Aerospace and defense 2017 year in review and 2018 forecast How are aerospace and defense companies performing today? What challenges and opportunities do they face? PwC takes a look. www.pwc.com/us/aerospaceanddefense Methodology Our data is drawn from financial reports on fiscal year (FY) 2017, results for the largest 100 aerospace and defense (A&D) companies by revenue (see Appendix A) and other publicly available information, such as company websites and press releases. Our cut-off date for publication was April 1, 2018. A&D companies include those that generate the majority of revenue from aerospace or defense activities or, for diversified companies, those reportable segments that derive a majority of their revenue from A&D activities. The results are reported in US dollars. Foreign currencies were translated at average exchange rates for years ending December 31, 2017 and December 31, 2016 respectively. Our report also expresses PwC’s point of view on topics affecting the industry, developed through interactions with our clients and other industry leaders and analysts. PwC Aerospace and defense 2 Aerospace and defense overview 4 Commercial aerospace 14 Defense 24 Mergers and acquisitions 32 Summary 34 Appendix 36 Additional resources 40 PwC Aerospace and defense 3 Aerospace and defense overview 2017 review The aerospace and defense industry reported record profits of Aerospace and $77 billion in 2017, an 18% increase over the prior year, and surpassing the previous record set in 2014 by 5%. Industry defense industry revenue was $728 billion, an increase of 4% over 2016, and reports record profit nearly matching the record revenues of $729 billion in 2014. Boeing’s operating profit exceeded $10 billion, a first for Revenue increases 4%; any A&D company. Boeing’s $4.4 billion profit improvement operating profit exceeded the total profits for all but two other companies increases 18% (GE Aviation and Lockheed Martin). Boeing’s performance catapulted it back to become the industry’s most profitable Boeing reports company by a large margin, an honor which was taken by GE Aviation in 2016. GE Aviation retained second place, with a 9% > $10 billion in profit improvement to $6.6 billion. operating profit to regain “most profitable company” status Commercial revenue passenger miles growth accelerates to 7.6% PwC Aerospace and defense 4 The top 100 A&D companies (see Appendix A), by revenue, reported $728 billion in revenue and $77 billion in operating profit in 2017. Operating margin improved by 130 basis points to 10.6%. Industry operating margin has reached double digits only once before in 2014. The improvement in operating profit and operating margin were broad based. There were 13 companies with profit fluctuations greater than $400 million (see Figure 2). Figure 1: Key industry metrics (US$ billions) 2017 2016 Change Revenue $728 $704 4% Operating profit $77 $65 18% Operating margin 10.6% 9.3% 130 bps Source: PwC analysis Figure 2: Profit fluctuations > $400 million (millions) Boeing +$4,444 Rolls-Royce +$1,680 Airbus +$1,359 Cobham +$1,186 Triumph +$1,148 GE Aviation +$ 527 Safran +$ 485 Bombardier +$ 454 General Dynamics +$ 443 CSRA +$ 435 Mitsubishi -$ 951 Korea Aerospace Industries -$ 455 BAE Systems -$ 448 Source: PwC analysis PwC Aerospace and defense 5 One trend we have been watching for several years is a shift in operating margin. The top quartile now reports operating margin on par or better than the industry average, due mostly to significant improvements at Boeing and Airbus, the industry’s two largest companies. Boeing’s operating margin is now 11%, slightly better than the industry average, while Airbus is less than half of that, at 5.1%, which included a non-recurring charge for A400M. Only the third quartile reported a decrease in operating profit and operating margin, which was mostly attributable to Korea Aerospace Industries’ performance. The improvement in the top quartile profitability was significantly influenced by Boeing’s performance. Profit improvement in the second quartile was primarily due to the absence of restructuring charges at Triumph Group ($1.1 billion profit improvement) and Cobham ($1.2 billion profit improvement). Figure 3: Key metrics by quartile Operating Operating Revenue Change profit margin Top quartile 3.0% 17.3% 10.9% +140 bps Second quartile 5.8% 55.3% 9.2% +290 bps Third quartile 3.9% -6.2% 11.2% -120 bps Fourth quartile 3.5% 10.6% 8.1% +50 bps Source: PwC analysis Prospects continue to be bright for commercial aerospace. Growth in revenue passenger miles accelerated to 7.6% in 2017 (see Figure 11), more than twice global GDP growth. And that’s on top of the two preceding years above 6% growth and greater than 5% growth since the Great Recession of 2008-2009. This growth is driving demand for new equipment and aftermarket in the near and long term. Also, new aircraft deliveries increased 3%, and the industry set a new record of 1,481 large aircraft deliveries in 2017 (see Figure 10), 45 more than 2016 and a 45% increase since 2011, and further production increases are planned for narrowbodies. Book-to-bill was back above 1:1 in 2017, after a modest dip in 2016, which resulted in new record backlog in excess of 13,000 aircraft and approximately nine years of production at current rates. PwC Aerospace and defense 6 The defense industry reported accelerating revenue growth in 2017. In March 2018, President Trump signed the omnibus spending bill, which sets the Department of Defense (DoD) budget at $700 billion, about a 20% increase in two years. Therefore, we expect continued acceleration of revenue and profit in 2018. During 2017 and into early 2018 the global threat environment continued to evolve. Coalition forces have substantially defeated ISIS. And while terrorist threats are likely to persist, the Pentagon is pivoting toward Russia, China, North Korea and Iran, particularly North Korea’s escalating nuclear missile program, causing the US to bolster its presence in the region. Furthermore, China’s military modernization is continuing to cause tension, particularly in the South China Sea. All these events underscore the complex and dynamic global security environment, which could cause rapid changes in US defense priorities. There were few changes to the top 100 list in 2017. BWXT and VSE were added to the list and B/E Aerospace and Digital Globe were deleted. There were, however, some significant deal announcements, which are pending or have closed in 2018, including UTC’s acquisition of Rockwell Collins and Northrop Grumman’s acquisition of Orbital ATK. Figure 4: Top 100 additions and deletions Added to the list BWXT #71 Spinoff from Babcock and Wilcox VSE Corporation #92 Acquisitions and organic growth Deleted from the list B/E Aerospace Acquired by Rockwell Collins Digital Globe Acquired by Maxar Technologies Source: PwC analysis PwC Aerospace and defense 7 PwC Aerospace and defense 8 Figure 5: Analysis highlights Largest increase in revenue (dollars) Lockheed Martin +$3,800m Largest increase in revenue Leidos +44% (percentage) Largest increase in profit (dollars) Boeing +$4,444m Largest increase in profit (percentage) Rolls-Royce +2827% Highest operating margin TransDigm 42.2% Largest increase in top 100 list Serco +12 Largest decrease in revenue (dollars) Boeing -$1,179m Largest decrease in revenue Korea Aerospace -31% (percentage) Industries Largest decrease in profit (dollars) BAE Systems -$448m Largest decrease in profit (percentage) HAECO -648% Korea Aerospace Largest decrease in top 100 list -17 Industries Source: PwC analysis Revenue Boeing was again the industry’s largest company in 2017. It reported $95 billion in revenue, which reflects a 2% decrease driven partly by defense revenues and lower commercial aircraft revenues due to mix of aircraft. Airbus reported flat revenue of €66.8 billion compared with €66.7 billion in the prior year, which resulted in a 2% increase in US dollars due to currency fluctuation. Lockheed Martin reported the largest revenue growth, for consecutive years, of $3.8 billion. Leidos reported the largest percentage growth in revenue, 44%, as a result of its acquisition of Lockheed Martin’s IS&GS business. PwC Aerospace and defense 9 Profitability • Boeing regained most profitable status in 2017, with $10.3 billion in operating profit, the first time any company in the industry has achieved the $10 billion mark. • Boeing also reported the largest increase in profit of $4.4 billion, achieved mostly in its commercial aircraft segment. • BAE Systems reported the largest decline in profit of $448 million. Operating margin Industry operating margin improved 130 basis points to 10.6% (see Figure 1), a record double-digit growth only previously achieved in 2014. Transdigm had the industry’s best operating margin at 42.2%, while GE Aviation improved 100 basis points to an operating margin of 24.3%, after achieving 20% for the first time in 2014. Figure 6: Companies with operating margin > 20% Top 100 rank # Operating margin GE Aviation 6 24.3% Honeywell Aerospace 13 22.2% Transdigm 41 42.2% SES 53 30.0% Heico 74 20.1% Aselsan 76 21.9% Crane Aerospace & Electronics 92 23.2% Source: PwC analysis PwC Aerospace and defense 10 Total shareholder returns The A&D industry delivered strong total shareholder returns (TSR) – defined as the annualized change in share value + dividends / buybacks – of 39.9% in 2017. These returns outperformed the S&P 500 TSR of 21.8% in 2017, continuing the sector’s outperformance over the last five years with the A&D index delivering 24.7% vs. the S&P 500’s 15.8%. Within the A&D index, the performance was led by the A&D airframers, which have delivered a 1 Year TSR of 88.4%, followed by the A&D primes’ 43.3% and suppliers’ 31.9%.