2021 Q2 Earnings call roundup

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According to the Wall Street Journal on September 6th, Aluminum pricing was the highest it has been in 10 years.  Labor costs are also soaring.  Most companies though said that the pressure was not substantial.  For some, Solvay and Kaiser for example, this is because they have contracts and leverage to pass the material price increases along.  As a reminder most aerospace long-term agreements do not permit passing labor cost increases along and many do not allow material cost increases either.  Passing along the cost increases, however, just transfers the problem to someone else in the supply chain because at the top of the supply chain, Boeing and Airbus have years of backlog at prices that are locked.  Ultimately the industry has nowhere to go with cost increases. An interesting question is why the increases might not yet be felt by company executives.  There are broadly two explanations.  One, the suppliers are still largely in the recall mode for their labor (who are coming back at their prior rate) and their material may be acquired on an LTA that has not yet been repriced.  A second, and more difficult one to detect, is it is not in the cost of goods sold yet because of the existence of substantial pre-pandemic inventory.  As companies bleed their inventory down, they issue parts carried on the books at pre-pandemic prices.  As they begin replenishing the inventory, the parts come into inventory with higher prices.  The total inventory falls because issues to floor exceed receipts of new material, but the average unit price of inventory rises as the replenishment parts are received into inventory.  Executives tend to focus on the total inventory level rather than the average unit cost of their stock, but this ultimately will roll into cost of goods sold.  So, one possible explanation is companies are simply not looking the right place for material cost pressures.  Labor costs to turn that inventory into product for sale are also rising and we will turn to that next.

Some companies talked about labor issues (Reliance Steel and Aluminum, Kaman and TriMas for example).  The issues fall into three co-existent problems.  First, there is the problem of keeping people on the job, particularly in California where employees can self-designate that they need to isolate at home and still draw pay.  Second, there is the problem we flagged a year ago.  As companies hire back, they are having to bring in new personnel.  Howmet, for example, said that they were currently hiring 25% new personnel and expected that to gradually shift to the majority of their hires being new employees by the end of the year.  Perhaps Howmet has production processes and training programs to bring in a wave of new personnel and not experience quality and delivery problems but that will not be true of many companies.  The probable outcome is difficulty getting the supply chain aligned and capable of reliably supporting rate increases.  Finally, the costs to hire people back are much higher, particularly at the low end of the pay scale where many smaller shops operate, than they were prior to the pandemic.  Warehouse personnel, shipping, receiving, drivers, deburr and a host of other jobs are all impacted, for example, by Amazon having an average starting wage of $18.32 (Wall Street Journal, September 14, “Amazon Adding 125,000 Workers in U.S., Opening Dozens of Facilities”) plus benefits like paid college tuition.

The 787 problems resulted in a reduction to a three per month production rate.  The impact is being felt throughout the supply chain.  Spirit recognized a $46M loss in the second quarter due to the fuselage problems that continue to plague the program and disclosed an additional forward loss projected to be between $40-60M due to the rate reduction that will be taken in the third quarter.  Obviously, will ripple through Spirit’s suppliers over the next few years in the form of reduced spend.  Perhaps the solution will come in October as forecast, but it is worth noting that by that time, it will be much easier for some customers to cancel their orders due a delay of over twelve months.  At a minimum this could result in pressures for a lower price to accept delivery.  While that should not immediately turn into a problem for suppliers, it will increase the pressure for further price reductions from suppliers on a program that will be operating at a low production rate for a long period of time.

Continuing with the question of production rates, Raytheon in their call said they were capacitized for 63 per month regarding their ability to support the rate ambitions of Airbus.  They are likely better positioned than some because they do believe they can get to 63/month.  Others have reduced footprint, capacity, and capability making a climb to 63 years off.

This takes me to the closing thought for this quarter.  Michael Bruno wrote an excellent piece in Aviation Week and Space Technology (August 17th) discussing mergers and acquisitions in the supply chain.  An additional factor to think about for the foreseeable future is a company acquiring a business to simply move the work into its existing underutilized shop.  In effect, converting two underutilized shops into one fully utilized shop.  Companies smaller than the ones that were the focus of the referenced article will employ this strategy.  The impact obviously is to reduce overall industry production capacity.  Be on the lookout for that.  This is a healthy response to a challenging time, but the result is near term disruption and ultimately some challenges to regaining both capacity and capability within the industry.  So, once again suppliers be careful as you meet the ramp up requested by OEM’s and tier ones to not get too far ahead of the pack