2021 aerospace and defense industry outlook

By Gérald Faustino, National Leader, Aerospace & Defence, Deloitte Canada

One of the sectors that’s been hardest hit by COVID-19 is aerospace. In our 2021 aerospace and defence (A&D)¹ analysis, we provide a thorough examination of the major challenges faced by the global industry, as well as opportunities for recovery. In the following, we focus on the Canadian perspective and highlight some of the ways that Canadian innovation has been offering a path beyond the downturn.

Commercial aerospace

A lengthy recovery

Canada’s commercial aerospace sector, like the global industry itself, can expect a lengthy recovery. Passenger air traffic has been heavily affected by COVID-19: Air Canada, for example, forecasts it will take at least three years before activity and subsequent earnings return to pre-pandemic levels.² In the meantime, airlines plan to minimize aircraft wear and tear and overall operating costs are increasing the use of their smaller, narrow-body aircraft over larger models, and by retiring older, less efficient planes sooner than otherwise planned. Another strategy is to use parts from existing grounded aircraft to help control spending on maintenance and repairs for models in use.

Additionally, original equipment manufacturers (OEMs) of engines and airframes will undoubtedly be looking for their own ways to optimize, retrench, and scale back operations. As such, we can expect to see the sale (with or without leaseback) of real estate and underutilized heavy equipment, which will provide one-time cash inflows and help improve asset utilization ratios (i.e., increase the proportion of revenues to assets). Foreign OEM companies, for their part, have been assessing the viability of their Canadian divisions, looking for product lines and/or business units to sell if abandoning our market proves to make fiscal sense.

Currently, we can’t predict how the pandemic will affect the innovation agenda for the sector. Will companies use this forced pause in operations as an opportunity to kick creativity, product development, and even the advancement of green technology into high gear? The possibilities are hard to estimate, but signs of resilience through innovation are beginning to appear.

Defence

Spending decline coupled with deficit growth

Defence spending is one aspect in which Canada is expected to differ significantly from the rest of the world. With the deficit predicted to reach $342.2 billion³ in 2020–21, due in part to economic stimulus programs enacted in response to COVID-19, cutbacks and/or deferrals in large-scale budgets—such as those for defence spending—are inevitable. When the pandemic began, military spending was expected to continue, as was funding for adjacent programs such as the National Shipbuilding Strategy. But now, without a substantial tax base, and even with attempts to stimulate and support the economy via a wide range of fiscal and monetary policy options, defence spending will likely be slashed. After all, this was the government’s strategy to help manage the large deficits of the 1990s and that resulting from the 2008-09 financial crisis.⁴ However, given that our defence capabilities are already limited, a key concern is that any cut runs the risk of being too deep.

Mergers and acquisitions (M&A)

Shakeout in unmanned aerial-systems segment

In a March 2020 piece about smart factories, we explored how Canadian companies have already made significant investments in this smart technology.⁵ In fact, Canada’s progress in digital transformation is beyond that of many other countries. As a result, our aerospace companies are better able to withstand market dynamics and will continue to be quicker to react to fluctuations.

We expect to see mid-market M&A activity increase across the country’s more than 400 A&D companies, with smaller businesses bought out in consolidation strategies by financially sound strategic and financial buyers. In addition, the saturated drone market is ripe for takeover activity, with strong indications of the devices’ increased use⁶ in recent months—especially as demand for contactless delivery soars and industries look for ways to conduct remote site inspections despite travel restrictions. Other positive developments are detailed in the following:

• In February 2020, NAV CANADA finalized an agreement with the startup Unifly to deploy a national unmanned traffic-control system.⁷
• In March 2020, Transport Canada approved the first unmanned beyond-the-line-of-sight drone flight, directed instead using detect-and-avoid technology.⁸ This advancement promises to bring long-range commercial drone flights closer to reality, and raises the prospect that mineral-extraction industries—such as those in the mining and the oil and gas sectors—will be allowed to use drones to perform infrastructure inspections.

Government support

Green technology, regional aviation, and emergence of broader assistance

Throughout our economic recovery, green technology will be an interesting area to continue to watch. One significant development, pre-pandemic but in response to the climate crisis, was the first fully electric-motor-powered flight, achieved by the BC-based regional carrier Harbour Air in December 2019.⁹ Given the government’s dedication to fostering these types of green-technology advances in light of the climate crisis, it’s conceivable to expect them to do so, as/if needed, in response to the current COVID-19 crisis.

Similarly, pandemic restrictions may inadvertently create opportunities for smaller carriers. Air Canada’s suspension of 30 domestic regional routes beginning at the end of June¹⁰ had such a detrimental impact on the communities the airline had served that, by September, the government announced¹¹ it would be launching a plan to re-establish flights to the affected airports. If given the opportunity to fill this service gap as our aerospace industry recovers from the pandemic, will the smaller players be able to establish dominance or even ownership over these routes? And if so, will these crisis-response opportunities help push them toward increased innovation, similar to Harbour Air’s situation?

In July 2020, during the height of the pandemic, many questioned whether Canada should support specific industries and sectors¹² such as commercial aviation and aerospace; at the time, financial assistance was limited to waiving airport ground-lease payments.¹³ In November, however, the government announced it was working on an assistance package¹⁴ for Canadian airlines, airports, and the aerospace sector—a significant development, especially when coupled with its earlier goal to restore select regional routes. While further details are pending a consultation process, we can expect a broad support package similar to those offered in the United States and France,¹⁵ which amounted to US$50 billion and US$17 billion, respectively.

Incidentally, France’s strategy offers an excellent additional model, in which a portion of aerospace-sector funds is earmarked for green initiatives within the field—in this case, 10 percent, or US$1.7 billion, to be put toward the development of carbon-neutral aircraft by 2035. Applied to the case of Harbour Air—a regional carrier that would stand to benefit from Canada’s assistance package as proposed—this supplementary, green-tech support could help the company continue innovating, such as by rolling out electric-motor technology across more of its fleet. Clearly, maximizing these types of government investments are win-win—strengthening our position as the world’s third-largest aerospace hub, and helping to shape the future of Canadian air travel.

To learn more about the current state of the global A&D industry, read the full outlook.