The Aerospace and Defence sector has continued to grow in recent years, but a steadily declining rate of expansion points towards a likely downturn in real terms this year. This downward trend is largely the result of a reduction in military investment across the globe, and specifically in the US, where major contractors have been hit with a series of delays and cancellations of large programmes. However, this negative trend is partially balanced by strong growth in the commercial aerospace sub-sector, driven by a stable global GDP, a low oil price, and increased demand for business and leisure passenger travel.
Passenger and freight
The commercial aerospace subsector is very buoyant right now, with continued growth in passenger traffic and huge demand for the new generation of fuel-efficient airliners. In a recent paper, Deloitte predicted that the global commercial passenger and cargo aircraft fleet will double over the next 20 years, as will the number of passengers. Passenger growth is most evident in those countries experiencing the fastest economic expansion – in China and the Middle East, India and the Asia-Pacific region. Socio-demographic changes in these regions are also a major driver of growth, as the expansion of the new middle class drives a sharp increase in demand for leisure travel.
It is notoriously difficult to unpick the complexities of the diverse political influences driving the US defence budget, but ultimately, the truth can be found in the numbers, which point to a steady decline in defence spending since 2010. Of course, this provides no indication of any likely future pattern, but is does help to explain global trends in recent years. Outside the US, heightened geo-political tensions in the Middle East, Eastern Europe and the South China Sea are already beginning to drive up spending in these regions, and it is unlikely that the US will allow its military advantage to be eroded for any significant period. Political instability and increasing tension between nations will always drive up defence spending.
The impact of oil price fluctuations
A declining oil price is frequently cited as a gloomy economic indicator, yet for the commercial airlines, it provides a massive lift in revenue and margins. This is because fuel makes up such a large proportion of total running costs, so any fall in crude oil drives a significant reduction in operating costs, which allows firms to reduce ticket prices and grow sales, which combines with the higher margins to create a multiplier effect on profits. And higher profits means greater investment in fleet expansion and upgrades. Of course, if the low oil price is driven by a global economic slowdown, this will ultimately hit demand for passenger travel. But if it’s primarily due to over-supply, airline executives need have no fear that the upturn in demand is only a short-term boost.
The other side of the coin in this scenario is that a low oil price drives down the GDP of the major oil-producing nations. And many of these are the highest spenders in terms of defence budget as a percentage of national GDP. So whilst the commercial aerospace sector is likely to benefit from a long-term slump in oil price, the effect on the defence sector is likely to be the reverse, although this may be tempered by growing concerns around national security. So the general outlook for the Aerospace and Defence sector appears reasonably positive, though not without a number of challenges on the horizon.