2020 Q4 Earnings call roundup

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Boeing, for example, has so much raw material in Puget Sound that it is storing some  in Wichita.  Another factor is whether the supplier worked with its customers to reduce supply voluntarily as the pandemic took hold, thereby protecting 2021 sales by giving up some 2020 sales (TriMas Aerospace, for example) or insisted that customers accept contractually required deliveries (Howmet, Kaiser and others).  Finally, another hidden factor is what did the suppliers themselves do.  Did they quickly engage in layoffs?  Did they stretch it out and continue to produce?  The first group will ramp up quicker than the second.  The takeaway is the industry will be sending very mixed messages regarding the trough.  We expect no pickup in the supply chain to speak of in the aggregate until second half of the year at the earliest and for some companies, it will be next year.  Our advice is to proceed to build only on firm purchase orders and build momentum gradually with an eye on your cash flow.  The return will be slow and uneven. 

The comparisons year over year from Q4 2019 to Q4 2020 are stark.  MOOG reported sales down to both Boeing and Airbus on every platform, ranging from 40% lower on the A320 to over 90% lower on the 737. Sales the 787 and the A350, were down between 50% and 60%.  Hexcel reported Commercial Aerospace sales decreased 66.6%.  As a result, Hexcel reduced their workforce by 35% and idled some facilities.  General Electric reduced headcount by 20,000 and reported that they expect the Aviation segment revenue to be flat year over year in 2021.  Arconic expects aerospace sales in 2021 to decline 25% to 30% from 2020.

Boeing and Airbus continue to build more aircraft than they are delivering.  One does not really provide significant guidance to their supply chain regarding rates and the other provides guidance the supply chain does not believe.  Boeing delivered 40 MAX aircraft from their final inventory reducing the total stored from 450 to 410; however, they are also still building, albeit at a very low rate.  As a result, they expect to have finished MAX planes stored into 2021.  In addition, Spirit has 130 MAX shipsets stored in Wichita (on Boeing’s books) with hopes of burning that off over the next 18 months.  The 787 program continues to be impacted by inspection of fuselages.  As a result, Boeing has not delivered to any customers since last year.  The fuselage problem goes beyond just sections 46 and 48 that Boeing builds in South Carolina but includes all the major sections, including Spirit’s section 41.  There will be changes to the production process needed.  Boeing has announced rate 5 on the 787 taking effect this month but with over 80 completed ships stored and low immediate demand from customers one can imagine the supply chain being slowed further.  Airbus has announced a 3 aircraft/month rate increase in the third quarter of this year for the A320 despite having roughly 100 finished planes in inventory.  Airbus guided flat year over year in deliveries in 2021 and did not provide any firm commitment on when they would unwind their finished goods inventory position.  If they cannot commit to that, I remain unconvinced that the rate increase is real.  Many suppliers feel the same way having just experienced a kick to the right at the last minute by Airbus in the rate increase last fall.

Airbus also announced that they consider aerostructures core to their future production plans.  Stelia and Premium Aerotec will remain in Airbus.  Airbus specifically stated they do not anticipate M&A in this space.  But there are some overlapping capabilities at Stelia and Premium and neither one does what is the most critical aerostructure, the wing.  Given that Gulfstream, Boeing and Bombardier have all moved in the past few years to control the wing build internally on new programs, it would be surprising if Airbus is not considering it.  A good candidate program for that would be the A220.  Airbus is losing money on the program while Spirit is also burning cash building the wing.  It should be noted that both companies plan to turn it into a money maker over the next few years.  But to make money on the A220, Airbus should be looking for a lower price for all major structures including the wing than what they are currently paying, which obviously puts additional pressure on Spirit.

The amount of raw material in the supply chain is remarkable as mentioned earlier.  Also noteworthy is the amount of growth in commercial packaging forecast for the aluminum industry.  As plastic containers for beverages come under environmental scrutiny, both Arconic and Kaiser reflected in their earnings calls on the significant growth in demand forecast for commercial packaging.  Arconic, for example, noted a study concluding that can sheet demand is expected to grow by more than 1 billion pounds over the next 5 years.  Given the quick recovery in automotive and industrial production, Arconic concluded that there is 3 billion pounds of additional demand forecast in the few years and noted that a study shows there is currently a one billion pound shortage of aluminum capacity in the US.  So, the aerospace industry is in the odd position of currently having significant inventory and facing potential growth in lead times to replace that inventory in the future.  This is exactly when mistakes are made in securing follow-on orders.  Although this problem is likely at least a year off, it bears watching.  In addition, it further dilutes the concentration that raw material producers have in Aerospace.  Arconic’s aerospace sales in the fourth quarter of 2020 made up only 9% of their total revenue.

 To wrap, we have two issues that should be kept in mind moving forward.  

• Year over year production, sales and earnings comparison will begin to skew starting next quarter.  For some companies, this is the last quarter with pre-pandemic production in 2019.  For some the second quarter still had some pre-pandemic sales and production, depending on when their customers cut orders.  By the third quarter at the latest, the comparisons will be to 40-50% reductions sustained in 2019.  A 50% increase year over year may sound great but it still leaves a company 25% down from where they were in 2019.  Percentage growth from an exceptionally low base can be misleading.
• There will be an impact on the industry from the fallout of Greensill Capital’s UK insolvency proceedings.  Greensill provided supplier financing.  Many of you are familiar with supplier financing as it is a fairly common and growing mechanism used by larger firms (e.g., Boeing) to manage cash flow in the supply chain.  But in case you are not that familiar with it, the basic mechanism is a financial entity (Greensill, for example) pays a customer’s suppliers at a slight discount earlier than the net 90 or 120 payment terms offered by the customer.  The customer then pays the financial entity later.  This allows the customer to hang on to cash longer while still flowing cash to the supply base.  The key is the customer carries this on their books as an account payable rather than a loan.  Prior to Greensill’s insolvency, the both the SEC and FASB were pushing for more transparency in company disclosures concerning supplier financing.  This will only accelerate that.  Add in a general increase in interest rates and reduced financial ratings for customers, both of which determine the amount of discount suppliers pay to get their money early, and one of the mechanisms to help manage cash will likely experience some pressure going forward.