Aftermarket Outlook

The good news is that flying activity is up by almost every measure. Worldwide airline traffic is already at or near pre-2001 recession levels. Business jet sales are recovering strongly. Military activity continues unabated. Helicopters remain a growing segment of aviation, slowly but surely becoming more significant. And light airplanes are pouring out of factories in numbers that haven't been seen in a long while.

The bad news is that fuel prices have risen dramatically in just one year and the commercial airline maintenance business is shifting further to an outsourced maintenance model, to the dismay of many airline-employed maintenance technicians but to the delight of third-party repair centers.

Of ten large U.S. airlines, outsourced maintenance exceeded 50 percent during 2004 for eight of the ten, according to Back Aviation Solutions (appearing in USA Today, March 30, 2005). Only American Airlines (42 percent) and Delta (35 percent) outsourced less than 50 percent of their maintenance during 2004, according to the Back Aviation data. American Airlines, it should be noted, disputed the Back Aviation report and stated that it performs 80 to 90 percent of its maintenance in-house.

Delta's number will undoubtedly exceed 50 percent this year following the airline's announcement that it is outsourcing heavy maintenance for most of its fleet. Delta will send its Boeing 757s and 767s to Air Canada Technical Services's Vancouver, British Columbia base. Heavy maintenance on Delta's MD-88s and MD-90s will be done by Miami, Florida-based Avborne.

Delta senior vice president Technical Operations Tony Charaf announced the outsourcing move in an internal memo to Delta TechOps employees dated March 29, 2005. The outsourcing is just one element in what Charaf called "three transformation initiatives for Delta TechOps" that are expected to save the airline $240 million during the next five years.

The other two initiatives are to shift some maintenance from Delta's Tampa, Florida base to its Atlanta headquarters, including package service visits and letter checks. At Atlanta, TechOps will continue working on Pratt & Whitney JT8D-219 engines, restart two cabin condition program lines, and add a new modification line for low-cost subsidiary Song. With regards to the -219 engine maintenance, he stated in the memo, "after a diligent, fact-based analysis, we determined that the numbers were not compelling enough to send outside. Therefore, the -219 engines will be kept in-house."

The outsourcing move will cause some pain, and Delta had already announced plans to eliminate 6,000 to 7,000 jobs last September, 1,600 to 2,000 of which are TechOps positions.

"Many airlines have already taken the steps Delta is taking today," the memo continued, "and I believe many more will follow. Our costs must be reduced and we must remain competitive. In order to accomplish this, we must not stick our head in the sand and pretend that the airline business hasn't changed. Instead, we must acknowledge how the industry is evolving, identify trends and make decisions which contribute to Delta's return to viability."

TechOps will, according to the memo, "continue to aggressively market our MRO capabilities and pursue new Delta TechOps customers where it makes financial sense to do so."

While maintenance outsourcing is a huge issue in the aviation industry, not all airlines are pursuing the outsourcing trend. American Airlines has stated that not only is it planning to perform more work in-house, but it is also going to attempt to turn its Tulsa, Oklahoma maintenance base into a profit center by offering services to other airlines. American's goal is for the Tulsa base to deliver profits by the end of 2006 and at the same time cost savings to the airline.

High hangar visits

What is becoming apparent is that hangars around the world are starting to fill up with all the work that is coming, although there is still excess capacity. Back Aviation's World Market Forecast predicts a hefty jump in total hangar days for Airbus and Boeing aircraft during the coming five years. The hangar days dropped to a low in 2002, likely due to the recession, SARS, and 9-11 attacks. Already for 2005, the hangar days are expected to climb dramatically, peaking in 2006, possibly because some maintenance was deferred to cut costs and some maintenance simply is coming due. The numbers loom large for both Airbus and Boeing operators, and this maintenance is going to have to get done somewhere.

The expectation of increased hangar visits is a combination of outsourcing from legacy air carriers and the growth of low-cost carriers, according to Roger Lehman, a director in Mercer Management Consulting's aviation and aerospace practice. "Network carriers are increasingly looking to outsource non-core, uncompetitive lines of work," he said, "and many newer low-cost carriers are coming out of maintenance `honeymoon' periods on major bodies of work like heavy airframe and engine overhauls."

AeroStrategy, a consulting firm that delivers annual reports on the state of the MRO business, now estimates the total annual amount spent on MRO worldwide to be $100 billion, which includes commercial, military, and general aviation aircraft. That number doesn't include major military modification programs.

For 2004, AeroStrategy broke the numbers down: military--$52 billion; air transport--$36 billion; and general aviation--$8 billion. The amounts of each of those segments that are outsourced are, respectively, 31 percent, 50 percent, and 90 percent. Clearly there are opportunities for more outsourcing in the military and air transport segments.

In the commercial segment, the breakdown is: engine--34 percent; line maintenance--23 percent; component maintenance--21 percent; airframe heavy maintenance--14 percent; and modifications--8 percent. More than half of airframe heavy maintenance is still performed in-house by airlines, according to AeroStrategy.

AeroStrategy forecasts robust growth in the MRO market through 2014, a compound annual growth rate of 5.6 percent per year, well above the current inflation rate.

Mercer Management Consulting's interesting survey of MRO and airline executives early this year found that most expect MRO revenues to increase in the coming years, mainly because airlines will outsource more maintenance. By 2008, according to Mercer partner Geoff Murray, airframe outsourcing spending will climb 9 percent. "It's rapidly growing," he said.

The reason for increased outsourcing, Murray explained, is that "airlines are taking a hard look at internal capabilities and where they have a cost advantage." Anything that isn't core is going to be scrutinized for possible outsourcing.

The survey revealed that when it comes to outsourcing maintenance, airline executives are now more concerned about the quality of service rather than just cost. "Service and quality are good enough now," Murray said, "that cost is becoming a real competitive advantage.

With regard to quality, two thirds of respondents said that outsourced maintenance quality is the same, and 19 percent said that quality had increased. "There is a perception," he said, "that quality goes down over time, but the survey didn't bear that out."

A surprising result of the survey is that a majority (70 percent) of respondents who plan to outsource maintenance will send their airframe work to U.S.-based maintenance providers. The next-largest contingent plans to send work to South American providers. "There's an increase in airframe maintenance moving south to Latin America," Murray noted.

Airline and MRO respondents were asked to rank attributes associated with outsourcing. The survey showed that airlines are more interested in basic attributes like quality, turn time, customer service, cost, warranty, and financial viability than with enhanced services such as materials and reliability management, condition monitoring, and engineering services. "Most of those enhanced services," Murray said, "the MROs believe are more important. The airlines said, `not really, those things don't really matter.' MROs just need to continue to focus on the fundamentals first."

Manufacturer views

Many aircraft and engine manufacturers publish annual forecasts, which helps them plan for future production and strategy. The view from the manufacturing side is fairly rosy, despite current problems such as high fuel costs and relentless price-cutting by low-cost carriers.

Engine and equipment manufacturer Honeywell sees flight hours climbing 4 to 5 percent in the commercial segment during 2005 and 2006 and for business aviation, 5 percent in 2005 and 7 percent in 2006.

Honeywell does a huge amount of business in the aftermarket, and 38 percent of the company's aerospace sales are aftermarket business, according to Scott Taylor, vice president sales and account management, Honeywell Business, Regional & General Aviation. "We feel very confident for 2005 and 2006," he said.

Rolls-Royce's outlook is bullish and said, "it appears 2005 will see the best year for new aircraft orders since 2000." The report went on, predicting "strong growth in the commercial aircraft and jet engine market over the next 20 years. In total, 96,000 new civil engine deliveries worth $550 billion are forecast. This requirement is driven by rapid growth in the Asian market, as well as continued demand for new aircraft in other, more mature, markets. Deliveries are also underpinned by the need to replace 12,700 airliners over the period."

Through 2014, Rolls-Royce expects deliveries of 7,352 business jets, 3,462 regional aircraft, and 9,710 "mainline" aircraft (including cargo). The engine market splits into 32,964 business jet engines, 16,588 regional aircraft, and 46,250 mainline.

For Rolls-Royce's aftermarket activities, all these deliveries mean 20 years and $500 billion worth of service and parts sales, according to the outlook.

Boeing is even more optimistic, with an estimate for 25,000 new airplanes worth $3 trillion (2003 dollars) delivered during the next 20 years. This breaks down to 4,290 regional jets, 14,770 single-aisle airplanes, 5,150 twin-aisle airplanes, and only 790 747-size or larger airplanes.

Supporting these deliveries will be global passenger growth averaging 5.2 percent per year, Boeing's market outlook stated, and cargo traffic growth of 6.2 percent per year.

Embraer, which just announced it is joining the very light jet marketplace, is expecting 7,800 new airplanes in its market segment of 30 to 120 seats. New Embraer airplanes in the 91- to 120-seat range should total 1,250 deliveries through 2014 and another 1,750 from 2015 to 2024. "A tendency of growth is expected," Embraer said in its long-term market outlook, "for all other segments covered by Embraer, specifically in the untapped market of 70- to 110-seat jets."

Airbus's global market forecast is different from Boeing's, with a 20-year estimate of 17,300 new passenger and cargo airplanes valued at $1.9 billion. Interestingly, Airbus predicts that airlines will fly larger aircraft carrying more passengers, which is opposite of the trend that Boeing sees. The Airbus forecast said "that the average number of seats per passenger aircraft will increase by 20 percent, from 181 to 215 over this [20-year] period."

Airbus's massive new A380 will be needed to serve increasingly consolidating major metropolitan areas all over the world. The Airbus forecast predicts a need for 1,250 new passenger airplanes, each capable carrying more than 450 passengers, and 400 similar-sized airplanes for the cargo business.

The FAA weighs in

The FAA's own forecast, released in March, is good news for many manufacturers and maintenance companies.

During 2004, commercial jet orders worldwide reached 908, which is up 125 airplanes or 16 percent from 2003. Jet airplane deliveries totaled 914 during 2004, up 2.7 percent, with most of those being large jets (602) and the remainder regional jets (312). Filling all these new airplanes are passengers flying at record-high load factors of 75.9 percent, with (calendar year 2004, estimated) available seat miles up 8.4 percent, revenue passenger miles up 11.4 percent, and enplanements up 8.1 percent.

At the end of April, the General Aviation Manufacturers Association released first-quarter 2005 shipment and billing numbers that reflected a strengthening general aviation industry.

Compared to the first quarter of 2004, general aviation shipments climbed 15.7 percent to 627 units, for a total billing of $2.7 billion (up 14.1 percent). Turboprops saw the greatest increase, at 67.6 percent, followed by business jets, 21.1 percent, and piston-powered aircraft, 9.6 percent. "Strong industry billings speak for the overall health of the general aviation industry," said Pete Bunce, GAMA president and CEO, "and the importance of private aviation as part of the world's transportation system."

For 2004, general aviation shipments totaled 2,355 aircraft, up 10.2 percent over 2003 and according to the FAA forecast, "ending three consecutive years of declines." The size of the general aviation fleet and hours flown aren't expected to climb much, the forecast stated. During 2004, the active fleet was estimated to reach 211,295 aircraft, up 0.3 percent, and flights hours to total 27.3 million, up 0.8 percent.

Fuel prices gone crazy?

A huge caveat for the projected growth of aviation as a whole is the price of fuel. While the potential for terrorist acts, diseases like SARS, and unforeseeable catastrophes always remains, there is a great deal of concern about the high cost of oil and how that will affect the fragile aviation industry.

"The remaining formidable hurdle for the commercial aviation industry as a whole will be the price of oil," said the FAA forecast. "Based on financial data compiled by ICAO [the International Civil Aviation Association], world air carriers (including U.S. airlines) reported operating and net losses of $2.8 and $6.5 billion, respectively, in 2003. Since 2000, world airlines have incurred cumulative operating losses of $28 billion and net losses of $30.8 billion. Air carrier financial results in 2004 were heavily impacted by significantly higher fuel prices during much of the year. In early December, the International Air Transport Association estimated that global airline industry losses could top $4.0 billion in 2004."

The forecast noted that the U.S. Office of Management and Budget believes that energy prices will climb by 21.3 percent in 2005 then drop by 9.6 percent in 2006 and 6.1 percent in 2007. During the 12-year forecast period, "OMB assumes that nominal energy prices will increase at an average annual rate of 1.5 percent."

In 2002, a typical fuel cost for an airline was about 67 cents a gallon. That climbed to about $1.16 a gallon in 2004, up 16 percent. It should be noted, however, that those prices are in those years' dollars. Adjusted for inflation, the energy prices of today appear in a different light.

Looking at oil prices adjusted for inflation, it turns out that the price of oil peaked in 1981 at $95 a barrel in 2005 dollars. In 1991, oil briefly climbed to today's $50-a-barrel level. Adjusted for inflation, U.S. gasoline prices were actually much higher in 1981--about $3 per gallon--than today.

The question is, will the flying public and the users of general aviation aircraft be able to absorb the high cost of fuel or will they reduce their travel and flying activities? So far, all indications are that the higher energy prices are being absorbed, probably because fuel prices today are actually about where they should be if energy costs had been rising at the same rate as inflation during the past 20 to 30 years.

The OMB predicts, according to the FAA forecast, "that real energy prices will decline over the 12-year forecast period, down 1.0 percent."

[SIDEBAR]

MTU AWAKENS

"MTU has been a sleeping giant," said Bernd Kessler, president and CEO MTU Commercial Maintenance. "We are in the process of waking up."

MTU is one of the world's largest independent turbine engine service companies. The Munich, Germany-based company manufactures parts for engine OEMs such as Pratt & Whitney, International Aero Engines, CFM International, Pratt & Whitney Canada, and General Electric and also offers its own extensive repair and engine overhaul capability. MTU was purchased by investment firm Kohlberg Kravis Roberts about 18 months ago. "The acquisition has helped us to put a financial focus in the company," Kessler said. "Paired with our strength around technology and manufacturing, it's a good combination."

MTU is firmly committed to the maintenance side of the business, and nearly half the company's revenues are from the MRO business. MTU's annual turnover is about $2.5 billion, and $1 billion of that is commercial MRO with another $150 million military MRO. The remainder is from MTU's manufacturing business, mostly making modules and spare parts for its OEM partners.

The engine part of the MRO market is currently growing at 6 to 6.5 percent per year, and Kessler expects to see it reach the $20 million range in 2009. "That's a good growth business," he said. "We intend to secure a large share of that business, and we think we can outgrow the market."

MTU's Munich headquarters is primarily involved in manufacturing activities, while the largest maintenance facility is based in Hannover. At Hannover, large engines are on the menu, such as the V2500, CFM56, CF6, and PW2000. A customer service center is located in Berlin, which is also a joint-venture with Pratt & Whitney Canada on the PW200 and 300. Berlin is also preparing to work on the PW500, PT6, and JT15D. Berlin also works on the GE CF34, as a GE-authorized licensee. The Vancouver base specializes in the CF6 and CFM56. And two years ago, MTU opened a modern new engine overhaul facility in Zhuhai, China, which is a 50-50 joint venture with China Southern Airlines for overhauls and maintenance on Asia-based V2500s and CFM56s. MTU also has a joint venture with Lufthansa Technik in Kuala Lumpur, Malaysia, for compressor vane and blade repair. "We have to find ways to do labor-intensive work in lower-cost regions," Kessler explained. "It's one of our strategies to remain competitive."

MTU Zhuhai has a huge test cell capable of running engines up to 150,000 pounds of thrust. "It's a greenfield operation," Kessler noted, "and it's one of the most beautiful MRO facilities I've seen in my career." Kessler expects the Zhuhai facility, which employs 300 people, to grow about 85 percent during 2005, thanks to its ability already to turn around a CFM56 or V2500 overhaul in just 60 days. "It's a super facility," he said. "Obviously our intention is to grow business not only in China but spread our wings and find business outside China. The growth rate in Zhuhai is just enormous."

The cost of labor outside of Germany isn't the only factor that drives MTU's decision on where to send engines. "If you look at our main engine business," Kessler said, "we still have enormous additional capacity in Hannover. At some point you have to get the right economies of scale." At Hannover, MTU has adopted continuous-flow techniques from the automotive industry (which is something that Pratt & Whitney Canada is doing to assemble its new PW600-series engine). The MTU shop is set up with a flow line that minimizes time spent disassembling the engine. All engine types begin at the disassembly stage, where they are taken apart into modules, then each module flows to a module-specific overhaul line. At the end of the process, the modules come back together at a reassembly flow line and the engine then is sent to the test cell. So far, Hannover is the only continuous-flow facility, but Berlin will be switched next, followed by Zhuhai. "It really requires a shift in mindset," Kessler said, "a cultural change, and investment, too."

To help MTU grow, Kessler added, "we're going to continue being a major partner with engine OEMs. The corporation has enormous potential for the future. We have to transform it and make it a more international and global company, more swift in the marketplace. We don't have a massive infrastructure like big aerospace companies; we can make quick decisions. It's certainly our intention to stay as a standalone company and leverage our technology capabilities and operational capabilities in the future."

[SIDEBAR]

VIEWS FROM THE HANGAR

We asked companies to discuss their views of the maintenance marketplace:

Walter Rittenhouse, senior vice president technical services, Banyan Air Service (turbine aircraft maintenance, avionics, modification services):

"Our maintenance workload has increased dramatically during the past year. All departments are busy. Our facilities are adequate to meet the need, but we are working hard at bringing on additional technicians. This is no easy task, as most general aviation maintenance facilities are working at capacity today and most talented technicians are employed. The biggest problem we have faced has been the peaks and valleys of work flow. Right now we can see activity well into the future, but there are still in recent memory periods when we were hard-pressed to keep the technicians busy and the shops profitable."

Ian Walsh, vice president, general manager Lycoming Engines (piston engine manufacturing and overhaul):

"We are making substantial process improvement on the aftermarket line. The purpose is to eliminate waste and thus improve cycle time and cost, while also improving safety. Part of this process improvement also encompasses improved forecasting. This helps reduce variation coming into the plant. The largest growth opportunities for us are making our engines smarter and more economical. From a maintenance perspective, this means carefully evaluating how we improve all aspects of the engine such as accessories versus new engines. Systems integration fore and aft of the firewall is also a place we are exploring growth opportunities. An engine is the hardware, and it is time for the hardware to outpace the software. The biggest opportunity for Lycoming is to reduce our cycle time in the maintenance side of our business. Customers demand faster turn times on their aftermarket engines.

Paul Fanelli, president and CEO, Aerospace Products International (parts distribution and supply chain management):

"[Business is] up double digits. Some of our customers have said that they are having a hard time finding qualified mechanics, which is hurting their business. [Largest growth opportunities are] corporate aviation, regional airlines. We're tailoring an exchange pool, and providing more personal attention through an expanded field sales force. [Customers] are looking for reliable service with consistent performance and quality. They need to be able to count on the turnaround times so they can meet their commitment to their customers."