Cashing in on the Peace Dividend?
Distributors left up in the air regarding the future of the aerospace industry
By John R Johnson -- Industrial Distribution, 12/1/1998
Nobody liked it when the U.S. was forced to respond to terrorist attacks by retaliating with air strikes over Afghanistan. We all got a little nervous when North Korea fired a missile across northern Japan in early September, and when India and Pakistan defied NATO orders and went ahead with testing of nuclear warheads earlier this year.But if there is any positive to the instability that sometimes rocks the world, it is an increase of business at defense manufacturers like Lockheed Martin, Boeing, Northrop Grumman, United Technologies, and the host of job shops that service the major aerospace providers. Usually, that's also good news for distributors, as there is more need to furnish products to the defense industry.
So just how is the defense industry shaping up for 1999 and beyond? That's tough to call. At first glimpse, things look good. After a 13-year decline in defense spending, which began with the end of the Cold War, the U.S. government plans to increase military procurement spending to $60 billion by 2002, a boost of $15 billion from present levels.
"With all the political instability around the world, the government may be asking for the reverse of the Peace Dividend," says Mark Baldwin, chief executive officer for Pentacon, Inc., a distributor of fasteners and other supplies, and a major supplier to the aerospace industry. The Peace Dividend called for spending funds that would have been earmarked for defense in other sectors, such as education.
Yet, despite the good news from Washington, defense manufacturers continue to release negative news. In early October, for example, Raytheon Co. announced layoffs and plant closings in its core defense business, and announced that its defense unit will have revenue shortfalls for 1998. Raytheon said layoffs in its defense unit, Raytheon Systems Co., will total 16 percent of its staff. The company also said it will close eight more defense facilities, on top of the 20 plants and office closings announced at the beginning of 1998.
Also this fall, aircraft engine maker Pratt & Whitney said it plans to cut about 1,000 jobs each in Connecticut and Florida, or about six percent of its global work force, by mid-2000 in a bid to boost profits and absorb a decline in production.
"While our financial performance has improved dramatically since 1993, and will remain strong this year, we expect commercial and military production volume to decline in 1999 and 2000,'' Pratt president Karl Krapek said in a memo to employees announcing the job cuts. Pratt's dwindling production volume "reflects the crisis in Asia and generally declining defense budgets globally,'' Krapek said.
United Technologies, the parent company of Pratt & Whitney, has also announced a major vendor reduction campaign that will drastically reduce its distributor base. The firm hired Bruckner Supply Co., recently acquired by WESCO, Inc., to handle its MRO supplies earlier this year.
Last but not least, Boeing chief executive officer Phil Condit said his firm needs to concentrate on cutting costs and improving margins, noting that Boeing expects government defense spending to remain relatively flat, a trend sure to affect its defense unit. Boeing's bid to pad its own margins could have the opposite effect for distributors that sell to the aerospace giant.
Jerry Stagg, president of Hawley Industrial Supply, part of Industrial Distribution Group's New England division, says that Pratt & Whitney was once its second-largest customer. However, the Pratt business is "in a downspin" due not only to the company's cutbacks, but to the fact that Pratt's parent, United Technologies, has brought in Bruckner Supply Co.
"[The Asian flu] is having an impact on Pratt now, no question about it, and it's had an impact on us," says Stagg. "That business is on the wane now to a significant degree. It has filtered down to the job shops and we're seeing that now."
Stagg expects downsizing himself as a result, noting that the economy and consolidation as a result of the IDG merger will reduce his workforce by a maximum of 10 percent. Stagg also expects revenues to be off by about five percent this year. Despite the gloomy forecast from the defense sector, Stagg sees potential new business offsetting the revenue shortfalls.
"We're not in a catastrophic free fall that we see at this moment," says Stagg. "At our present run rate [Pratt] is still one of our top 10 customers. It's far from stopped. We don't have the variety of large users that we used to have, but there is tremendous variety in smaller business, and there's good opportunity there, and that will offset some of the UTC losses. There's a lot of opportunity out there, but there aren't many Pratt & Whitneys, period."
Mark Nelson, president of Apostle-Nelson, also located in Connecticut, says the impact on his state could be significant. "I think it's obviously going to have an impact," he says. "It's impacting Pratt because the number of fighter planes for the military is being cut back. But the other side of the equation having equal impact is that because of the Asian flu, a lot of these foreign countries [the U.S.] sells [defense equipment] to are cutting back. So there have been cutbacks from foreign governments too, and it's definitely going to impact Connecticut."
The outlook doesn't look much brighter in the commercial aircraft sector. Pentacon's Baldwin expects the sector to flatten out in the near term.
"The commercial side of the aerospace group is getting close to hitting its peak and will probably flatten out," says Baldwin. "The backlog that the commercial aircraft people have is substantial. We don't see a downturn, but a flattening for the next year or two until some of the [economic] uncertainty gets answered. Clearly a bit of caution has been thrown into the demand for aircraft going out to 2002-2003."
However, like Stagg, Baldwin sees other options -- telecommunications, for example -- for growing revenues. "The part of the business that we see offsetting a slowdown in aerospace is the telecommunications and commercial missile business that will continue to grow," he says. "There are a number of companies putting up low orbit satellites, and I think all the uses for satellites are going to promote a continued growth in that area."
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