Crypto News: Aerospace suppliers need to be more resilient

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Aerospace manufacturers are cranking out more jet parts as supply chains finally start to stabilize, but the learning moment from the challenges of the past few years shouldn't get lost in the healing process.

Like all companies, makers of jet engines and cockpit controls have struggled with semiconductor shortages, the availability of raw materials and the myriad other challenges inherent in bringing the world's factories back to pace after slowing them to a crawl during the depths of the pandemic. But the aerospace sector's supply chain challenges have been a particularly slow grind and a tough brake on companies' ability to satisfy robust demand post-Covid. Airbus SE and Safran SA both said this week that they expect disruptions to linger into 2024. Whereas manufacturers of other products were able to make substitutions or rework designs to circumvent specific supply challenges, that's much harder to do in the heavily regulated aerospace manufacturing industry. "There are 3 million pieces in an airplane, and if only one is missing the airplane can't take off," Airbus Chief Executive Officer Guillaume Faury told France Inter radio this week.

But the stubbornest bottlenecks have more to do with labor than chips and aluminum. When demand for air travel virtually evaporated during the pandemic, airlines parked planes and dialed back deliveries of new ones, decimating the cash flows of aerospace manufacturers. The US planemaking supply chain wasn't offered the same payroll backstop that airline counterparts were, leading these companies to make deep cuts to their workforces. When aircraft manufacturers tried to rehire workers, they found they were all competing with one another over a shrunken pool of experienced labor. There's a "post-pandemic deficit of capacity and capability that no one has backfilled," General Electric Co. CEO Larry Culp said in an interview this week. "The 57- and 58-year-olds that were welders or machinists who were laid off or took early retirement in the bowels of the pandemic didn't all come back. Maybe you can get someone who is 28 to come in and take that job. But that's about a 30 year gap in experience."

Training less-experienced employees takes time and can slow the manufacturing process. Delivery snags on Honeywell International Inc. parts are forcing General Dynamics Corp. to build Gulfstream business jets out of order, Phebe Novakovic, CEO of the defense giant, said on its earnings call this week. This work is inherently less efficient, but it's creating particular challenges for a workforce that has never built planes that way, Novakovic said.

There are some early signs that the aerospace supply chain is finally improving, or at least stabilizing. Material receipts increased 5% in the first quarter relative to the year-earlier period at Raytheon Technologies Corp.'s missiles and defense division, helping improve the flow of products through its factories and contributing to 4% overall sales growth for the business in the first quarter. The Pratt & Whitney jet-engine unit saw a 30% improvement in castings deliveries in the first quarter compared with the final months of 2022, allowing it to keep pace with demand from Airbus. "Now that's not to the level of flow that we need," said Christopher Calio, Raytheon's chief operating officer. "We continue to see some manpower, sort of labor challenges in that supply chain."

GE was able to boost deliveries of its marquee Leap jet engines by more than 50% in the first quarter compared with those in the period a year earlier and by 10% from the fourth quarter of 2022. About 70 of the company's defense engines that had fallen behind schedule were shipped in the first week of April. That reflects progress in suppliers' on-time delivery rates and material input availability, CEO Culp said. "Things are better at the margin but still challenging on a daily basis," he said. "We're doing a better job in terms of the level of rigor, discipline and intensity, both in our own operations and with our suppliers." The 2% revenue decline in GE's defense business in the first quarter shows there's more work to be done, he said. GE is using lean manufacturing principles to take waste out and get more out of the labor it does have.

Meanwhile, progress on material availability and supplier follow-through helped Honeywell's aerospace division boost output by 20% in the first quarter compared with the period a year earlier. This improvement, combined with continued strong demand, encouraged the company to increase its full-year organic sales guidance for the aerospace business to low double-digit growth. Still, the past-due backlog for Honeywell's aerospace unit remains at a historically high level, and its factories aren't yet humming along perfectly. CEO Darius Adamczyk, who is due to step down in June, took umbrage, however, with General Dynamics' comments about Honeywell being the holdup in its supply chain: "I can assure you that in terms of the bottlenecks, it's not Honeywell," he said on the company's earnings call this week. "We have a lot of issues with our supply base as well. And frankly, some of those being large public companies." He added: "I'm not going to use somebody else as an excuse for us not delivering. That's our job to manage. And frankly, an earnings call is not the right place to actually have those kinds of discussions."

It is worth remembering that the aerospace manufacturing labor challenges are to some extent self-inflicted. Contract awards continued to flow to defense giants during the depths of Covid, and the Department of Defense accelerated progress payments with the apparent aim of flushing cash flow into the hands of suppliers, many of which also serve the beleaguered commercial industry. But no similar program existed specifically for aerospace manufacturing. There was a $17 billion pool of federal loans included in the initial $2 trillion Covid stimulus package available for companies deemed vital to national security. This was reportedly crafted specifically for Boeing Co., but it went untapped by its intended recipients, in part because companies balked at the terms, and the Federal Reserve's aggressive efforts to prop up the credit markets provided alternatives.

"If you were to do a simple compare and contrast with the US manufacturing base in aerospace and the Europeans who had government support to avoid the actions that many of us in the US took, I think you see a different recovery underway," Culp of GE said. "The other contrast you could draw is the government came in and provided significant support to the airlines themselves so they didn't go through what so many of us in the manufacturing arena did. I don't know what that means. God forbid we see another pandemic. But those two comparisons are not lost on us working so hard to ramp up new unit deliveries and service the airlines."

The deep cuts at the top of the aerospace food chain had far-reaching ripple effects. At one point, Boeing was contemplating shrinking its commercial aviation workforce by 30,000. In May 2020, GE said it would cut 25% of the aviation unit's workforce, or about 13,000 jobs. Honeywell cut about 7,800 jobs in the second quarter of 2020, mostly in its energy-related and aerospace businesses. Raytheon announced plans to eliminate a total of 20,000 jobs in 2020, including 4,000 contractor positions and 1,000 previously expected adjustments because of the company's merger with United Technologies. As of October 2020, the company was aiming to bring back only about half of the 15,000 jobs it was cutting in its commercial aerospace businesses once demand recovered eventually. "We've got to keep the other 50% from coming back, and that's what's going to give us leverage on the upside when we do indeed see a return to normalcy in air traffic," CEO Greg Hayes said at the time. How is that working out? Raytheon's share repurchases in 2021 and 2021 totaled more than $5 billion combined.

These companies were all facing drastic declines in their aerospace profits, while Boeing and GE were contending with particularly acute cash-flow problems and large debt loads. Few predicted demand would rebound from the pandemic doldrums as quickly as it eventually did. So it's unfair to second-guess these layoffs in hindsight.

But it's interesting to compare the aerospace manufacturing sector with railroads, another corner of the industrial world that let go of workers en masse during Covid and was surprised at how hard it was to bring them back. While the aerospace sector is still broadly in the complaining phase, some railroads, particularly CSX Corp. and Norfolk Southern Corp., have been pondering how to add more resiliency to their business models and have concluded a more restrained approach to furloughs would pay greater dividends than knee-jerk cost cuts.

"The industry went through a period where we generated a lot of returns by driving productivity. That was good; everyone needs to focus on productivity. We do it, our customers do it. I get it," Norfolk Southern CEO Alan Shaw said in an interview this week. But "too many times rail has missed the upturn," he said. It's time to chart a new course where railroads bet on the long term and invest predictably in locomotives, tracks, intermodal terminals and people "through upturns and downturns so we're right there facing that market when it recovers," Shaw said. "If that comes at the expense of near-term operating profit, that's probably OK." Norfolk Southern has about 900 conductor trainees right now and it's continuing to hire, even amid a macroeconomic environment that Shaw says is rife with "uncertainty and crosscurrents."

In its investor day presentation in December, Norfolk Southern laid out some numbers to support its case. The railroad might get $35 million in annual savings from the kind of furloughs it's typically done in downturns. But service disruptions from a slower-than-needed network can cost the railroad $40 million a quarter. It costs about $50,000 to recruit, hire and train a new conductor; multiplied by 200, that's $10 million. This is to say nothing of missed revenue opportunities because the company can't meet customer demand and a longer-term loss of confidence that factors into shippers' willingness to choose rail transport over trucks. The math on curbing furloughs makes sense, and that's appreciated by shareholders, particularly those that take a longer view, Shaw said. And customers like the idea of a railroad actually doing what a railroad is supposed to do. "No company is going to grow if it gives its customers a lousy customer service product," Shaw said.

Separately this week, Norfolk Southern said it took a $387 million charge in the first quarter in connection with the February train derailment that dumped chemicals in East Palestine, Ohio. The charge encompasses estimated costs associated with environmental cleanup and community support, legal fees and a preliminary estimate of claims and settlements (which may be revised higher as more details are hammered out) but doesn't include payouts from insurance or recoveries from third parties that may bear some responsibility for the accident.

I'd love to see someone in the aerospace industry run a similar analysis to Norfolk Southern on furloughs and resiliency. Covid was a unique situation, but there will be other downturns, and even before the pandemic, the aerospace supply chain was struggling to keep up with Boeing and Airbus's production ramps. I asked Culp whether he thought investors would be more tolerant of aerospace manufacturers operating with a greater staffing buffer in slower markets, given the hiring challenges of recent years. "You're the first person to ask me that question," he said.

"It's gnarly. It was difficult to find. But an employee raised their hand and noticed a bad procedure and everybody jumped on it. Within a week, we had this resolved with the FAA. We had a clear picture of the airplanes that were impacted and we were all at work on the rework. That is a signal of a healthy supply chain, not a weak one." — Boeing CEO Dave Calhoun

Calhoun made the comments on Boeing's earnings call this week in reference to the company's disclosure earlier this month of a manufacturing problem that forced it to pause deliveries of its 737 Max jet. The problem involves incorrect installation by supplier Spirit AeroSystems Holdings Inc. of two of the rear fittings where the Max's vertical tail is attached to the body of the plane. The glitch is impossible to assess visibly once the manufacturing process is complete because a sealant is applied on top of the fitting, Calhoun said. About 75% of the 225 already-built Max jets that Boeing has sitting in inventory will require repairs. The scope of the work is measured in "a few weeks" rather than months, Calhoun said. Jets that are still in the production cycle and haven't yet had their vertical tails attached can be fixed in days.

Still, the timing is far from ideal, with the delivery delays affecting flying plans for some airline customers during the peak summer season. "We feel terrible about that," Calhoun said. Southwest Airlines Co. this week cut its outlook for 2023 Boeing Max deliveries for a second time, resulting in a percentage point decline to its capacity growth plans with the biggest impact in the fourth quarter. American Airlines Group Inc. CEO Robert Isom said that there would be a minimal impact on operations from this latest issue but that the airline needed Boeing "to get their act together."

Boeing is betting it can ramp up deliveries materially in the second half of 2023 and still meet its goal for 400 to 450 handoffs of 737 planes this year. The company is also keeping suppliers on track to increase output to 38 jets a month later this year and 50 a month by 2025 or 2026, even if this will leave it with extra cash-burning inventory as it works through the latest manufacturing and delivery hiccups. With the aerospace supply chain still so constrained, Boeing really doesn't have much of a choice but to keep pushing forward with production targets.

Carrier Global Corp. agreed to buy closely held German heat-pump maker Viessmann Climate Solutions for €12 billion ($13.2 billion) to expand in a fast-growing segment of the European heating and cooling market. Carrier will separately look to divest a business that supplies refrigeration units to convenience stores and grocers and its remaining fire and security assets (it already sold its Chubb fire alarm and safety surveillance systems business to APi Group Corp. for $3.1 billion in 2022). The combined portfolio moves will focus Carrier on heating, cooling and ventilation and better position the company to take advantage of a shift toward more climate-friendly technologies. The company expects heat-pump use in Europe to increase by 25% annually to 40 million units by 2030. Carrier also highlighted Viessmann's solar and battery storage technologies, products that the acquirer doesn't currently offer. Given the strategic importance of heat pumps in Europe's efforts to reduce carbon emissions, it's not surprising that Germany's economy minister Robert Habeck vowed to "pay attention" to the deal. "It is important that the benefits of our energy policy, and profits generated by it, continue to benefit Germany as a business location," he said in a statement.

Honeywell agreed to pay $670 million for a compressor controls business that was part of the package of Roper Technologies Inc. industrial assets in which Clayton, Dubilier & Rice acquired a majority stake last year. The business provides control hardware, software and services to the liquified natural gas, refining, gas processing and petrochemical industries. After years of companies prioritizing breakups or pricey software purchases, it appears industrial deals are back in vogue. The Honeywell compressor controls acquisition and Carrier's takeover of Viessmann helped make April the biggest month for North American industrial takeovers of industrial assets in the past five years apart from some unique outliers that were dominated by a single, blockbuster transaction. A resurgence of capital spending in the industrial sector, aided by a rewiring of the world's supply chains and a massive influx of government stimulus targeting infrastructure and climate change, is motivating companies to bulk up in key affected markets. Honeywell's purchase of the compressor controls business will give the company more asset-management tools to offer customers seeking to accelerate their energy transition in addition to some technology around carbon capture and sequestration.

3M Co. announced this week that it would eliminate 6,000 jobs as part of its latest effort to get the company back on track. This is the latest in a long string of similar restructuring initiatives over the past few years, all in the name of "streamlining." But there's been been little visible benefit to 3M's bottom line from these cost cuts, and the need for yet more streamlining begs the question of what exactly the company was doing during past restructuring phases. 3M is swinging a bigger ax this time around, which perhaps suggests that it didn't cut deeply enough in the past. 3M anticipates this latest cost reduction will boost operating income by $700 million to $900 million annually. Ultimately, however, this amounts to rearranging deck chairs on the Titanic because job cuts don't do anything to help with the real issue for 3M shares: a pair of legal headaches tied to military earplugs and legacy manufacturing of per- and polyfluoroalkyl substances (PFAS) that analysts estimate could end up costing the company in the ballpark of more than $30 billion on a combined basis.

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