Winter is coming for aerospace and defense, and some observers are fearful the sector’s business activity may feel a chill due to rising energy costs. But does that outlook have any juice?
With the beginning of fall in the Northern Hemisphere, financial analysts who cover aerospace and defense are paying more attention to rising energy costs, especially in Europe. Long dependent on Russian energy supply, European countries are facing worsening economic warfare this winter with Russian President Vladimir Putin, who launched his country’s invasion of Ukraine in February.
“Of all the negative news on European energy prices that we saw over the past week or two, the one that hit me the most was the one that characterized natural gas at the equivalent of $500 per barrel of oil,” Melius Research analyst Rob Wertheimer said Aug. 29.
On Sept. 2, Dutch aluminum-maker Aldel announced a halt to the remaining capacity at its Farmsum facility, citing continuing high energy prices and a lack of government support. Aldel adds to a growing list of companies cutting or halting European production as gas and electricity prices have soared hundreds of percent this year over 2021 levels, according to Reuters.
Not surprisingly, companies across aerospace and defense are struggling with the higher cost of doing business, whether it is inflation in salaries, raw materials or transportation of goods. Higher energy prices underpin growth prospects in the latter two segments directly.
“We’re clearly seeing inflation,” said Greg Hayes, Raytheon Technologies chairman, president and CEO, on Sept. 14 at an investor conference. “In the supply chain, [it] is mostly in raw materials and energy.”
He said the U.S.-based Super Tier 1 aerospace and defense supplier is revisiting plans to cut expenses in manufacturing, energy costs and shipping. The unspecified plans made less sense when costs were lower, but not anymore. “We’re revisiting some of our old plans, and those projects are making their way to the top of the pile now,” he said.
Still, the good news, according to a Sept. 9 report from consultancy Jefferies, is that aerospace and defense should not be among the first industries affected by any energy-related crisis. For instance, the entire transportation market is responsible for 23% of global aluminum consumption, and aerospace and defense, with its relatively low rates of production, is a fraction of that. Direct exposure to higher gas and electricity rates also might be muted for the sector due to cost-saving actions.
“Direct-cost concerns are limited, as we estimate all companies within our coverage show less than 1% of sales related to energy costs,” wrote the authors of the Jefferies Group report. “We understand that for gas hedging has been put in place, which should protect this winter and, in some cases, most of 2023. Regarding electricity, contracts in place also imply much lower price increases than current wholesale data.”
Of course, if higher energy costs persist, it will affect business models. Jefferies said engine supply chains were generally more exposed, given their greater need for energy-intensive forgings and castings of metal parts. But the analysts think it would take a “highly negative scenario of widespread shortages” to alter the business.
So how do individual European aerospace and defense companies fare? Ranked lowest to highest in exposure, relatively, Jefferies listed BAE Systems, Thales, Rolls-Royce, Airbus, Safran and MTU.
“BAE Systems should be largely spared, due to its strategic activities and low exposure to Germany,” the analysts wrote. “Thales should be protected from disruptions but is the most exposed to wage inflation risks. Within engine manufacturers, where risks rank higher, we see Rolls-Royce as slightly less exposed due to lower volumes and [airliner] ramp-up needs than Safran and MTU.” In particular, German companies—such as MTU—will have to monitor wage inflation.
Finally, due to its position, Europe’s aerospace and defense leader remains the most exposed on first glance. “Airbus sits at a crossroads, showing an average risk profile, but engine supply disruptions could add pressure on its outlook,” the Jefferies analysts wrote. But penalties on suppliers for underperforming could offset some of this.
What remains certain is that energy inflation will be another major watch item as aerospace and defense works through one of the most energy-dependent seasons.
“Most companies are not seeing much pressure yet in Europe,” Vertical Research Partners analysts say, “but all acknowledge it could be a rough winter.”
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