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PMA Market Outlook: When Will The Market Recover?

PMA Market Outlook: When Will The Market Recover?. Presented by Tom Tran 7 - 9 April 2010 San Diego, California 12th Annual Gorham PMA-DER Conference. Ann Arbor, Michigan • Amersham, United Kingdom • Singapore www.AeroStrategy.com. MRO Market Outlook PMA Market Outlook. AGENDA.

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PMA Market Outlook: When Will The Market Recover?

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  1. PMA Market Outlook:When Will The Market Recover? Presented by Tom Tran 7 - 9 April 2010 San Diego, California 12th Annual Gorham PMA-DER Conference Ann Arbor, Michigan • Amersham, United Kingdom • Singapore www.AeroStrategy.com

  2. MRO Market Outlook PMA Market Outlook AGENDA

  3. MRO Market Outlook Two Major Factors Influence Aircraft MRO Activity… Simplified MRO Supply Chain 1. Fundamental Demand For Aircraft MRO • Predicted airline maintenance spending as a result of aircraft demographics, utilization, equipment reliability, maintenance programs and regulations • A good predictor of supplier MRO and aftermarket activity in normal times 2. MRO Supply Chain Practices • Inventory stocking & destocking, use of surplus components, deferred and reduced scope maintenance • All of the above act as a buffer between fundamental demand and realized revenue by OEMs and MRO suppliers • Important in times of crisis Source: AeroStrategy

  4. MRO Market Outlook ...And The First Factor, Fundamental Air Transport MRO Demand Is $42.7 Billion In 2009… 2009 Air Transport MRO Market ($42.7B) Eastern Europe 3% India 1% Modifications 7% Africa 4% Latin America 5% North America 34% Engine 36% Airframe 15% Middle East 5% China 5% By Activity By Region Asia Pacific 16% Line 20% Components 22% Western Europe 27% Source: AeroStrategy/OAG Aviation

  5. MRO Market Outlook …Which Is $2.3B Lower Than The 2007 Peak 2003-2009 Global Air Transport MRO Market ($B) 50.0 $45B $44.0B $42.7B Modifications 40.0 Airframe 30.0 Components 20.0 Line 10.0 Engine 0.0 2003 2004 2005 2006 2007 2008 2009 Recession = Three Years Of Lost Growth! Source: AeroStrategy/OAG Aviation

  6. MRO Market Outlook Fundamental MRO Demand Is Expected To Recover And Reach $58 Billion By 2019 Air Transport MRO Market Growth By Segment ($B)* • The MRO market is expected to recover early next decade and reach $58B by 2018 – a 3.2% CAGR (excludes inflation) • Airframe maintenance will have the lowest growth due to retirements and introduction of less maintenance intensive aircraft 70 60 50 Line 40 30 20 Total = 3.2% 10 0 2009 2011 2013 2015 2017 2019 Source: AeroStrategy OAG Aviation * Constant 2009 US$

  7. MRO Market Outlook India, China And The Middle East Will Be The Fastest Growing Regions… Air Transport MRO Market Growth By Region ($B)* • India, China and the Middle East will be the fastest growing regions • North America and Western Europe , the largest markets, will be relatively flat 60 50 40 30 20 10 Total = 3.2% 0 2009 2011 2013 2015 2017 2019 Source: AeroStrategy OAG Aviation * Constant 2009 US$ Asia pacific excludes China and India Note: * Excludes China and India

  8. MRO Market Outlook …And Absolute Market Growth Will Be Driven By China And The Rest Of Asia-Pacific • Asia-Pacific (excluding China and India) will have the highest absolute increase in MRO spending • MRO spending in China will increase by $3B • Despite high growth, Indian MRO spending will increase by <$1B Air Transport MRO Market 2009-2019 Change in MRO Spend 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Source: AeroStrategy OAG Aviation * Constant 2009 US$ Asia pacific excludes China and India Note: * Excludes China and India

  9. MRO Market Outlook The Second Factor, MRO Supply Chain Practices Attenuate Fundamental MRO Demand In Times Of Crisis… Simplified MRO Supply Chain 1. Fundamental Demand For Aircraft MRO • Predicted airline maintenance spending as a result of aircraft demographics, utilization, equipment reliability, maintenance programs and regulations • A good predictor of supplier MRO and aftermarket activity in normal times 2. MRO Supply Chain Practices • Inventory stocking & destocking, use of surplus components, deferred and reduced scope maintenance • All of the above act as a buffer between fundamental demand and realized revenue by OEMs and MRO suppliers • Important in times of crisis Source: AeroStrategy

  10. MRO Market Outlook …And Operators Have Numerous Options For Reducing Maintenance Spend In Times Of Crisis Options For Reducing Maintenance Spend Engines Components Airframe Heavy • Reduced scope of maintenance – more “repair” and less “replace” • Defer replacement of expensive life limited parts until they reach absolute cycle limits(e.g. short-stub engines) • Greater leverage of spare engines in lieu of overhauls • Acquisition of surplus engines for mature aircraft • Renegotiate MRO contracts • Burn down rotable inventory in lieu of component MRO repair • Reduced scope maintenance – more “repair” and less “replace” • Acquisition of surplus rotables for mature aircraft • Renegotiate MRO contracts • Reduce utilization and rotate in-service aircraft to minimize heavy maintenance checks required by hour/cycle limits • Park older aircraft approaching expensive heavy checks • Reduce discretionary modifications (e.g. Interior upgrades, painting) Source: AeroStrategy

  11. MRO Market Outlook One Alternative Is To “Destock” Some Of The $47 B Of Inventory In The MRO Supply Chain… MRO Supply Chain Inventory And Holding Cost • About $47B in inventory • The weighted average holding cost of 21.5% implies a cost $10.1B for the industry • Airlines bear the brunt of this burden - $6.3B per annum or 62% of the total 50.0 $47B 45.0 14% 40.0 35.0 19% Surplus 30.0 21.5% Distributors 25.0 MROs 20.0 OEMs Airlines 15.0 61% $10.1B 10.0 5.0 0.0 Total Inventory Holding Cost Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey, Aerostrategy / OAG MRO model

  12. MRO Market Outlook …And Operators Hold 60% Of MRO Supply Chain Inventory; ~40% Is Aircraft Rotables Air Transport MRO Supply Chain Inventory* - $47B Outside Parts Repairs & Processes Airline Operator Overhaul Shop By Organization Airlines: 61% MRO suppliers: 14% OEMs: 19% Distributors 6% By Type Of Inventory Rotables (components): 41% Consumables 24% Spare engines 12% Airframe parts 8% Other (piece parts) 17% Service Parts Casting, Forging & Raw Materials Inventory Inventory Inventory Source: AeroStrategy * Inventory estimates based on a 2009 global supply chain survey conducted by AeroStrategy and IATA

  13. MRO Market Outlook The 2002/2003 U.S. Airline Industry Crisis Highlights The Impact Of Destocking And Deferred Maintenance 2001 – 2008 US Maintenance Costs & Capacity (Indexed) 1.15 Capacity (indexed ASM) 1.10 1.05 Total Maintenance Spending (indexed) - 4% 1.00 0.95 0.90 - 12 % 0.85 0.80 2001 2002 2003 2004 2005 2006 2007 2008 • The last airline crisis was in the U.S. in 2002/2003 • Post 9.11 shock = reduced demand and yields • Several airlines entered Chapter 11 and restructured • Airlines aggressively pursued cash conservation • US capacity reduced by 4% • Airlines reacted by burning off inventory, deferring non-essential maintenance, increasing outsourcing, and parking older aircraft • The net result was a 12% decrease in maintenance spend – three times the level of ASM reduction Source: Air Transport Association, AeroStrategy analysis

  14. MRO Market Outlook The Near-Term Impact Of Destocking Will Be Greatest For Downstream Suppliers Simplified MRO Supply Chain – Impact Of MRO Demand Buffers Outside Parts Repairs & Processes Airline Operator Overhaul Shop Service Parts Casting, Forging & Raw Materials Inventory Inventory Inventory Near-term impact of inventory reduction on MRO demand Moderate Significant Very Significant Source: AeroStrategy

  15. MRO Market Outlook ...Resulting In Larger Swings In Parts Demand Than Overhaul & Repair Services O&R And Parts Expenditure Versus Airline Capacity (Conceptual) Airline Capacity Overhaul & Repair Services Service Parts 2009 2001 2002 2003 2004 2005 2006 2007 2008 Source: AeroStrategy

  16. MRO Market Outlook Most OEMs Experienced A 10-20% Reduction In Aftermarket Revenue In 2009… Near Term Reduction In MRO Supply Chain Revenues Due To Industry Crisis Fundamental MRO demand down in 2009 Outside Parts Repairs & Processes Airline Operator Overhaul Shop Service Parts Casting, Forging & Raw Materials Near-term reduction in supplier revenues (10 – 15%) (15 – 30%) (20 – 40%) • AeroStrategy estimates that OEMs and MRO suppliers will see between a 10 and 40% reduction in 2009 due to the industry crisis – depending on the position in the supply chain and on the supplier’s portfolio • Most OEMs had a 10 – 20% reduction in aftermarket revenue in 2009 – based on a blend of service parts and overhaul services Source: AeroStrategy

  17. …As Evident By The 9% Decline In Revenue For HEICO’s Flight Support Group In 2009 1997-2009 HEICO Flight Support Group* Revenue ($M USD) 2009: Down 9% 2002: Down 9% 1997-2008 CAGR = 24%** Note: * Flight support group includes distribution, repair and PMA business ** Growth rate includes organic growth and acquisitions Source: HEICO 10-K

  18. MRO Market Outlook There Is Still Room For Continued Destocking – Particularly In The Middle East And Asia-Pacific 2009 Airline Inventory Per Aircraft US$ - Millions* Airline Average = $1.9 M USD per aircraft * Book Value Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  19. MRO Market Outlook AeroStrategy Anticipates A Return To MRO Growth In 2010 With The Makeup For “Destocking” In 2011/2012 Air Transport MRO Market – Realized Supplier Revenue($B) * Realized supplier revenue 60 Fundamental MRO demand 50 2012: Low double digit growth 40 30 2011: Mid Single digit growth 2009: Down 15-20% 20 2010: Low Single digit growth 10 0 2008 2010 2012 2014 2016 2018 Source: AeroStrategy/OAG Aviation * Constant 2009$

  20. MRO Market Outlook PMA Market Outlook AGENDA

  21. PMA Market Outlook The 2009 PMA Market Contracted By An Estimated 8% Air Transport PMA Market ($M) • 2009 PMA market is down 8% versus 2008, from $381M to $353M • Since the peak in 2007, the PMA market has fallen by 17% • Several factors drove the PMA market contraction • Airline use of buffers • Deferred maintenance • Work scopes (e.g. more repair and less replace) • Cannibalization of surplus aircraft and engines • Lack of airline resources devoted to PMA approval process • OEM defensive measures PMA Penetration (%) ($M) $416 M $381 M $353 M Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey, Aerostrategy / OAG MRO model

  22. AeroStrategy Conducted The Survey In Conjunction With IATA; Respondents Include More Than 70 Companies 2008 MRO Inventory and Supply Chain Logistics Survey Survey Objectives MRO Inventory and Supply Chain Logistics Survey Respondents OEMs 13% (10) Distributors 14% (11) Airlines 47% (36) • Sent survey instrument to more than 200 airlines via IATA and 100+ airlines, OEMs and distributors via AeroStrategy • Survey questions included • Current inventory value and type • Location of inventory • Inventory turns and costs • Anticipated changes in inventory levels • Use of pooling, vendor-owned inventory, and PMA parts MROs 25% (19) • 36 airlines with over 3,800 aircraft in total • 19 MROs with over $11B in MRO revenue • 11 distributors and surplus dealers with inventory valued at $2.6B • 10 OEMs with nearly $3.5B in spare parts sales volume

  23. PMA Market Outlook The Majority Of Airlines And MROs Feel That OEM Pricing Policy Significantly Drive The Usage Of PMA… Extent Of Which OEM Pricing Policy Drive The Use Of PMA % of Respondents Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  24. PMA Market Outlook …And Have Seen Price Increase From The OEMs Of At Least 3% In Recent Years… Annual Material Price Increases Seen From OEMs In Recent Years % of Respondents Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  25. PMA Market Outlook …While The Perception Is That PMA Offers At Least 20% Discount Compared To OEM Parts Typical Price Discount For PMA Parts Versus OEM % of Respondents Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  26. PMA Market Outlook Over 90% Of The Airlines In The Survey Have Authority To Use PMA Parts… PMA Usage – Airline & MRO Perspective % of Respondents Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  27. PMA Market Outlook …But Many Airlines Believe That Leasing Companies Are The Largest Barrier To Greater PMA Penetration Barriers to PMA – Airline Perspective 18 16 14 12 # of Respondents 10 Regulatory 8 OEM Agreements 6 Leasing Companies Culture 4 Other 2 0 5 Very Significant 4 2 1 Insignificant 3 “It is not even possible to arrive at a reasonable financial formula to allow a lessee to use substitute materials in return for a higher rent.” – Chief Technical Officer of A Leasing Company Source: AeroStrategy/IATA 2009 Inventory & Logistics Survey

  28. PMA Market Outlook The Air Transport PMA Market Is Expected To Reach $618M Within The Next Five Years 2009-2014 Air Transport PMA Forecast* • The PMA market will begin to recover in 2010 with an estimated 7% growth rate • In 2011, the PMA market is forecasted to spring-back with a robust growth rate of 15% • Overall, the PMA market is estimated to grow from $353M in 2009 to $618M in 2014, a 12% CAGR • PMA penetration expected to reach 3.3% of total material consumption 2012-2014: 12% Growth 2011: 15% Growth 2010: 7% Growth • * Constant 2009 US$ Source: AeroStrategy analysis, AeroStrategy Engine Overhaul Survey

  29. Key Messages • Fundamental air transport MRO demand is $42.7 billion in 2009, which is $2.3B lower than the 2007 peak • In the near-term, use of MRO demand buffers will magnify the recession; most OEMs experienced a 10-20% reduction in aftermarket revenue in 2009 • AeroStrategy anticipates a return to MRO growth in 2010 with the makeup for “destocking” in 2011/2012 • Airlines and MROs in the survey feel that OEM pricing policy drive the usage of PMA and have seen price increase of at least 3% in recent years • While over 90% of the airlines surveyed have authority to use PMA parts, many airlines believe that leasing companies are the largest barrier to greater PMA usage • The 2009 PMA market contracted by an estimated 8%, but is expected to reach $618M within the next five years

  30. Thank You For Your Attention! • AeroStrategy is a specialist management consulting firm devoted to aviation and aerospace sectors with offices in Ann Arbor , Amersham, U.K., and Singapore • To learn more about AeroStrategy visit www.aerostrategy.com or contact: • David Stewart, PartnerPh: + 44 1494 431 600dstewart@aerostrategy.com • Kevin Michaels, PartnerPh: +1 734 821 0220kmichaels@aerostrategy.com • Hal Chrisman, PrincipalPh: +1 734 821 0227hchrisman@aerostrategy.com

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