The Year in ReviewFri, 12/01/2017 - 17:32
The aviation and aerospace industries are flying high in Mexico and globally. A need to update fleets and a record backlog of orders is keeping OEMs busy, while the advance of low-cost carriers is helping to boost passenger numbers and underpin commercial airline revenues.
The aerospace sector alone has reported years of record-breaking growth in terms of revenue since 2012, with global revenue reaching US$709 billion in 2016. But the pace of growth has slowed, with 2017 expected to come in at 2.0 percent, down from 3.0 percent in 2016 and 3.8 percent the year before that.
A number of factors suggest the sector is heading in the right direction. Deloitte highlights stable GDP growth globally, lower commodity prices and strong passenger travel demand as key drivers for aviation and commercial aircraft orders in the coming years. PwC points out that revenue passenger miles grew 6 percent in 2016 for a second year in a row. Furthermore, the existing backlog for major OEMs is at an all-time high with Boeing and Airbus reporting 5,659 and 6,691 units, respectively. In its 2016 annual report, Boeing stated the world will need a total of 41,030 new aircraft by 2036, worth US$6.1 trillion. However, orders have been sluggish in 2017. For the first nine months of the year, Airbus received only 319 new orders in comparison to the 556 during the same period in 2016, On the other hand, Boeing is increasing its orders, with 565 booked in first nine months of 2017 and only 409 during that same period in 2016.
Aircraft deliveries also slowed in 2016 due to transitions to new models and supply chain problems, according to Deloitte. Yet, Deloitte expects that deliveries will reach 1,456 during 2017 with the production of 96 more aircraft, driven by strong passenger traffic and higher demand for next-generation airplanes. Both Airbus and Boeing expect deliveries to rise between 2017 and 2018, mostly for the A320neo and the 737 MAX, modern versions of their classic aircraft.
On the demand side, airlines want greater fuel-efficiency, leading to a preference for single-aisle, twin-engine aircraft. Boeing’s most popular plane during the first nine months of 2017 was the twin-engine 737, with 360 orders. “We expect single-aisle aircraft will be most in demand in Latin America, such as the 737 MAX, the fastest-selling aircraft in Boeing’s aviation history,” says Donna Hrinak, Vice President of Boeing and President of Boeing Latin America. This trend is also affecting manufacturing decisions across the board. For instance, in mid-2017, Airbus decided to cut back on the production of the A380 super-jumbo jet, which uses four engines, as orders for the aircraft have been waning since it entered commercial service in 2007. In fact, to October 2017, there had been zero orders for this aircraft. On the other hand, the OEM announced plans to ramp up the production of the A320 by the first quarter of 2019. It also wants to manufacture 52 737s a month by 2018. Considering that forecasts suggest the industry will need approximately 2,000 new aircraft per year, these increases might be sustainable, especially taking into account that the current production rate is closer to 1,400 aircraft per year, according to PwC, which also says that further production increases are planned for narrow-bodies.
As players jockey for position in the industry, consolidation is becoming key. During the first half of 2017, there were 26 mergers and acquisitions totaling US$18 billion. This represents a 9 percent increase in comparison to the same period in 2016 and 14 percent higher than in 2015. About half of the deals were in the aircraft and parts category, representing 47 percent of the value of all mergers. PwC says that most of the industry deals have been local, with 85 percent of all mergers and acquisitions over the past three years taking place within country borders. The major acquisition of 2017 has been without a doubt Safran’s purchase of Zodiac Aerospace valued at US$7.8 billion.
Despite growth, there is never-ending pursuit to keep costs down in every industry and throughout the entire supply chain. With a plethora of advantages, Mexico remains among the leading manufacturing centers worldwide. The country has cost-efficient labor, qualified human capital, numerous free trade agreements, a growing middle class and a key location as an entry point to both the US and Latin America. “Since 2004, Mexico’s aerospace sector has grown 15 percent annually,” says Carlos Robles, President of FEMIA and General Manager of Bombardier Queretaro. “In 2016, exports reached US$7.18 billion, which helped us climb from 10th place to become the sixth-biggest exporter of aerospace parts to the US, the largest aerospace market in the world.”
In the first quarter of 2017, the number of aerospace companies in Mexico totaled 312, according to the Ministry of Economy, of which 80 percent perform manufacturing, 11 percent MRO activities and the remaining 9 percent do design and engineering. Over the years, Mexico has developed capabilities working with sheet metal and performing traditional assembly. The country is also strong in the manufacture of harnesses for airplanes and is developing the skills to work with composites. “Our expectation for 2017 is to reach 60,000 jobs, to have 330 industrial facilities, to surpass US$8 billion in exports and to reach a 23 percent trade surplus with the US for aerospace products. Globally, Mexico is ranked 14th for competitive manufacturing platforms and our goal is be in the Top 10 by 2020,” says Robles.
CLOUDY SKIES AHEAD?
While the skies seem mostly clear for the aerospace sector, it is undeniable that there are some clouds on the horizon, both locally and internationally. An overall climate of uncertainty is settling over the sector at a global level, brought about by questions regarding Brexit in Europe and US President Donald Trump’s protectionist policies, which could be trouble for Mexico.
When asked about the potential impact of Brexit, Loren Engel, former General Manager of GKN Composites, said it “remains to be seen it but we expect volatility over the next couple of years as the UK and the rest of the world negotiate what the exit really means. In the short term, the uncertainty may cause distress in the British market. GKN Composites will have to wait and see how the relationship with our largest aerospace customer, Airbus, works out and how this will indirectly affect the business.”
The US administration has indicated it wants to hike the defense budget, which would have a positive influence on the aerospace sector, according to Deloitte. At the same time, the professional services company warns of the impact of rising populist sentiment in the US, which might take shape in protectionism and anti-globalization policies. While the impact of these policies is expected to be felt worldwide, Mexico, the US’ second-largest trading partner, might find itself in a precarious position.
“Tax reductions and changes suggested by President Trump could be problematic for Mexican manufacturers. A significant reduction of taxes on products manufactured in the US could counteract any benefit that Mexican companies can offer foreign investors. We still do not know what impact this will have on the Mexican aerospace sector but it is not possible to ignore that the largest company in the sector, Boeing, is based in the US,” says Francisco Bautista, Leading Partner of Aerospace Industry at EY.
A third challenge is currency volatility. Expectations for positive fiscal stimulus, cuts in corporate taxes and higher interest rates have helped strengthen the US dollar against other currencies. Emerging economies, such as Mexico, are in the crossfire. The peso-dollar exchange rate skyrocketed after the US election, from MX$18.31 on Nov. 8, 2016 to MX$20.80 three days later. The US dollar peaked at MX$21.95 in January 2017 only to gradually decrease to pre-election levels during the year. However, the sector remains dubious of the Mexican peso’s long-term stability.
Mexico’s challenges do not come only from foreign influences. The country is still pushing to consolidate its supply chain. While Mexico can boast of hosting plants for some of the largest aerospace companies in the world, including Airbus, Honeywell, Safran, Fokker, Zodiac Aerospace and GKN Aerospace, the country still lacks a base of suppliers. This generates a series of gaps in the supply chain, from raw materials to final processes, that reduce the country’s competitiveness.
The local aerospace sector is fully aware of this problem and is making a great effort to find a solution. “In December 2016, we created a commission for supply-chain development. This commission will identify the country’s capabilities and determine, alongside all industry players, what the country needs to start developing. This commission will search for companies and help them to acquire the necessary certifications to supply OEMs and Tier 1 companies,” says Robles.
Another local hurdle is the lack of sufficient human capital to address the sector’s needs. “Mexico faces a challenging situation in terms of human capital development and education. Almost 50 percent of all new graduates are not prepared to address the industry’s needs. As a result, people who know they have the right skills and training are always looking for the company that offers the best deal and the most attractive compensation plan,” says Gabriel Aparicio, Country Manager of Kelly Services.
Nonetheless, growth remains on track. FEMIA expects aerospace exports will rise 12 percent during 2017 to a total of US$8 billion. Investment also continues to pour in. FDI is up to US$33 billion to October 2017.
AVIATION’S LOW-COST ATTRACTION
Just in 2016, almost 3.7 billion passengers flew all over the world, a 6.7 percent increase over the previous year. One of the main drivers behind this growth are low-cost carriers (LLC) explains ICAO, which expects for this trend to continue. According to Deloitte, travel demand, measured in revenue passenger kilometers (RPK) has grown at an annual rate of 4.7 percent for the past 10 years, to almost double the number of passengers a decade ago.
Deloitte expects this trend to continue for the foreseeable future, with passenger traffic growing at an average annual growth rate (AAGR) of 4.8 percent for the next 20 years, while air cargo is seen growing at a 4.2 percent rate during that same period. Passenger load factor, referring to the utilization of an aircraft, rose to 80 percent in 2016 at a global level. CANAERO explains that the sector provides 9.9 million jobs around the world and by 2026 it will represent US$1 trillion.
Latin America was once behind other world regions in terms of aviation. The reason, explains Eduardo Iglesias, former Executive Director of ALTA, is that “in Latin America, aviation was historically perceived as a luxury product.” This is changing. In its 2017 Current Market Outlook, Boeing says that airline traffic, measured in RPK, is expected to grow at a 6.1 percent annual rate over the next 20 years. This effect, a result of economic reforms and a competitive landscape, puts the region well above the world’s expected growth of 4.7 percent per year.
“The region will continue to see strong passenger growth in the next decade that requires a significant influx of new ideas, out-of-the-box solutions, and investments to accommodate these additional travelers,” says Iglesias. He says that the region as a whole is undergoing a transition period caused by the introduction of LLCs into the market, which are pushing major airlines toward the creation of partnerships and alliances to optimize their profits. “Aviation follows economies of scale. An airline has fixed costs per airplane. Thus, to optimize spending we must increase the number of hours our aircraft are flying and the number of passengers and cargo per flights,” says Iglesias.
Still, airlines in Latin America must overcome a few hurdles to continue growing. One is the lack of harmonized regulations across the region. “There are over 45 different consumer regulations in our region while the EU has a single regulation for roughly the same number of people,” says Iglesias. High airport charges add to the issue. As the increased number of competition has forced airlines to reduce their prices, airport taxes and fees across the region continue to rise. “We lower fares, they increase taxes and fees. We incorporate new technologies, increase productivity, lower fuel consumption, and lower costs, but they raise taxes and fees. We cannot go on like this forever. In some airports, passengers pay more in airport charges than for the flight itself and operating an airport cannot be riskier and more complex than running an airline,” says Iglesias.
Mexico is in a good position in terms of aviation, in comparison to Latin America. In 2016, Mexican domestic aviation grew 15.6 percent in terms of operations and 10.7 percent in terms of passengers in comparison to the previous year for a total of 82.7 million passengers, according to DGAC, and just in the first eight months of 2017 this number had already reached 61 million. Growth has also been heavily influenced by Mexican LLCs, which are quickly overtaking the market. “Low-cost flights have grown exponentially, making it possible for many people to travel by plane and leading airlines to make important changes,” says Miguel Peláez, Director General of DGAC. Aviation represents 3 percent of Mexican GDP and generates almost 1 million jobs, according to the organization.
Led by tourism and a stable economy the aviation sector in Mexico is expected to keep growing. Which is leading local airlines to update and increase their fleets. For instance, in 2013 Viva Aerobus made the largest acquisition of airplanes in a single deal for a total of 52 A320. In the middle of 2017, it decided to acquire a new one. Expectations are high across the industry due to its growth history. “The sector has an enormous opportunity for growth and consolidation,” says Cuitláhuac Gutiérrez, Country Manager of IATA Mexico.
Airport infrastructure is another chief challenge. The WEF Global Competitiveness Index 2016-2017 ranks Mexico 61st out of 138 countries in quality airport infrastructure. An unavoidable hurdle is located in the heart of the country. Namely, the oversaturation at AICM. This airport was designed to have capacity for no more than 32 million passengers per year. In 2016, it transported 41.7 million passengers, 8.5 percent more than the previous year, and this figure is expected to keep growing as demand for flights keeps increasing.
The oversaturation causes a number of logistical problems not just for passengers and airlines operating in it. It is also a barrier for new airlines to come into Mexico City and for those already here to expand their operations. Some, such as United Airlines, have found alternatives. “Replacing smaller aircraft with bigger planes has enabled the airline to increase and even double capacity. For instance, changing from 75-seat aircraft to 146-seat planes almost doubles the number of available seats per flight,” says Rolf Meyer, Managing Director, Mexico and Latin America Sales of United Airlines.
The situation at AICM has many believing the construction of its replacement, NAICM, cannot be finished soon enough. “NAICM’s capacity will be valuable for the country as AICM is saturated and there are companies that want to fly to Mexico City but are unable to. NAICM will bring in more companies and more people, generating a trickle-down economic effect that will result in investment that benefits both Mexico City and the country. Its three air strips per terminal will enable more simultaneous take-offs and landings, permitting more flights to more destinations,” says Meyer.