As a result of COVID-19, the severe demand-side depression alongside the potential supply-side challenges associated with various Brexit outcomes, leaves the UK Aerospace & Defence (A&D) industry squeezed from both sides with limited room to manoeuvre.
COVID-19 uncertainty and severe disruption
The impact of the pandemic has undoubtedly been severe for the A&D sector. Most notably on the reduction in civil aviation market activity, with travel restricted by governmental lockdowns and more recently, the quarantine regulations in place across the globe. The Guardian recently reported that, according to trade body ADS, aircraft manufacturers received only 13 orders in July and August 2020, and none at all in September, compared to 152 over the same period in 2019.
With passengers not flying (the freight market has held up relatively well by comparison), airlines have been forced to make significant cuts to schedules. A more recent impact of this prolonged level of demand reduction is now being seen in the early retirement of older models. For example, British Airways’ decision to retire the 747 fleet. However, defence spending has remained resilient over the period, protecting some supply chain positions. Although with global economic data weak and a potential change in US Government, it is not stretching feasibility to imagine spending pressures in this section of the market in the near to mid-term also.
Recent economic data from August was relatively disappointing. Output in the A&D sector is still 28% down on the level in February, compared a 9% contraction in the economy at large. The prolonged reduction is placing significant pressure on all levels of the supply chain and leading to almost a breaking point in some areas.
Liquidity is of greatest concerns across the sector. Recently we have seen Rolls Royce announce plans to raise significant funds from the debt and equity markets. The precise impact on liquidity and cost bases of the scaling back of government support as the Job Support Scheme replaces the Job Retention Scheme remains unclear but we would likely expect leaders to be forced into making difficult choices with market activity still significantly depressed.
Our view is that H1 2021, without a significant uptick in market activity will be extremely tough for UK businesses with major liquidity-led distress arising. If activity levels do ramp up, we would expect to see similar liquidity pressures as cash flow levels struggle to support required working capital build requirements.
Brexit looming large again
Recent media reports suggest that the chances of a negotiated Brexit outcome on 31st December 2020, are increasing. This is welcome news for the UK’s 300,000+ strong A&D supply chain workforce. Further comfort comes in the form of pronouncements that in the event of a no-deal outcome, specific mini-deals may be negotiated covering both transport and aviation.
Without some form of agreed mitigation and process around movement of goods across UK/EU borders and alignment on aviation regulations, the risks for impacted UK businesses would be severe.
The challenges Brexit presents are the exacerbation of this uncertainty, with direct liquidity-based issues less impactful, given the low market activity levels. Working capital buffers to manage border movement delays will not need to be as pronounced. The loss of access to labour is far less of a challenge given 10-20% headcount reductions are being sought across the board.
Flexibility and agility required to thrive
The COVID-19 pandemic is unlike previous shocks that have impacted this sector. At the outset, organisations have focused on immediate measures to keep their people safe and their businesses solvent. As an industry, reaching consensus on the ‘new future’ as quickly as possible is critical. It will allow supply chains to adapt to revised production rates, collectively identifying and mitigating transition risks.
When sector leaders weigh up all these points together, the uncertainty they face is significant. It is not suited to a sector where long term investment cycles exist. Those who have spent the pandemic period robustly reviewing potential scenarios and Brexit sensitivities, whilst also shoring up supply chains and streamlining cost bases, will be the winners in the coming period. Those who have not adopted this approach, will find the dual impact of these two events highly challenging to overcome in the future.