0.33 Change in net debt (1,245) (1,581) (438) (469) Net debt at end 6,217 4,636 4,199 3,730 Share price performance Balance Sheet (US$) 12/16A 12/17E 12/18E 12/19E Assets Cash & cash equivalents 1,863 2,957 3,394 3,863 Account receivables 974 949 1,032 1,086 Inventory 2,253 1,842 1,953 2,066 Other current assets 802 681 681 681 Total current assets 5,892 6,429 7,060 7,696 Total fixed assets 5,499 5,435 5,445 5,488 Intangible assets and goodwill 5,148 5,170 5,170 5,170 Investment securities - - - - Other assets 3,499 2,804 2,804 2,804 Total assets 20,038 19,838 20,479 21,158 Liabilities Accounts payables 1,744 1,440 1,583 1,665 Short-term debt 36 47 47 47 On 28-Apr-2017 the S&P 500 INDEX closed at 2384.2 Other short term liabilities 969 943 943 943 Daily May02, 2016 - Apr28, 2017, 05/02/16 = US$24.64855776 Total current liabilities 2,749 2,430 2,573 2,655 Long-term debt 8,044 7,546 7,546 7,546 Other liabilities 4,104 3,929 3,789 3,649 Total liabilities 14,897 13,905 13,908 13,850 Shareholder equity 5,115 5,919 6,558 7,296 Minority interests 26 13 13 13 Total liabilities and equity 20,038 19,838 20,479 21,158 Net debt 6,217 4,636 4,199 3,730

Source: Company data, Thomson Reuters, Credit Suisse estimates

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Companies Mentioned (Price as of 28-Apr-2017) ABB (ABBN.S, SFr24.36) AVIC Aircraft Company Limited (000768.SZ, Rmb23.9) Adient Plc (ADNT.N, $73.56) Airbus Group (AIR.PA, €74.23, OUTPERFORM, TP €100.0) Allegheny Technologies, Inc (ATI.N, $18.35) Amphenol Corporation (APH.N, $72.31) Arconic, Inc. (ARNC.N, $27.33, RESTRICTED [V]) Astronics (ATRO.OQ, $32.51) Autodesk Inc. (ADSK.OQ, $90.07) BAE Systems (BAES.L, 627.0p) Ball Corporation (BLL.N, $76.89) Barnes Grp (B.N, $54.97) Boeing (BA.N, $184.83, NEUTRAL, TP $200.0) Bombardier Inc (SVS) (BBDb.TO, C$2.11) China Eastern (0670.HK, HK$4.08) Crane (CR.N, $79.91) Curtiss Wright (CW.N, $93.46) Dassault Aviation (AVMD.PA, €1254.65) Dassault Systemes (DAST.PA, €81.93, OUTPERFORM, TP €85.0) Deutsche Lufthansa (LHAG.DE, €15.84) Ducommun (DCO.N, $29.39) Eaton Corporation (ETN.N, $75.64) Embraer (ERJ.N, $19.2) Esterline Technologies (ESL.N, $91.45) FACC (FACC.VI, €6.97) Fanuc (6954.T, ¥22,655) Figeac Aero (FGA.PA, €20.54) GKN (GKN.L, 358.9p) General Dynamics Corporation (GD.N, $193.79) General Electric (GE.N, $28.99) Harris Corporation (HRS.N, $111.89) Heico Corp (HEI.N, $71.07, OUTPERFORM, TP $85.0) Heroux Devtek (HRX.TO, C$12.04) Hexagon AB (HEXAb.ST, Skr385.7) Hexcel Corporation (HXL.N, $51.75) Honeywell International Inc. (HON.N, $131.14) IHI (7013.T, ¥378) International Airlines Group (ICAG.L, 560.0p) Irkut Corp (IRKT.MM, Rbl10.67) Jamco (7408.T, ¥2,598) Kuka (KU2G.DE, €114.7) L3 Technologies (LLL.N, $171.77) LATAM Airlines (LFL.N, $12.67) LMI Aerospace (LMIA.OQ, $13.87) Latecoere (LAEP.PA, €3.62) Lisi (GFII.PA, €36.0) MTU Aero Engines (MTUAY.PK, $46.84) Meggitt (MGGT.L, 462.5p) Midea Group Co Ltd (000333.SZ, Rmb33.66) Mitsubishi Heavy Industries (7011.T, ¥446) Moog (MOGa.N, $68.65) Northrop Grumman Corporation (NOC.N, $245.96) Orbital ATK Inc. (OA.N, $99.0) Panasonic (6752.T, ¥1,330) Parker Hannifin Corporation (PH.N, $160.8) Qantas (QAN.AX, A$4.24) Raytheon Company (RTN.N, $155.21) Rockwell Collins, Inc. (COL.N, $104.09) Rolls-Royce (RR.L, 812.0p) Safran (SAF.PA, €76.02) Senior (SNR.L, 214.4p) Siemens (SIEGn.DE, €131.6) Sigma Labs (SGLB.O, $0.055) Singapore Airlines Limited (SIAL.SI, S$10.25) Spirit AeroSystems (SPR.N, $57.16) Stratasys (SSYS.OQ, $24.76) Swire Pacific (SWRAY.PK, $13.72) Textron (TXT.N, $46.66) Thales (TCFP.PA, €96.52, OUTPERFORM, TP €102.0) TransDigm (TDG.N, $246.73) Triumph Group Inc (TGI.N, $26.2) United Technologies Corp (UTX.N, $118.99) Woodward Inc (WWD.OQ, $67.67) Yaskawa Electric Corp (6506.T, ¥2,129) Zodiac Aerospace (ZODC.PA, €22.29)

Disclosure Appendix Analyst Certification Olivier Brochet, Robert Spingarn, Julian Mitchell, Andre Kukhnin, CFA, Charles Brennan CFA, Curt Woodworth, CFA and Neil Glynn, CFA each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

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3-Year Price and Rating History for Airbus Group (AIR.PA)

AIR.PA Closing Price Target Price Date (€) (€) Rating 18-Nov-14 46.74 42.00 U * 16-Feb-15 50.45 59.00 O 12-Mar-15 62.08 69.00 10-Sep-15 56.50 68.00 30-Oct-15 63.36 80.00 08-Jun-16 53.61 79.00 28-Jul-16 53.57 74.00 13-Mar-17 69.95 76.00 * Asterisk signifies initiation or assumption of coverage. UNDERPERFORM OUTPERFORM

3-Year Price and Rating History for Boeing (BA.N)

BA.N Closing Price Target Price Date (US$) (US$) Rating 10-Jul-14 126.79 162.00 O 23-Oct-14 122.03 133.00 N 28-Jan-15 139.64 152.00 22-Jul-15 146.47 156.00 18-Dec-15 139.58 158.00 27-Jan-16 116.58 144.00 12-May-16 134.42 148.00 27-Oct-16 143.31 152.00 19-Jan-17 159.00 165.00 17-Apr-17 179.02 175.00 OUTPERFORM NEUTRAL 26-Apr-17 181.71 200.00 * Asterisk signifies initiation or assumption of coverage.

3-Year Price and Rating History for Dassault Systemes (DAST.PA)

DAST.PA Closing Price Target Price Date (€) (€) Rating 23-Jul-14 47.02 53.00 O 24-Jul-14 49.46 56.00 08-Jan-15 50.04 63.00 12-Feb-15 58.06 65.00 23-Apr-15 69.07 75.00 08-Jan-16 69.41 85.00 * Asterisk signifies initiation or assumption of coverage.

OUTPERFORM

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3-Year Price and Rating History for Heico Corp (HEI.N)

HEI.N Closing Price Target Price Date (US$) (US$) Rating 28-May-14 42.87 46.92 N 19-Dec-14 46.41 47.20 25-Feb-15 46.90 47.20 * 20-May-15 48.76 48.00 26-Aug-15 40.29 44.80 26-Feb-16 46.05 48.00 26-May-16 53.52 49.60 25-Aug-16 57.38 54.40 15-Dec-16 61.24 68.80 O 01-Mar-17 68.90 76.00 NEUTRAL OUTPERFORM * Asterisk signifies initiation or assumption of coverage.

3-Year Price and Rating History for Thales (TCFP.PA)

TCFP.PA Closing Price Target Price Date (€) (€) Rating 18-Nov-14 41.83 52.00 O * 09-Feb-15 49.00 56.00 26-Feb-15 50.53 59.00 13-Jul-15 56.72 68.00 20-Oct-15 62.09 R 27-Oct-15 65.45 68.00 O 07-Jan-16 68.69 80.00 23-Feb-16 70.90 83.00 25-Jul-16 80.00 93.00 01-Feb-17 87.99 102.00 OUTPERFORM REST RICT ED * Asterisk signifies initiation or assumption of coverage. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return poten tial within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months.

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*An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 45% (64% banking clients) Neutral/Hold* 39% (61% banking clients) Underperform/Sell* 14% (55% banking clients) Restricted 2% *For purposes of the NYSE and FINRA ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors. Important Global Disclosures Credit Suisse’s research reports are made available to clients through our proprietary research portal on CS PLUS. Credit Suisse research products may also be made available through third-party vendors or alternate electronic means as a convenience. Certain research products are only made available through CS PLUS. The services provided by Credit Suisse’s analysts to clients may depend on a specific client’s preferences regarding the frequency and manner of receiving communications, the client’s risk profile and investment, the size and scope of the overall client relationship with the Firm, as well as legal and regulatory constraints. To access all of Credit Suisse’s research that you are entitled to receive in the most timely manner, please contact your sales representative or go to https://plus.credit-suisse.com . Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: https://www.credit- suisse.com/sites/disclaimers-ib/en/managing-conflicts.html . Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

Target Price and Rating Valuation Methodology and Risks: (12 months) for Airbus Group (AIR.PA) Method: We use a sum of the parts to value Airbus, with different prospects and cycles in each of its three business lines. It also captures some adjustments to assets & liabilities not well captured at the operating earnings level (stake in Dassault Aviation and JVs, launch aids, etc). We are using a 2020E SOTP with a recurring mid-cycle multiple to better capture the possibility of a structural improvement in profitability as a result of technology disruption, yielding a EUR100 target price. Our Outperform rating reflects the strong upside we see to the stock, on the back of the prospects of a strong FCF generation later in the decade and reduced earnings volatility. Risk: The main risks to our target price of EUR100 and Outperform rating are a euro strengthening, due to the group's significant EUR/USD net exposure, and a failure to profitably implement technology disruptions in its production process (automation, additive manufacturing, digitalisation), preventing the group to reduce its earnings volatility. A deterioration in the aerospace cycle (order cancellations/deferrals) would hit the group's prospects and could result in a rating change if severe enough, as would a problematic production ramp-up for the A350 or the A320neo or the launch of an A380neo. Cancellations of A330ceo orders would be a small negative as would be large new A400M charges. Target Price and Rating Valuation Methodology and Risks: (12 months) for Boeing (BA.N) Method: For Boeing we apply a target FCF yield of 7.0% to our 2017 FCF/share estimate. This yields a $200TP. Our Neutral rating is a result of macro headwinds that will likely prevent Boeing from trading on its fundamental valuation in the near-term. Risk: Risks to our $200 BA target price and our Neutral rating include a weaker-than-expected commercial aircraft outlook; deferrals or cancellations of defense contracts, credit, and residual exposure at Boeing Capital; and erosion of commercial margin. Target Price and Rating Valuation Methodology and Risks: (12 months) for Dassault Systemes (DAST.PA)

Method: We value Dassault by looking at the company's underlying earnings potential and valuing this on a PE of 25x to get our target price of €85 and Outperform rating. We also take account of the net cash position. Given the upside potential indicated by our target price, we rate the stock Outperform. Risk: The key downside risk to our target price and Outperform rating is currency weakness, especially the JPY where Dassault has limited hedging in place. We also feel that Dassault could improve financial disclosure around organic growth, especially as the company is likely to be making more acquisitions in the future. Target Price and Rating Valuation Methodology and Risks: (12 months) for Heico Corp (HEI.N)

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Method: We use a DCF methodology to arrive at our $85 target price (8.5% WACC, 11.5% revenue growth, assuming acquisitions). Our Outperform rating is a result of greater upside relative to the rest of our coverage universe. Risk: Risks to our $85 target price and Outperform rating for Heico Corp (HEI) include: declines in airline capacity, slower aftermarket growth, defensive engine OE moves against HEI replacement parts, IP disputes, failure to meet regulatory standards, M&A integration, moderating defense funding. Target Price and Rating Valuation Methodology and Risks: (12 months) for Thales (TCFP.PA) Method: We value Thales using an average of a 2018E and 2021E SOTP. EBIT is restated for capitalised R&D and stake in DCNS (valued as an asset). It captures the return to growth. We use US and European peers for the various branches. Our Outperform rating and EUR102 target price assume that the favourable order momentum continues, supported in particular by defence and security global needs and a weaker euro. Risk: The main downside risks to our TP of EUR102 per share and Outperform rating include a drop in French or British defence spending. Technical issues on programmes can also damage earnings heavily. A strengthening of the euro would also hurt Thales.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures/view/selectArchive for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (HEI.N, TCFP.PA, ARNC.N, AIR.PA, BA.N, DAST.PA, HXL.N, SIEGn.DE, TDG.N, UTX.N, SIAL.SI, RTN.N, NOC.N, HRS.N, ADSK.OQ, ADNT.N, BAES.L, 0670.HK, GE.N, ZODC.PA, TGI.N, SPR.N, SAF.PA, RR.L, OA.N, MOGa.N, MGGT.L, LLL.N, LHAG.DE, LFL.N, ICAG.L, HON.N, GD.N, ETN.N, ESL.N, ERJ.N, COL.N, BBDb.TO, BLL.N, AVMD.PA, 6752.T, 000333.SZ, ABBN.S, 6954.T) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (ARNC.N, TDG.N, SIAL.SI, RTN.N, NOC.N, ADNT.N, 0670.HK, GE.N, SPR.N, SAF.PA, RR.L, LFL.N, GD.N, ETN.N, BBDb.TO, BLL.N, ABBN.S) within the past 12 months. Credit Suisse provided non-investment banking services to the subject company (AIR.PA, SIEGn.DE, TDG.N, SIAL.SI, NOC.N, BAES.L, GE.N, LHAG.DE, HON.N, ETN.N, 000333.SZ) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (ARNC.N, TDG.N, SIAL.SI, NOC.N, 0670.HK, GE.N, LFL.N) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (ARNC.N, TDG.N, SIAL.SI, RTN.N, NOC.N, ADNT.N, 0670.HK, GE.N, SPR.N, SAF.PA, RR.L, LFL.N, GD.N, ETN.N, BBDb.TO, BLL.N, ABBN.S) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (HEI.N, TCFP.PA, ARNC.N, AIR.PA, BA.N, DAST.PA, HXL.N, SIEGn.DE, TDG.N, UTX.N, SIAL.SI, RTN.N, NOC.N, HRS.N, ADSK.OQ, ADNT.N, BAES.L, 0670.HK, GE.N, ZODC.PA, WWD.OQ, TXT.N, TGI.N, SPR.N, SAF.PA, RR.L, PH.N, OA.N, MOGa.N, MGGT.L, LLL.N, LHAG.DE, LFL.N, ICAG.L, HON.N, GD.N, ETN.N, ESL.N, ERJ.N, COL.N, BBDb.TO, BLL.N, AVMD.PA, 7013.T, 7011.T, 6752.T, 000333.SZ, ABBN.S, 6954.T) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (AIR.PA, SIEGn.DE, TDG.N, SIAL.SI, NOC.N, BAES.L, GE.N, LHAG.DE, HON.N, ETN.N, 000333.SZ) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (GE.N). A member of the Credit Suisse Group is party to an agreement with, or may have provided services set out in sections A and B of Annex I of Directive 2014/65/EU of the European Parliament and Council ("MiFID Services") to, the subject issuer (HEI.N, TCFP.PA, ARNC.N, AIR.PA, DAST.PA, HXL.N, TDG.N, SIAL.SI, NOC.N, ADSK.OQ, ADNT.N, 0670.HK, GE.N, ZODC.PA, TGI.N, SPR.N, SAF.PA, RR.L, PH.N, OA.N, MGGT.L, LFL.N, ESL.N, ERJ.N, BBDb.TO, AVMD.PA, 7013.T, 7011.T, 6752.T, 000333.SZ, 6954.T, 6506.T) within the past 12 months. As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (ARNC.N, RR.L). As of the end of the preceding month, Credit Suisse beneficially own between 1-3% of a class of common equity securities of (ABBN.S). Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (6954.T). Credit Suisse beneficially holds >0.5% short position of the total issued share capital of the subject company (SIEGn.DE). For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683. For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to the link: https://rave.credit-suisse.com/disclosures/view/report?i=296746&v=- 6oda4hmficbxx6c19w28ku99t . Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. 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The following disclosed European company/ies have estimates that comply with IFRS: (TCFP.PA, AIR.PA, DAST.PA, SIEGn.DE, BAES.L, QAN.AX, RR.L, MGGT.L, LHAG.DE, ABBN.S). Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (ARNC.N, BA.N, TDG.N, SIAL.SI, RTN.N, NOC.N, ADNT.N, 0670.HK, GE.N, LHAG.DE, LFL.N, BBDb.TO) within the past 3 years. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: Credit Suisse Securities (USA) LLCRobert Spingarn ; Julian Mitchell ; Curt Woodworth, CFA ; Jose Caiado ; Justin Harnett ; Serena Rocha Calejon Credit Suisse International ...... Olivier Brochet ; Andre Kukhnin, CFA ; Charles Brennan CFA ; Neil Glynn, CFA ; William Lunn To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the FINRA 2241 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse International ...... Olivier Brochet ; Andre Kukhnin, CFA ; Charles Brennan CFA ; Neil Glynn, CFA Important Credit Suisse HOLT Disclosures With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this report accurately reflect the Credit Suisse HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the specific views disclosed in this report. The Credit Suisse HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the Credit Suisse HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default algorithms available in the Credit Suisse HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. The adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes the baseline valuation for a security, and a user then may adjust the default variables to produce alternative scenarios, any of which could occur. Additional information about the Credit Suisse HOLT methodology is available on request. The Credit Suisse HOLT methodology does not assign a price target to a security. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The default variable may also be adjusted to produce alternative warranted prices, any of which could occur. CFROI®, HOLT, HOLTfolio, ValueSearch, AggreGator, Signal Flag and “Powered by HOLT” are trademarks or service marks or registered trademarks or registered service marks of Credit Suisse or its affiliates in the United States and other countries. HOLT is a corporate performance and valuation advisory service of Credit Suisse. Important disclosures regarding companies or other issuers that are the subject of this report are available on Credit Suisse’s disclosure website at https://rave.credit-suisse.com/disclosures or by calling +1 (877) 291-2683.

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