Demand for aircraft may be aplenty, but that hasn't stopped big, profit-thirsty aerospace manufacturers from reportedly telling their suppliers to cut prices or risk losing business. Swelling orders fuelled by fast-growing disposable incomes in emerging markets mean Boeing (US: BA) and Airbus (Fr: AIR) now boast record backlogs of almost 12,000 jets. Yet despite opening with $30bn (£19bn) of firm contracts, analysts expect this year's Paris Air Show to be more about cost efficiency, as planemakers face the daunting task of churning out trillions of dollars worth of jets already sold.
"Given the fact that order books have swelled so large, it is unlikely that the headlines will be about large blocks of orders at this show," says aerospace consultant Jerrold Lundquist. Instead they are much more likely to be about "the production process and viability of the supply chain", he adds. Cowen & Co analyst Cai von Rumohr seconded that cautious tone, saying the combined Boeing and Airbus order tally for civil aircraft at the Le Bourget is likely to be below the lofty averages of the past few years.
Those warnings follow reported claims from an unnamed company that it negotiated a 15 per cent reduction with Boeing over five years, in response to the US giant's demands for significant savings. That report emerged despite Boeing's hopes that its gamble on smaller jets will yield hundred of sales at this year's Paris Air Show.
Fresh from the controversy surrounding the A400M military transport carrier crash in Seville that killed four people after three engines failed, Boeing’s European rival Airbus is also said to be adopting a similar strategy. Recent newspaper reports indicate that GKN (GKN) - one of its main suppliers - has already felt the brunt of this, having been asked by the French-based aerospace behemoth to cut prices by at least 10 per cent.
Airbus is reportedly considering inviting other suppliers to pitch for GKN's work on its short-haul A320 jet, in an attempt to widen the meagre profit margins it currently makes on planes. As the planemaker accounted for 21 per cent of GKN's aerospace revenues in 2014, and the A320 contract alone is worth about £250m a year, the implications could be very damaging. Sentiment in the aeroplane and auto parts supplier had already taken a hit in February when Airbus vowed to cut wide-body A330 aircraft production from 10 to six a month. According to Liberum, that particular decision could create a £40m and £105m drag on GKN's revenues for the 2015 and 2016 financial years, respectively.
But despite growing speculation that the two big beasts of aerospace are keen to make their suppliers sweat over parts, and that these demands will push pressures further down the supply chain, appetite for aircraft isn't expected to taper off. Indeed, by 2035 it is estimated that the number of people flying will more than double from about 3bn to 7bn. Investec Securities analyst Rami Myerson reckons global airline capacity growth could accelerate sharply in the second half of this year, thanks to an improving global macroeconomic environment and the continued benefit of low oil prices. Although oil prices have rebounded from a six-year low in January of $45 a barrel, Mr Myerson calculates that the current jet fuel price still represents anything between a 16 per cent to 26 per cent reduction in airline operating costs.
Rising air traffic and an improving economic backdrop could spur demand for more profitable after-market parts. Companies like engine parts manufacturer Meggitt (MGGT) tend to supply original equipment at lower margins and then compensate for this by commanding higher margins for spares. Such an approach, however, hasn’t been too fruitful in recent years as original equipment revenues significantly outgrew aftermarket ones.
