COVID-19 – HOW WE WILL NEED TO RETHINK THE

AEROSPACE INDUSTRY

Portrait of Manfred Hader

Manfred Hader
(URL:https://www.rolandberger.com/en/Persons/Manfred.Hader.html)

SENIOR PARTNER, CO-HEAD OF GLOBAL AEROSPACE & DEFENCE PRACTICE

Hamburg Office, Central Europe
+49 40 37631-4327

( U R L : h t t p s : / / w w w. l i n k e d i n . c o m / i n / m a n f r e d - h a d e r - 5 9 a 7 5 0 8 8 )

( m a i l t o : M a n f r e d . H a d e r @ r o l a n d b e r g e r. c o m )

APRIL 8, 2020

Plunge in air traffic will deeply impact demand for new aircraft

The COVID-19 pandemic has the potential to trigger a global economic crisis (URL:https://www.rolandberger.com/en/Point-of-View/Coronavirus-Current-status-and-economic-impact-forecast.html) of
significant dimensions, affecting all industries. One of the industry sectors in the eye of the coronavirus storm is aerospace. Global air traffic has been brought to an
almost complete standstill by the COVID-19 outbreak. While air traffic has consistently shown a solid recovery from previous crises, the debate is wide open about
how traffic will recover following the current crisis and what this will mean for the civil aircraft manufacturing industry, the supply chain and aftermarket support
businesses.
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Previous crises like 9/11, SARS or the financial crisis of 2008/09 all demonstrated a recovery along V- or U-shaped curves back to the pre-crisis growth path. As
COVID-19 is a fully global crisis of unprecedented magnitude, we need to consider whether we might see an L-shaped recovery with consistently lower levels of air
traffic and permanently slower growth after the crisis. (URL:https://www.rolandberger.com/en/Insights/Global-Topics/Coronavirus-business-response/)

The debate is fueled by two questions for which there is no real precedent to extrapolate from but which could be transformational for the industry:

What is the magnitude of the COVID-19 crisis, and will it change the way we perceive air transport?

Will the crisis highlight obsolete industry structures and cause the bubble of huge aircraft orderbooks to burst?

This article discusses three key questions:

1. How deep will the crisis be for aviation, and how long will it last?
We examine different scenarios for global air traffic development in the coming years.

2. What will be the impact on the aerospace industry?

We derive the impact of these scenarios on the demand for new aircraft and MRO (maintenance, repair and operations).

3. What needs to be done to manage the crisis?

We discuss what the aerospace industry could look like in a post-COVID-19 world and what measures need to be taken to mitigate risks and capture opportunities.

Demand for new aircraft will fall significantly in the short term and may remain subdued for years.
Demand for new aircraft will fall significantly in the short term and may remain subdued for years.

1. How deep will the crisis be and how long will it last?

The magnitude of the air traffic crisis can be characterized by four key indicators:

Duration of air travel restrictions

The longer the restrictions last, the more airlines will run out of liquidity, leading to bankruptcies, nationalizations or consolidation, hence causing an irreparable
change in the industry landscape and customer structure for aircraft manufacturers. Moreover, the longer the restrictions last, the greater the possibility that temporary
behavioral changes imposed by the pandemic may become permanent (e.g. reduction of business travel as a result of increased digital communication).

Time to recovery
Once the air travel restrictions are lifted, the time to recovery will be impacted by potential new outbreaks of the disease, leading to recurrent waves of further travel
restrictions and hence fluctuating travel volume at lower levels.

"New normal"
The combination of a long duration of travel restrictions and repeated outbreaks over an extended period of time might lead to a "new normal", with global air traffic
volumes settling at a lower level – an effect that has never occurred before in the history of commercial aviation.

Future growth path

Finally, fundamental structural changes in the industry and sustained behavioral change triggered by the crisis might lead to lower post-crisis long-term growth rates
compared to the long-term trends observed over the past decade.

With a fast recovery, i.e. a return to pre-crisis traffic levels during the summer flight plan 2020, already ruled out, we have developed the following three scenarios:

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Scenario 1: Rebound
Air travel restrictions will last for two months and the "new normal" will be reached beginning with the winter flight plan 2020. Travel volume will reach 100% of pre-
crisis levels.

Scenario 2: Delayed cure

Air travel restrictions will last for four months and the winter flight plan 2020 will be affected. The "new normal" will be reached beginning with the summer flight plan
2021. Travel volume will reach 90% of pre-crisis levels.

Scenario 3: Recession
Air travel restrictions will last for six months and both the summer and winter flight plans for 2021 will be affected. The "new normal" will only be reached beginning
with the summer flight plan 2022. Travel volume will reach 80% of pre-crisis levels.

While more accurate values for the possible outcomes across the scenarios will become much clearer in the coming weeks and the scenarios will need to be refined,
this first assessment already gives a ballpark view of the range of possible futures for global air traffic.

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2. What will be the impact on the aerospace industry?

We took these three scenarios for global air traffic as a basis to model demand for new aircraft and MRO services, considering retirements of older aircraft, potential
deferrals or cancellations of current orders, a dramatic slowdown in new aircraft orders, and the consequent evolution of the fleet.

Demand for MRO services is primarily driven by the size and flight activity of the global fleet, albeit with some complex transitory factors. As soon as aircraft are
grounded, demand for all flight hour/flight cycle linked maintenance disappears (although calendar time-based maintenance remains). Thus, MRO is hit first in any
downturn, and MRO providers and spare parts suppliers suffer immediately. As aircraft return to flight, MRO activity picks up, but MRO shops first consume existing
inventory before purchasing new parts from suppliers. In addition, aircraft that have been grounded may be disassembled and their parts used as spares, further
reducing demand for spare parts from equipment suppliers.

The picture is very different when it comes to the demand and production of new aircraft. As a pre-crisis reference point, we took the industry consensus of global
aircraft demand for 2020-2030, which predicted that the market needed around 21,760 new aircraft over the next ten years.
As a result of the crisis we must assume that cash-constrained airlines will postpone scheduled aircraft replacements, especially as current fuel prices will make it
economic to continue to fly relatively older, less fuel-efficient aircraft.

We therefore plugged the following assumptions into our model:

· Scenario 1 (Rebound): Replacements postponed for 12 months
· Scenario 2 (Delayed cure): Replacements postponed for 18 months
· Scenario 3 (Recession): Replacements postponed for 24 months

Although not included in the model at this stage, it is worth noting that there is an additional risk of replacement cycles being extended after the initial postponements,
especially if the oil price remains as low as it currently is.

Depending on the scenarios for global air traffic development, the overall aircraft demand 2020-2030 varies significantly.

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Scenario 1 (Rebound)

In scenario 1, a prolonged V-shaped scenario, the industry is only mildly affected. The demand for new aircraft comes to a halt in the next 12 months and then reverts
to the pre-crisis demand curve. The cumulative demand for new aircraft over the next ten years therefore drops by only 800 aircraft (-4%) as a result of the small-
scale postponement of replacements. The key issue for the industry will be to maintain production at a level that allows it to quickly ramp back up to previous levels
while safeguarding liquidity.
Scenario 2 (Delayed cure)

The ten-year demand for new aircraft in scenario 2, a U-shaped scenario, drops to 15,840 new aircraft (-27%), driven by both the postponed replacement of existing
aircraft and the lower level of air traffic in the future. The latter has a far more significant impact on demand for new aircraft, and in this scenario the industry will be
forced to downsize its operations significantly. In addition to the reduction in the number of aircraft, it can be assumed that the lower level of traffic will also affect the
replacement strategy and the product mix in the fleets. For example, an A220-300 may replace an A320 or a B787-8 may replace a B787-9 to make up for the lower
number of passengers on given routes.
Scenario 3 (Recession)

These effects are even more pronounced in scenario 3, an L-shaped scenario. The low volume of travel (80% of pre-crisis levels) and lower growth in the "new
normal" result in a drop in new aircraft demand of almost 50% over the next ten years. Changes to the replacement strategy and the product mix in the fleets as
described in scenario 2 will also be more significant. This scenario will inevitably result in a heavy downsizing and restructuring of the whole industry and supply
chain.
The scenarios highlight that demand for new aircraft will fall significantly in the short term and may not return to pre-crisis levels in the medium term. Of course, this
must be offset against existing aircraft OEM orderbooks and the airlines' contractual obligations to purchase already ordered aircraft even though the demand for
them may have evaporated. However, faced with the extreme situation of the COVID-19 crisis and looming airline bankruptcies, the robustness of each individual
order must be open to question.

In sum, the aircraft manufacturing industry faces three major challenges:

1
Minimize cancellations or postponement of aircraft orders (e.g. due to the B737 MAX grounding, or delays where the OEM cannot claim force majeure).

2
Bridge the time until the demand for new aircraft returns, while keeping the aerospace supply chain alive and healthy.

3
Ramp down and adjust the size of the aerospace supply chain to the "new normal" sustainable production level in the medium term.

3. What needs to be done to manage the crisis?

It can already be anticipated that the post-crisis aerospace industry will not look like it did before the crisis:

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Significant downsizing of operations is to be expected for both OEMs and suppliers – the industry will need to offset the resulting loss of scale with a step up in
efficiency, potentially taking advantage of the crisis to take actions that would be unpalatable in easier times.

Weaker suppliers (e.g. those with heavy exposure to the B737, more aftermarket exposure and less counter-cyclical defense business) will come under severe
financial pressure.

A significant consolidation of the industry by companies with strong balance sheets must be expected, either to take advantage of distressed assets or to bail out
suppliers to safeguard the stability of their supply chain.

One of two possible post-crisis industry models could emerge:

1. A more OEM-centric industry model whereby the OEMs consolidate key parts of the supply chain to stabilize and rationalize it.

2. A more balanced industry model between OEMs and key Tier-1 suppliers, where the Tier-1s have consolidated even more, amassed scale and are now on a level
playing field with the OEMs.

As the aerospace industry relies on a highly interconnected and mutually dependent supply chain, the crisis needs to be managed on two levels in parallel:

On an individual company level, cash will be king. Protecting cash positions will be key to ensuring survival while managing the ramp-down, stabilizing and securing
the supply chain and seizing opportunities in the market – we may therefore expect a cash squeeze in May and June as new production schedules become
established but activities have not yet been rationalized. Preparing for the "new normal", rightsized and potentially repositioned operations must start immediately. To
this end, the company's strategy, its industrial footprint and operating model, needs to be reviewed and a blueprint developed to fit with the "new normal" and provide
the right framework for short-term actions and strategic moves.

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 At industry level, companies and governments will need to work closely together to ensure that key industrial capabilities do not fall through the cracks, as this would
put the whole industry at risk. Therefore, the industry will have to:

Quickly reach a consensus on the "new normal" production rates

Define a joint plan for how to transform the industry from its status quo to the "new normal" level

Identify at-risk elements in the transition process and develop plans to support them

Once this picture is clear, government support may need to be called upon to safeguard the short-term functioning of the industry and help manage the transition to
the "new normal" for this strategically important sector.

Further reading

GLOBAL TOPIC ARTICLE

Coronavirus: Immediate measures for businesses World economic growth plunges due to coronavirus
(URL:https://www.rolandberger.com/en/Insights/Global-Topics/Coronavirus-business-response/) (URL:https://www.rolandberger.com/en/Point-of-View/Coronavirus-Current-status-and-economic-impact-forecast.html)

GLOBAL TOPIC

Aircraft electric propulsion

(URL:https://www.rolandberger.com/en/Insights/Global-Topics/Electric-Propulsion/)

Robert Thomson Holger Lipowsky

(URL:https://www.rolandberger.com/en/Persons/Robert.Thomson.html) (URL:https://www.rolandberger.com/en/Persons/Holger.Lipowsky.html)

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 Didier Bréchemier Tobias Schönberg
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SENIOR PARTNER, CO-HEAD OF GLOBAL AEROSPACE & DEFENCE PRACTICE PARTNER

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