Aerospace & Defense

Increase in deliveries bodes well for aerospace outlook despite supplier risks, says Moody's

Key Points
  • Moody's report is upbeat on the aerospace industry outlook in 2018 due to rising commercial aircraft deliveries for Boeing and its rival Airbus.
  • But Moody's warns about continued risk of supply chain disruptions, whether involving engines for jets popular with airlines or other issues.
  • The defense industry's 2018 outlook also is positive, with Moody's predicting defense budgets will grow about 5 percent and "maybe higher."
  • Moody's also said defense contractors are likely to "continue to face pressure to accept more of the risk on contracts."
Boeing stock on pace for best year in nearly four decades

The outlook remains favorable for the defense and aerospace industries, although supply chain hiccups pose a risk to the commercial aircraft sector and Pentagon acquisition reform could pressure contractors, according to a new report.

Moody's Investor Service predicts "strong aircraft order backlog" will fuel 10 percent growth in the aerospace industry's delivery ramp-up, which will boost profits and cash flow for companies.

"We anticipate a period of elevated execution risk over the next 12 to 24 months as Boeing and Airbus ramp up their narrowbody production rates," Moody's said. "Supply chain manufacturers have been making significant capacity investments to meet the production rate increases."

Boeing currently has a backlog of 4,413 planes for its 737 narrowbody jet, and the company has previously said it plans to boost production to 52 planes per month in 2018 and 57 in 2019. Moody's noted that the 2017 rate for the 737 model is 47 planes per month.

At the same time, Moody's said Airbus should see its production rate on its A320 narrowbody plane increase, from a rate of 50 aircraft per month in 2017 to 52 in 2018.

The strong demand globally for the single-aisle jet shows no signs of slowing, and the company boasts orders from at least 92 countries.

Supply chain vulnerabilities

As Boeing ramps up production, it is counting on suppliers to keep up. A significant problem in the supply chain could have a far-reaching impact on the company.

Indeed, Boeing announced in May it had grounded 737 MAX aircraft due to engine issues it had discovered. The issue with the engines appears to have been resolved but still highlights the risk of manufacturing or supplier problems delaying aircraft deliveries.

Still, Moody's said, "We view the supply chain to be generally well-positioned to meet production rate increases of narrowbodies."

Then again, Moody's said there could be issues in 2019 to accommodate even more aggressive production rate increases by Boeing and Airbus.

"The ability of the supply chain to make necessary investments to accommodate 60 narrowbodies per month for the A320 and 57 for the B-737 in 2019 is less clear but this is a 2019 issue," Moody's said.

For smaller suppliers and aircraft engine makers such as United Technologies' Pratt & Whitney subsidiary and Rolls Royce, there also are "execution risks in 2018," Moody's said.

Specifically, Moody's pointed out that Canada's Bombardier has seen delivery delays with its C Series "due to persistent issues with Pratt & Whitney's geared turbofan engines." Also, it said U.K.-based Rolls Royce's Trent 100 engines have had "turbine blade issues," causing "utilization constraints for certain 787 Dreamliners" manufactured by Boeing.

Defense spending uptick

As for the defense industry, Moody's forecasts that defense budgets will grow by about 5 percent in 2018 but "maybe higher," although that will depend on Congress and how much money it sets aside for military spending in fiscal 2018.

Last week, Congress approved a short-term continuing resolution that funds defense operations and the rest of the government through Dec. 22, but there's still no agreement on a budget that appropriates money for the full fiscal 2018 period through Sept. 30.

The White House proposed a base budget 6.6 percent above 2017 but it exceeds the current budget caps and passage would require legislation and bipartisan support.

Still, the report said there's "strong political support for budgets to exceed Trump's proposal."

Pentagon shifting risk

However, one thing that does appear certain is Pentagon acquisition reform in the Trump administration.

"Contractors will continue to face pressure to accept more of the risk on contracts," the Moody's report said.

Moody's added, "Fixed-price incentive contracts for development work are becoming more common," even as the cost-plus contracts are declining. The cost-plus contracts essentially mean the government picks up the cost of the contractor's expenses, including the cost of materials, but it also has led to more situations of cost overruns, particularly for the Navy.

According to Moody's, the government is focusing more on pricing in military contracts as it faces fiscal challenges. It follows President Donald Trump early in his presidency getting personally involved in negotiations for some big-ticket programs to lower price, including the F-35 stealth fighter, the F-18 Super Hornet and the two Boeing 747 replacement aircraft for Air Force One.

Last week, the Pentagon's acquisition chief announced details on how she plans to speed up and reform the Defense Department's acquisition system.

Ellen Lord, undersecretary of defense for acquisition, technology and logistics, spoke to the Senate Armed Services Committee last week and said she intends to emulate private industry by taking a leaner approach and making things run more smoothly.

"Reforming and improving the defense acquisition system to create an agile enterprise is a continuing process requiring close partnership across the department and with Congress," she said. "Some of the ways we intend to do this is ... incentivizing contractors to submit responsive proposals in 60 days or less and implementing electronic department-wide streamlining tools."

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