Oklahoma Aerospace Summit & Expo Tulsa Convention Center, Tulsa, OK 6-8 June 2011

Oklahoma Aerospace Summit & ExpoTulsa Convention Center, Tulsa, OK

6-8 June 2011

Photo: US Air Force

Commercial & Defense Industry UpdateCommercial & Defense Industry Update

Presented byPresented by

Hal Chrisman, PrincipalHal Chrisman, PrincipalAeroStrategy LLCAeroStrategy LLC

© 2011 AeroStrategy OAA Aerospace Summit 2011

Agenda

Defense Market Outlook

Commercial Market Outlook

Aftermarket Implications

2

© 2011 AeroStrategy OAA Aerospace Summit 2011 3

US And Western Europe Face Massive Structural Deficits That Must Be Addressed …

Country

2011Defense

Budget (B US$)

Defense as % of

GDP

2011 Deficit

2011 National

Debt

Nat’l Debt as % of

GDP

USA $698 B 4.7% $1.5 T $14.3 T 91%

UK $60 B 2.7% £131 B £1.1 T 77%

France $59 B 2.3% € 102 B € 1.7 T 87%

Germany $45 B 1.4% € 60 B € 2 T 80%

Italy $37 B 1.8% € 69 B € 1.9 T 120%

Spain $16 B 1.1% € 67 B € 693 B 64%

Greece $9 B 3% € 17 B € 320 B 142%

Source: IMF World Economic Outlook April 2011 SIPRI Military Expenditures Database

Fiscal Summary For USA And Select Western European Countries

DefenseDefenseMarketMarketOutlookOutlook


… Some European Union Countries Are Changing Military Spending Plans As A Result Of Budget Pressures …

Cuts up to $9B through 2016

At least $3B cut over next 5 years

Cut 5% since 2009 Planned cuts of 10%

•Cost overruns,•Reduced orders•Cancelled orders?

Germany France Spain Greece

A400M Eurofighter


Source: AeroStrategy analysis 4


… While The US Has Been Slowly Coming To Terms With The Current Fiscal Situation …

Robert GatesSecretary Of Defense

“Given the fiscal challenges facing the nation, the Department of Defense must make every dollar count. But as I’ve stressed before, this effort is ... about getting more bang for the buck by shifting resources”

“The reductions would likely fall most heavily on our operations and maintenance accounts. Cuts in maintenance could force parts of our aircraft fleet to be grounded… Cuts in operations would mean fewer flying hours…all of which directly impacts readiness.”

2001-2010 US Defense Budget And Annual Budget Deficit

Source: IMF World Economic Outlook April 2011 SIPRI Military Expenditures Database



… But Recent Rhetoric Suggests That This Will Change Quickly

FY 2010 FY 2011 Change Percent

Milpers $152,997 $151,842 ($1,155) -0.8%

O&M $291,763 $294,428 $2,665 0.9%

Procurement $135,889 $134,164 ($1,725) -1.3%

RDT&E $80,655 $80,905 $250 0.3%

Mil Const $23,379 $17,319 ($6,060) -35.0%Family

Housing $2,425 $3,108 $683 22.0%

Resolving Funds $4,683 $4,568 ($115) -2.5%

TOTAL $691,971 $686,317 ($5,457) -0.8%

Source: DoD FY 2012 Budget Request

FY 2010 & 2011 Defense Base And OCO Budget Comparison



0

200

400

600

800

1,000

1,200

1,400

1,600

1980 1991 1994 1997 2001 2007 2011

7

Initial Production1,368 Aircraft

Major Aircraft Review1,196 Aircraft

Navy version terminated in 1992

Successive Program Reductions thru FY2007

Final F-22 (187)

Air

craf

t

Current Programs At Risk?

JSF

2,456 (p)

V-22

430 (p) / 135 (b)

Programs Probably Safe

Programs Definitely Safe

F/A-18E/F

515 (p) / 454 (b)

C-130J

307 (p) / 120 (b)

P-8

117 (p)

EA-18

114 (p) / 28 (b)

UH-60M

1,221 (p) /270 (b)

MH-60R/S

572 (p) / 238 (b)

Source: Teal Group

The History Of The F-22 Sheds Some Light On The Future Of New Weapons Systems


Font too way small


As The Economic Growth Shifts, The Relative Size Of Domestic Defense Budgets Will Shift As Well …

?

Source: CIA World Factbook Economist Intellgence Unit

2010 – 2020 GDP Versus Military Expenditures

Asia & China26%

Asia & China

36%

19%



… While The Rise Of China Will Change The Geopolitical Environment …

• China’s defense capabilities are growing in parallel with its torrid economic growth− Defense budget growing 8-10% per annum− Expanding deep-water navy− Large investments in asymmetric warfare capability− Unexpected unveiling of J-20 Stealth Fighter program in 2010

• In addition, China is expanding its use of foreign aid, diplomacy, and alliances throughout Asia, Africa and Latin America to support its national interests…including access to raw materials, shipping lanes, and oil

• China’s rise, in turn, is creating angst throughout Asia and beyond from potential rivals− USA− Japan− India− South Korea− Vietnam− Russia− Australia

China’s Share Of Global GDP*

China’s J-20 Steath Fighter

SouthChina Sea

Source: IMF, Global Security ; Note: GDP data in purchasing power parity



…And That Will Drive Defense Budgets In Asia Pacific

2010 Estimated GDP, Asia Pacific Countries

Country

GDP Growth (2011-2015)

Key Programs

Japan 3.0%Fighter ReplacementP-1 Maritime Patrol

India 10.4%Fighter Competition

Attack/Utility HelicopterMultiple Other Programs

Australia 1.2% F-35 JSF

S. Korea 6.1%Utility Helo (KUH)

Figher Replacement (JSF)

Taiwan 10.8%Attack Helo (AH-64)Utility Helo (UH-60)

Source: CIA World Facebook AeroStrategy analysis



An Outbreak Of Democracy Could Slow Growing Military Budgets In the Middle East

2011 Middle East Defense Budgets And Percentage Of GDP

Source: CIA World Facebook AeroStrategy analysis

Global Average = 3.6% of GDP


Sa

ud

i A

rab

ia


Conventional Warfare Irregular Warfare

Threats Faced Today Are Different Than 20 Years Ago, Dictating A Change In The Nature Of Warfare …

ISR ParapublicExpeditionary / Urban Warfare



Technological Innovations Such As The UAV Have Driven Growth In Battlefield Intelligence

Airborne ISR Full Motion Video Collection (Flight Hours)

Source: US DoD Briefing



Para-Public Missions Have Grown And Driven The Demand For More Vertical Lift Capability

Drug Interdiction

Plan Colombia: $1B international aid program

includes the acquisition and support for approx. 100

helicopters

Humanitarian

US Civil and Military Forces have participated in over 30 humanitarian missions since 2001, most requiring significant vertical lift

Border Patrol

US Borders And Customs Patrol has added 50 helicopters in the past decade (total force on 70) and expected to add 55 more in the next 5 years

Source: AeroStrategy analysis

Examples Of Parapublic Missions



Expeditionary Battlefield Requirements Are Driving Demand For Vertical Lift, ISR, And Transport Aircraft

Expeditionary Warfare:

Robust Intel And Communications (C4ISR)

Technological Interoperability

Flexible and Swift Logistics

Adaptive Force Packaging

Mission Impact

Fighters

Helicopters

Tactical Transport

Strategic Transport

ISR

UAV

The Impact Of Expeditionary Warfare Of Aviation Needs




Over The Next Decade, Fixed Wing Aircraft Production Will Be Replaced In Part By UAV Production …

Worldwide Military Fixed Wing Aircraft Production (2011-2020)

Source: OAG Aviation

Un

its

Mission, CAGR




17

… While Helicopter Production Is Expected To Remain Relatively Flat

Source: OAG Aviation

Worldwide Military Rotary Wing Aircraft Production (2011-2020)U

nit

s

Helicopter OEM


Agenda




18


Air Transport Production Rates Are Driven By The Complex Interrelations Of Several Factors

19

Air TravelDemand

EconomicGrowth

Air TravelValue

Proposition

RequiredAircraft

AircraftDemand

For Growth

Aircraft operatingfactors

(utilization, speed, size, load factors)

Current Fleet

TemporaryStorage

Retired/Scrapped

TotalAircraftDemand

AircraftDemand For Replacement

Air Transport Production Demand Drivers

Source: AeroStrategy

CommercialCommercialMarketMarketOutlookOutlook


Oil Prices Are Approaching The High Levels Of The 2008 Price Spike…

20

Annual Average Fuel Costs 1978 to present

(cents per gallon)

Source: Air Transport Association, IATA

2002: 11% of airline expenses

Current: 30+% of airline expenses

March 2011

price


© 2011 AeroStrategy AMMAMM

…Which Is Changing The Economics Of Aircraft Operation…

21

US Airlines – 2009 Fuel Costs/ASM (cents)

Winners

Winners Losers

Losers

Source: US Air Transport Association

* 2009 figures are based on $1.75 - $1.95 gallon fuel

gal

Fuel cost/

ASM (cents)

High fuel costs exacerbate aircraft

cost differences

*


© 2011 AeroStrategy OAA Aerospace Summit 2011 Source: Airline Monitor

Air Transport Retirements and Deliveries

Retirements

Deliveries

400 Retirements per year is the new normal

Production breakdown

~60% for growth

~40% for replacement

Aircraft

...And Contributing To A Surge Of Aircraft Retirements...

22



AeroStrategy Developed Three Scenarios For Air Transport Production Rates Based On Fuel Prices

23

2011 – 2021 Air Transport Production Scenarios

Sources: AeroStrategy analysis, Airline Monitor

Aircraft Demand Factor

Optimistic Nominal Pessimistic

Long-term Oil Price (WTI)

$50-60/bbl $80 – 120/bbl $150+/bbl

Average Global GDP growth

~4% ~3% ~2%

Average Global RPK growth

5.1% 4.4% 3.6%

Net Return of Parked Aircraft

400 Nil Nil

Total 2011-21 Aircraft Retirements

5,100 5,600 6,000

Aircraft Utilization (hrs/day)

7.7 8.0 8.2

2021 Projected fleet(2010 = 20,500) 32,900 30,400 27,000

Aggregate 2011-21 Aircraft Production

17,000 16,000 12,500

Downside Risk Outweighs Upside Opportunities



In AeroStrategy’s Nominal Scenario, Air Transport Production Exceeds 1,600 By 2021

24Source: AeroStrategy

Air Transport Nominal Production Scenario 2011-2021*By OEM

* Drop in production rates from 2014 to 2016 is due to a change in orders, shifting from legacy aircraft to next generatin

Un

its

Aircraft Demand Factor Nominal

Long-term Oil Price (WTI) $80 – 120/bbl

Average Global GDP growth ~3%

Average Global RPK growth 4.4%

Net Return of Parked Aircraft

Nil

Total 2011-21 Aircraft Retirements

5,600

Aircraft Utilization (hrs/day)

8.0

2021 Projected fleet(2010 = 20,500)

30,400

Aggregate 2011-21 Aircraft Production 16,000



Agenda




25


The Air Transport And Military Aftermarket Combined Were Almost $130B In 2010

AIR TRANSPORT

• Airlines and freight carriers

• Turboprop and jet aircraft

• Fleet of about 25,000

• 60 million hours a year or ~ 2,400 per aircraft

MILITARY

• Attack, transport, trainers

• Fixed- and rotary wing

• Fleet of about 39,000

• 11 million hours a year or ~ 300 per aircraft

$87.1B

2010 Military Sustainment Market

$43.6B

2010 Air Transport MRO Market

AftermarketAftermarketImplicationsImplications


AeroStrategy Anticipates Mid-To-Upper Single Digit MRO Growth In 2011…

27

Air Transport MRO Market – Realized Supplier Revenue($B) *

Source: AeroStrategy* Constant 2009 US$

0

10

20

30

40

50

60

2008 2010 2012 2014 2016 2018

Fundamental MRO demand

Realized supplier

revenue

2011: Mid-to-upper single digit growth

2012: Low double digit growth

Key Assumptions• Fuel costs in $80

– $110 /bbl range

• 2-3% global GDP growth and modest airline profitability

• Some make up for deferred maintenance and modest inventory restocking

2009: MRO demand down 15-20%

2010: 1-3% growth



… But The Impact Of High Fuel Prices Could Further Change Airline Supply Chain Practices …

28

200

8-20

10

Economic Crisis

Supply Chain Practices•Burn Inventory

•Deferred Maintenance•Cannibalization / Surplus

Depressed Demand

+%

-%

“Normal”MRO Demand

(FundamentalDemand = realized supplier demand)

Factors Supressing Fundamental MRO Demand

2009/10: Reduction to fundamental demand from destocking and deferred maintenance

Further Depressed Demand+%

-%

“Normal”MRO Demand

(FundamentalDemand = realized supplier demand)

2009/10: Reduction to fundamental demand from destocking and deferred maintenance

2010/11: MRO demand suppressed by aircraft

cannibalization and high use of surplus

parts….

201

0-20

12

High Fuel Prices

Supply Chain Practices•Aircraft Retirements

•Parting Out•Excess Surplus Parts




…And Future Growth Will Be Highly Dependent On The Fluctuation In Fuel Prices

29

MRO Growth Scenarios Based On Fuel Costs

Nominal case

Oil $80 – 110/bbl


Best case

Oil < $80/bbl

• Fuel costs fall to less than $80/bbl

• Falling costs boost GDP, air travel growth, and airline profits

• Facilitates return of hundreds of aircraft from storage – which need MRO

• Fuel costs remain in $80-110/bbl range

• Modest (2-3%) global GDP growth…and airline profitability

• Fuel costs limit return to service of most stored aircraft

Worst case

Oil > $110/bbl

• Fuel costs escalate to >$110/bbl…or much higher

• A dramatic spike in fuel costs could lead to a “W” shaped recession and reduced air travel growth

• Airlines again in red, which results in further capacity reductions and cost cutting

• More aircraft to desert

AeroStrategy

Forecast


© 2011 AeroStrategy

Recent Rhetoric Suggests That All Aspects Of The Defense Budget Will Feel Pressure …

30


“Although reducing the defense budget cannot alone solve our deficit problem, it is hard to envision an overall solution that does not include some contribution from the 20 percent of government spending that goes toward defense.” – Deputy SecDef Bill Lynn


… And Reductions In O&M Spending Will Impact The Military Aftermarket

Bil

lio

ns

All Values In 2010 U.S. Dollars

2010-2015 North America & Europe Military Sustainment Forecast


Lower utilization reduces sustainment … or lower

budgets reduce readiness which lowers utilization

Recovery to expected levels by 2014?

10% reduction in utilization for aircraft excluding

helicopters and fixed wing transport results in a 6% decline in sustainment

spending



In Summary….

32Source: AeroStrategy

US And Western Europe face Massive Structural Deficits That Must Be Addressed resulting in severe defense budget pressures

China’s Emergence As A Great Power Creates Angst Throughout Asia … and drives Asian Defense budgets

An outbreak of democracy in the Middle East could slow robust growth in defense spending

Changing mission requirements drive increasing need for ISR, vertical lift and fixed wing transport

UAVs are the bright spot is fixed wing production and rotary wing production is projected to be flat

• Aircraft economics have fundamentally changed as a result of high fuel prices, leading to premature retirement of hundreds of aircraft

• The air transport MRO market, after a difficult recession, is currently valued at $43.6 billion

• The parting out of aircraft is suppressing a rapid recovery in MRO demand with 15-20 aircraft parted out per month

• The shape of MRO recovery is tightly linked with the price of oil

• 2011 MRO demand growth of mid-to-upper single digits is anticipated in the nominal scenario

• Long-term MRO growth will be 3.3% CAGR, led by engines and modifications

US And Western Europe face Massive Structural Deficits That Must Be Addressed resulting in severe defense budget pressures

China’s Emergence As A Great Power Creates Angst Throughout Asia … and drives Asian Defense budgets

An outbreak of democracy in the Middle East could slow robust growth in defense spending

Changing mission requirements drive increasing need for ISR, vertical lift and fixed wing transport

UAVs are the bright spot is fixed wing production and rotary wing production is projected to be flat

• Aircraft economics have fundamentally changed as a result of high fuel prices, leading to premature retirement of hundreds of aircraft

• The air transport MRO market, after a difficult recession, is currently valued at $43.6 billion

• The parting out of aircraft is suppressing a rapid recovery in MRO demand with 15-20 aircraft parted out per month

• The shape of MRO recovery is tightly linked with the price of oil

• 2011 MRO demand growth of mid-to-upper single digits is anticipated in the nominal scenario

• Long-term MRO growth will be 3.3% CAGR, led by engines and modifications


1Thank you for your attention!

33

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Oklahoma Aerospace Summit & Expo Tulsa Convention Center, Tulsa, OK 6-8 June 2011