Examining MRO And Aftermarket Trends And Forecasting Business Demand

Presented by Tom Tran

Ann Arbor, Michigan Amersham, United Kingdom Singapore

www.AeroStrategy.com

Agenda

Engine MRO Overview When Will The Market Recover?

2011 AeroStrategy

Two Major Factors Influence Aircraft MRO Activity: Fundamental Demand And Supply Chain Practices
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
3

2011 AeroStrategy

The 2010 Air Transport MRO Market Was $43.7 Billion

2010 Air Transport MRO Market Modifications 7% Airframe 15% Engine 35%

Engines: includes off-wing shop visits, excludes onwing engine activity Components: includes O&R, excludes purchase and carrying cost of inventory Line: includes transit, overnight and A checks (labour and material) Airframe: includes C and D checks (labour and material) Modifications: includes PTF conversions, painting, cabin upgrades, avionics and component upgrades Areas of maintenance expenditure excluded from chart:

$43.7B
Line 21%

Components 23%

Maintenance control

Technical services (~ US$2.5B)

Inventory carrying costs (~ US$10B)

2011 AeroStrategy

Source: AeroStrategy/OAG Aviation

Which Is $1.3B Lower Than The 2007 Peak

2003-2010 Global Air Transport MRO Market ($B)

50.0
Modifications

$45B

$44.0B

$42.7B $43.7B

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!

2011 AeroStrategy Source: AeroStrategy/OAG Aviation

Fundamental MRO Demand Is Expected To Recover And Reach $58 Billion By 2019
Air Transport MRO Market ($B)* 70 60 Mods CAGR 7.2% 1.2% 1.5% 3.1%

50
40 30 20

Line

Airframe Line Components

The MRO market is expected to recover early this 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

Engine 10 0 2009 2011 2013 2015 2017

4.0%

Total
2019

= 3.2%

2011 AeroStrategy

Source: AeroStrategy OAG Aviation * Constant 2009 US$

Europe Is A Significant Exporter Of Engine Overhaul

2010 Engine Overhaul Demand And Supply (US$) By Region

-24%

+64%

-2%

$3.6B

$4.3B

$5.1B

Asia Pacific Net Importer

Europe Net Exporter

North America Net Importer

MRO Demand

MRO Supply

2011 AeroStrategy

Source: AeroStrategy/OAG Aviation

Approximately One Quarter Of Engine Overhauls Are Done In House Today

2010 Engine Overhaul Outsourcing By Region
100%
Non OEM 31%

2010 Airframe Heavy Maintenance Outsourcing By Region

OEM ~2%

100%
15% Ind. 20%

80%

38%

28%

80%

15% ATP 30% 53%

60%
OEM 43% 47%

60%

40%

36%

40%
IN HOUSE 50%

12%

20%
26% IN HOUSE 26% 25%

20%

70%

33%

0%

0%

Asia Pacific

Europe

North America

Asia Pacific

Europe

North America

ATP = Airline Third Party; IND = Independent

2011 AeroStrategy

Source: AeroStrategy OAG Aviation

But Engine MRO Outsourcing Is Expected To Increases Significantly By 2020

2020 Engine Overhaul Market Shares 100
In-house 25%

(12%)

In-house 10%

80 60 40 20 0
OEM 42% ATP + IND. 33%

Captive engine maintenance declines significantly OEM adoption of licensed service centers and JVs for some engine models restricts PMA encroachment to less than 5% Vertical integration by airline third party and independent overhaul providers into parts repair OEMs retain the largest share and control 50% of the engine overhaul market

+ 6%

ATP + IND 40%

+ 6%

OEM 50%

2010
ATP = Airline Third Party; IND = Independent

2020

2011 AeroStrategy

Source: AeroStrategy Note: OEM includes JVs

Material Drives 65% Of Engine MRO Costs And New Parts Drive Material Costs; PMA Is Approximately 2% Today
Breakdown Of Engine MRO Costs Breakdown Of Engine MRO Material Costs

Inside P.R. 10%

Outside P.R. 12%

Used/serv iceable 10%

PMA 2%

$15.2B
Labor 13%
Material 65% LLP 27%

$9.9B

New Parts 61%

2011 AeroStrategy

Source: AeroStrategy

10

But Is Anticipated To Be Strong From 2009 Especially Outside Of The Engine

2009-2014 Air Transport PMA Forecast*
700 600
2011: 15% Growth 2010: 7% Growth 2012-2014: 12% Growth

The PMA market will begin to recover in 2010 with an estimated 7% growth rate and double digit growth through 2014 Most of this growth is expected in the components and airframe areas, not engine In 2014, PMA penetration is expected to reach 3.3% of total material consumption By 2019, AeroStrategy estimates PMA penetration will reach about 5%
* Constant 2009 US$

500
400 300

Engine
Components Airframe

200
100

2009 2010 2011 2012 2013 2014

Penetration (%) 2.3% 2.4% 2.7% 2.9% 3.1% 3.3%

2011 AeroStrategy

Source: AeroStrategy analysis, AeroStrategy Engine Overhaul Survey

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Agenda

Engine MRO Overview When Will The Market Recover?

2011 AeroStrategy

12

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
13

2011 AeroStrategy

And Airlines Utilized Several Cost Savings Levers Since Late 2008
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)

2011 AeroStrategy

14

As A Result, OEM Aftermarket And MRO Supplier Revenues Plunged In 2009

2009 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%)

Most suppliers had a 10 25% reduction in MRO/aftermarket revenue in 2009; the effects were more pronounced for parts suppliers than overhaul shops

2011 AeroStrategy

Source: AeroStrategy

15

A Key Difference From Previous Recessions Is The Scope Of Parked Aircraft That Could Come Back Given Todays Fuel Prices
Air Transport Fleet: Temporarily Inactive/ In Storage
Aircraft Family 737-3/4/500 MD80 DC9 737-1/200 146 727 EMB-135/140/145 757 747-1/2/300 747-400 CRJ-100/200 F100 A300-600 DC8-6/70 DC10 F28 328JET A310 A300 MD11 717 L1011 707 F70 BAC 1-11 MD10 MD90 Total
Source: OAG Aviation

Aircraft Family 767 737-6/7/8/900 777 A320 Series A330 A340 CRJ-700/900/1000 EMB-170/190 Total

Sep-10 67 15 3 64 11 20 4 7 191

12%
High potential to return to service at current fuel prices

1,553
88%

Lowmoderate potential / obsolete

Despite the large size (1,553) of the parked fleet, only a small portion 200 is likely to return to service at current fuel prices
This equates to 1% of global capacity.or approximately two months of production rates
2011 AeroStrategy

Sep-10 201 181 136 106 74 73 78 54 47 47 56 48 43 32 38 31 29 12 19 9 9 12 10 4 2 5 6 1,362

16

High Fuel Costs Have Also Contributed To Early Aircraft Obsolescence And Growing Retirements
Air Transport Retirements and Deliveries
1400

1200

Deliveries
1000

High fuel costs combined with the recession have contributed to higher retirement rates In 2007/08, 400 aircraft were scrapped each year equivalent to 40% of deliveries

800

600

Retired/scrapped aircraft
400

200

0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Qantas recently changed its depreciation policy to recognize shorter aircraft economic lifespans; will other airlines follow suit?
17

2011 AeroStrategy

Source: Airline Monitor Feb 2010

And The Parked Fleet Continues To Shrink Primarily Due To Scrapping And Parting Out Aircraft
Air Transport Fleet: Temporarily Inactive/ In Storage (Sept 2010 vs. April 2010) High Potential Return To Service Low Potential Return To Service

The high potential parked fleet has declined 48 (~20%) since April 2010; most were likely returned to service The low potential fleet is also 110 smaller; most of this difference is due to scrapping and parting out aircraft

2011 AeroStrategy

Source: OAG Aviation

18

An Estimated 15-20 Aircraft Are Being Parted Out Each Month

Globally, 15-20 aircraft per month are being parted out

Engines, avionics, and other aircraft components are re-circulated to the market, thereby suppressing MRO demand
Facilitating this phenomenon is a new breed of surplus parts suppliers, with an impressive blend of financial skills, technical capability and market savvy Parting out is not limited to mature aircraft; new generation aircraft are also being cannibalized including A320, A340, and advanced B767 models

Hot surplus parts markets include:

Aircraft: B737-3/4/500, B767, B747-400, CRJ Engines: CFM56-3, CFM56-5, CF34, V2500A1, CF6-80C2

High value components: APUs, avionics, others

Surplus parts represent 15%+ of total aircraft parts spendingand for some products 30-40%!
2011 AeroStrategy Source: AeroStrategy interviews

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Which Is Suppressing Aftermarket Demand Even As Inventory De-Stocking Runs Its Course
Factors Supressing Fundamental MRO Demand
+% Start of global recession
Addition To Fundamental MRO Demand Due To Deferred Maintenance & Destocking

Reduction To Fundamental MRO Demand Due To Deferred Maintenance & Destocking

Normal MRO Demand (Fundamental Demand = realized supplier demand)

-%
2011 AeroStrategy

Reduction To Fundamental MRO Demand Due To Aircraft Cannibalization & High Use Of Surplus Parts
Source: AeroStrategy

20

AeroStrategy Anticipates Mid-To-Upper Single Digit MRO Growth This Year, Followed By Low Double Digit Growth In 2012
Air Transport MRO Market Realized Supplier Revenue($B) *

60
50 40 30 2009: Down 15-20% 20 10 0 2008

Realized supplier revenue

Fundamental MRO demand Key Assumptions Fuel costs remain high (>$80/bbl) Modest global GDP growth Improved airline profitability continues in 2011

2012: Low double digit growth

2011: Mid-to-upper single digit growth

2010: Low Single digit growth 2010 2012 2014 2016 2018

The Wildcard: Will Improving Airline Profitability Change Behavior?

2011 AeroStrategy

Source: AeroStrategy * Constant 2009 US$

21

The Outlook For MRO Market Recovery Will Depend On Economic Growth And Fuel Costs
Economic Recovery (Global GDP Growth)
Low W Shaped Recession Modest 2-3% GDP Growth

High (>$80/bbl)

Worst case: Depressed market

AeroStrategy Scenario

Fuel Costs

Low (<$80/bbl)

Slow Recovery

Best case: V Shaped Recovery

The Wildcard: Will Improving Airline Profitability Change Behavior?

2011 AeroStrategy Source: AeroStrategy

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Key Messages
The global economic recession will result in significant airline capacity, inventory reduction and losses. As a result, the MRO market will contract from $45B in 2007 to $43.7 B in 2010 Engine MRO market is the largest segment of MRO spend at 35% of total or $15.2B Approximately one quarter of engine overhauls are done in house today, but engine MRO outsourcing is expected to increases significantly by 2020 In the near-term, use of MRO demand buffers and cost control measures will magnify the drop in spend, but AeroStrategy anticipates mid-to-upper single digit MRO growth this year, followed by low double digit growth in 2012

2011 AeroStrategy

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Thank you for your attention!

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www.aerostrategy.com
2011 AeroStrategy