GE Capital notes in a recent report on the aerospace and defense industries, that while the worst fears for declines in defense spending have not been realized, we expect yet another year of divergent fortunes between the commercial aerospace and defense sectors. The commercial airplane production “super-cycle” is in its middle stages and, barring any unforeseen global economic collapse, is expected to remain intact through the next three or four years.

Conversely, the defense industry will continue to adapt its business models and cost structures to the realities of a lower “new normal” for domestic and global defense spending.

GE Capital said the pimary trends that will influence the commercial aerospace and defense supply chains during 2015 include the following:

• Positive commercial aerospace fundamentals: The factors underpinning the positive fundamentals of the global airline industry are expected to remain intact. Moderate global gross domestic product (GDP) growth should translate into a slow expansion of global passenger traffic and, likewise, airline fare and fee revenue. Increasing airline revenue will continue to be leveraged by the profit-enhancers of lower fuel prices, airline (capacity) consolidation and post-bankruptcy rationalization of the industry’s financing cost structure. All of these factors support a record high backlog and a strong production growth outlook for the commercial aerospace supply chain.
• Growth in aircraft deliveries: Large commercial aircraft deliveries are expected to grow 4-5% through 2019, given six to nine years of production backlog at Boeing and Airbus. Declines of older platforms (such as the Boeing 747 and 777) will be more than offset by a steady increase in new platforms (such as the Boeing 787). Additionally, while the annual number of narrow-body units produced is currently more than double the number of wide-body units, the expected five-year compound annual growth rate (CAGR) of wide body production (5-6%) is expected to outpace the expected growth in narrow body production (3-4%).
• Aircraft replacement demand may be in jeopardy. The prior urgency for “re-fleeting” demand for more fuel-efficient commercial aircraft has been supported by high oil prices over the past couple of years and is undoubtedly at risk if oil stays at very low levels for a long period of time. The flip side of lower oil is a tailwind for commercial airline financials, particularly for those airlines that are unhedged, that have rarely been better. Given the healthy financial condition of most airlines, near-term deliveries of fleet upgrades should remain intact given the long-term nature of the asset-acquisition decision and from a competitive standpoint to expand capacity and routes while providing a superior passenger experience. That being said, orders for replacement aircraft that are scheduled for delivery two or more years out may be more susceptible to cancelation or deferral if fuel prices stay at low levels into 2016. As such, the commercial book-to-bill that has been well above parity for the past few years is likely to revert toward parity and may even dip below parity as the year progresses.
• Funding sources will remain diverse: Despite a lingering threat to the reauthorization of the Export-Import Bank of the United States, both international and domestic airlines will continue to have access to diversified, readily available financing sources for aircraft purchase orders. These include original equipment manufacturer (OEM) captive financing, a growing number of public and well capitalized aircraft lessors, and accommodative bank debt and capital markets.
• Defense markets are likely to remain under pressure. The worst of the domestic defense spending declines will likely bottom out in 2015 and then stabilize as the push for fiscal austerity is diluted by lack of political will. Pressure on defense spending is not just a domestic issue as global defense spending is expected to decline by 3-5% into 2016, according to a forecast by Moody’s Investors service. As such, intense competition for fewer new foreign military programs will pressure the profitability of those opportunities.