Macroeconomic trends (e.g. expansive monetary measures in the Eurozone, with the consequent depreciation of the euro, the drop in the prices of hydrocarbons and raw materials, a general slowdown in growth rates at a global level) are consolidating. In the currency market the US Dollar is strengthening against a steep devaluation of the Rouble, which reached its lowest value ever in 2016, also owing to a gap in Russian state revenues caused by a fall in the price of gas and by economic sanctions for the situation in Ukraine, and against a devaluation of the British Pound which started in the months preceding the Brexit referendum on 23 June 2016. The value of the US Dollar, which is the reference currency for the aerospace market, of the British Pound and of the Euro have an impact on the business areas of Leonardo.
There are expectations of higher public expenditure in 2017, with a potential effect on the group’s business areas. The persistence of the crisis in Ukraine and the threat from terrorism in Europe sustain both the now generalised increases in NATO countries’ defence budgets and in expenditure on internal security in European countries, which are potential terrorist targets and are caught up in the phenomenon of mass immigration. The new Trump administration and the majority which the Republican Party achieved in Congress generate expectations regarding an increase in the United States defence budget and its effects in European countries, which are asked for greater commitment to NATO. In the Asian Pacific area quarrels regarding disputed maritime areas, the Chinese power policy and the North Korean nuclear policy are causes of substantial rearmament in the countries involved, in particular Australia, South Korea, Japan, Indonesia and Vietnam. Because of the geopolitical tensions in 2016 India increased its defence budget to $bil. 51 and it now ranks fourth in the list of top global defence spenders, with the expectation to raise its defence budget to $bil. 56.5 in 2018. The Middle East continues to be an important market for defence, although the fall in revenues due to the collapse in oil prices in some oil exporting countries is creating budgetary problems and pressure to cut down/defer investment in Defence. For example, even if Saudi Arabia is still one of the top spenders on defence, the decline in hydrocarbon revenues is starting to have an impact on the public purse, also leading to having to find a balance between demands for social and military expenditure, including the costs of the operations in Yemen and the fight against the Islamic State. Recourse to currency reserves and borrowing cannot be sustained in the long term.
The global Aerospace, Defence and Security market, as a whole, shows a positive trend with annual average growth rates that are in the region of 3.2% in the next decade. The short-term scenario is one in which defence expenditure budgets are expected to rise (+1.4% between 2017 and 2020, with an average annual value higher than €bil. 1,500), mainly supported by some countries such as Saudi Arabia, China, South Korea and India.
With reference to the “domestic markets” in which Leonardo operates, the United States continue to be the major market, with the main new generation systems programmes (multi-role aircraft, unmanned systems, integrated command, control and communication systems, naval units, increasingly including cyber warfare, the investments in which passed from USDbil. 3.9 in 2013 to USDbil. 6.7 in 2017).
With the Trump administration, an increase in the defence budget is expected as it can count on the support of a Congress with a Republican majority which should be great enough to outweigh the minority of Republican members who are contrary to increases in federal expenditure. In the election campaign President Trump said he did not agree with the defence sequester or the Budget Control Act for the Pentagon and that he wished to remove limits on expenditure by means of a “Restoring National Security Act”.
During the election campaign Trump announced an increase of 90,000 troops for the US Army, bringing the total up to 540,000, and 100 operational fighter aircraft for the Air Force, bringing the total up to 1,200. The Navy should rise to 350 ships and the Marine Corps from 24 to 36 combat battalions. An increase in missile capacity is expected, particularly shipborne. Trump also said he is in favour of the modernisation and expansion of the nuclear triad, consisting of submarine-launched ballistic missiles, land-based missiles and strategic bombers. The renewal plans, however, were already launched during the Obama administration.
President Trump also asked industry to be more efficient in limiting programme development costs, in particular Lockheed Martin for the F-35 aircraft and Boeing for Air Force One. Boeing was also asked to submit proposals for an updated F-18 E/F to create competition and put pressure on the F-35 aircraft. Similar criticisms were also directed at the shipbuilding industry.
The new administration intends to strike up a new relationship with industry and the United States will continue its innovation process started with the Defence Innovation Initiative in order to keep the technological advantage through new weapons programmes, while the processes of the Department of Defence will be reviewed, improved and made more flexible.
In the United Kingdom defence policy, for now, follows the decisions in the Defence budget statement (SDSR 2015). The 2015 Spending Review cut large sections of public expenditure but allocated additional funds to the defence budget until 2021, including the Joint Security Fund for military operations and funds for countering terrorism and the strengthening of the Single Intelligence Account. With the contribution of these additional funds, the defence budget will rise by 3% in real terms for the first time since 2010 during the financial years from 2015-16 to 2019-20, in addition to achieving the 2% target of GDP for the military expenditure required by the NATO. In November 2015 there was the announcement of an increase in investments by GBPbil. 12 (about €bil. 16), thus bringing the total expenditure for the procurement of weapons up to GBPbil. 178 until 2026 within the framework of the ten-year planning programme (Defence Equipment Plan). Nevertheless, this funding was decided before the Brexit referendum; the effects of Brexit on GDP, not very significant up to now, could become so, particularly on the target of devoting 2% of GDP to Defence. If British GDP goes down, funds for defence will consequently also diminish, with the possibility of some programmes not being financed. The same effect would be caused by an unfavourable economic situation. According to the British Government, Brexit should lead to heightened cooperation in defence with the United States but the depreciation of the Pound against the Dollar makes the purchase of equipment from the United States more costly, just as the rapid depreciation of the Pound against the Euro made it necessary to speed up planned purchases from the Eurozone countries in the last months. In order to counter the possible loss of European Union research funds, the Ministry of Defence plans to put GBPmil. 800 in a Defence Investment Fund to support military research, a project inspired by the US Defence Innovation Initiative, in addition to other funds from private sources and from local authorities.
The transformation that has occurred in the international scene in the last years has seen the NATO countries involved in the development of a new concept of defence and security in order to become more efficient in operational terms in dealing with the new situation. As regards investments, this has given rise to the need for the allied countries to adopt targeted measures aimed at countering the new threats, above all in relation to the capacity of (i) situation awareness, (ii) protection, (iii) greater interoperability between means and resources deployed in the theatres of operations and (iv) a prompt response of the force projection. At the same time, in terms of reduction in operating costs, various allied countries have launched structural reforms of their respective organisations, many of which are still being implemented. At present the European Union is worldwide the region that is closer than any other regions to a number of situations of continuing crisis, such as the Ukraine, the civil war in Libya, the “Islamic State” between Turkey, Syria and Iraq, to which must be added the critical issues connected with the control of sea and land borders that are affected by unstoppable migration flows from the crisis zones, while terrorists attacks continue in the European cities. The threat to Europe is both conventional, in the form of an act of aggression or a kinetic strike against a Sovereign state, and hybrid. Hybrid warfare consists in using non-traditional methods of war such as propaganda, computer attacks and the use of paramilitary militias which cannot be directly traced back to the aggressor country, which make it hard to “name and shame” the attacker. NATO is paying increasing attention to high-intensity “conventional” conflict scenarios of a high technological level.
In Poland, after a decline in 2016, a growth of 4.5% is expected until 2020. The Polish Government sustains defence expenditure for reasons of both national security and economic growth. Poland is one of the few countries to have fixed the amount of the defence budget as at least 2% of GDP of the previous year by law, in line with the NATO requirements. An ambitious Armed Forces modernisation plan has also been launched for the years 2013 to 2022. For the first phase from 2013 to 2016, the Plan amounts to PLNbil. 130 (about €bil. 32), with an annual expenditure of 20% of defence budget. This year the plan entered its second phase, from 2017 to 2022, with an expected expenditure of PLNbil. 273 (about €bil. 68) for the five years under consideration. The new Polish Government might even raise the allocation because it does not believe that the funds budgeted take the costs of supporting and keeping up the programmes into account. The Government has also initiated a reorganisation of defence structures, especially the bodies responsible for armaments procurement and management, and has started a review of the programmes assigned during the last two years.
Italy presents a substantially stable investment expenditure of around €bil. 4.5 per year, including the funds made available by the Ministry of Economic Development and by the Naval Law. In the last months Leonardo signed big contracts with the Italian Ministry of Defence’s Air Force Armaments and Airworthiness Directorate-General for the first batch of M-345 HET aircraft for the Italian Air Force, which will be delivered in 2019 and which will also be used by the Frecce Tricolori aerobatic squadron and for starting to develop and delivering from 2021 the new exploration and escort helicopter (NEES) for the Italian Army, to replace the AW129D, which will be decommissioned starting in 2025 after 35 years of service. Furthermore, in 2017 Leonardo will deliver to the Italian Army the new armoured vehicle Centauro 2 for medium-weight vehicles. There has also been renewed interest, in line with present tendencies, in cyber defence in the biggest countries: the Defence and Security White Book, in fact, suggests the institution of a Joint Forces Command for Cyber Operations, which is being formed and is another opportunity for Leonardo.
Analysis by business sector
- The civil aviation segment, with an overall market value of about €bil. 1,600 over 10 years, will continue to show a limited growth trend (around 2.5% on average per year). The demand is especially driven by the countries in the areas of Asia and Middle East and is affected by some macro-economic and technological dynamics (i.e. a better financial stability of the major airlines furthered by low fuel costs, the gradual availability of new technological solutions and advanced materials, the need to replace less-efficient previous-generation aircraft). Commercial Narrow- and Wide-Body aircraft accounts for more than 80% of the total market. The demand for narrow-body aircraft is mainly linked to the global economy performance and to the launch of re-engined versions A320 NEO and B737 Max of the Airbus family, in expectation of the launch of new programmes to replace this aircraft, which is not expected to occur before the next decade. The growth in wide-body aircraft is linked to Airbus A350 and to the ramp-up of Being B787, while the rate of production of the A380 and of the B777 and B747 is falling drastically. There was an order contraction in 2016 compared with previous years, and both Boeing and Airbus fell short of the expected target of new orders, and a Book-to-Bill of less than 1 (new orders compared to invoiced deliveries) for Boeing. This could be the beginning of a negative cycle also due to the persistence of low fuel prices and a transformation of economic fundamentals. Demand for wide-body aircraft in particular is lessening while it is steady for narrow-body aircraft, which are manufactured at a lower profit margin. As to regional aircraft, the highest value, most dynamic segment is that of reaction engine aircraft; however, the aircraft with turboprop engines, thanks to lower operating costs, maintain an important applicative niche. Over the next few years, it is expected that a new generation of aircraft for regional transport, equipped with features (operating range, transport capacity, speed) superior to those of aircraft that is currently in service. From an industrial standpoint, more prudent policies are applied on the part of some prime contractors to outsource the design and production of structural components, particularly composites, but the market for outsourcing the supply of aerostructures will maintain annual growth rates of around 2.5% in the next decade.
- The military aircraft segment, in part due to delays on a number of important supply orders, presents an interesting growth trend over the next 10 years (although they are highly cyclical), with an overall value of new deliveries of about €bil. 600 and an average annual growth rate of around 8%. The most important segment, in terms of numbers of deliveries and related value, is that of combat aircraft, in which the programmes for (i) JSF F-35, which is in a phase of accelerating production, (ii) the export of Rafale and Eurofighter and, even to a lesser extent, (iii) the new Gripen E/F are very important. Finally, the advanced training aircraft and tactical transport aircraft segments will also be characterised by interesting growth prospects, substantially liked to the development of armed versions.
Overall, around 50% of worldwide demand for military aircraft (manned and unmanned) will come from the United States and Western Europe, where the greatest technological and industrial capabilities continue to be present, although there is a gradual (but still limited) process under way of transferring technology to newly industrialised countries, which are increasingly interested in developing their own local offering. Specifically, many countries (South Korea, Turkey, Japan, China) are considering a new fighter plane. Their national industries have often entered into an alliance with a partner (Lockheed Martin in the case of South Korea, while China has cooperated with Pakistan and Russia) or looked for a technological partner (the case with Turkey, which has chosen BAE Systems).
Over the medium/long term, interesting opportunities in Europe may arise in relation to the collaborative development of a new generation of unmanned vehicles (UAS – Unmanned Aerial Systems) for long-persistence strategic surveillance, protection and monitoring, and reconnaissance and combat applications. European projects mainly consist of: (i) the definition phase of the MALE 2025, a joint Airbus Group, Dassault and Leonardo programme, and (ii) the FCAS Anglo-French feasibility study for a future unmanned fighter aircraft, in which BAE Systems and Dassault are involved with a major contribution of Leonardo and Thales in relation to on-board sensors and mission electronics. The extension of unmanned aircraft to the civil sector depends on the exact contents of the forthcoming regulations, which are being discussed at the present time, for safe navigation in non-segregated airspace; significant progress can be made thanks to the stimulus from the USA.
There is still a market characterised by some uncertainty mainly in the Oli&Gas and civil segments, albeit a moderate recovery. Overall, the new helicopter deliveries amount to around €bil. 190. This trend is linked, in addition to the above-said recovery in the civil segment, to a concurrent temporary contraction in the military segment, due to the completion of ongoing programmes, mainly in the United States and to the lack of new large programmes during the period under consideration. In the civil segment, demand will continue to concern aircraft equipped with the most advanced performance features and lower operating costs, especially in the Oil & Gas segment, which is currently affected by a fall in oil prices. The military segment, by contrast, depends heavily upon the developments in the US market, which experienced a peak in demand in 2014 due to significant orders for the upgrading of fleets awarded to domestic industries. In 2015 there was also a major consolidation with Lockheed Martin’s acquisition of Sikorsky. At the end of 2016 Leonardo’s Helicopters Division acquired full control over Sistemi Dinamici S.p.A., thus strengthening its commitment to unmanned systems. New players will also come into the sector as a result of the development of new markets (South Korea, Turkey, India) and the diffusion of new technologies: tiltrotor, compound and unmanned systems. No new large military programmes are expected in following years in Europe or in the United States, partly offset by growing demand in other regions. However, it should be pointed out that, over the medium/long term, the American JMR/FVL programme will become increasingly important, as it will allow the development of a new generation of helicopters able to meet the most advanced operational requirements (speed, range and rate of climb). The JMR demonstrators of Lockheed Martin and Bell Textron will flight during 2017.
Electronics, Defence and Security Systems
The Defence Electronics market shows an overall value of more than €bil. 900 over ten years, characterised by a growth rate of about 2%. The main trends in the Electronics sector are:
- Airborne & Space Systems: the growing demand for: (i) integrated electronic warfare systems for both new platforms (F-35, J-11B/SU-27, etc.) and the modernisation of platforms already in service owing to the delay in some programmes for new systems; (ii) new AESA (Active Electronic Scanned Array) combat radars for the Typhoon, Gripen aircraft and new programmes such as F-35, the Chinese/Russian aircraft J-11B/SU-27 and the new Chinese domestic fighter aircraft; (iii) Precision Strike Capability systems (EO/IRST); (iv) highly performing mission systems (Helmet Mounted Display and Glass Cockpit Suite); (v) Integrated Communications systems for manned and unmanned platforms; (vi) interoperable systems for airspace safety and protection of forces; (vii) integrated Simulation and Training solutions (Integrated Live, Virtual & Constructive);
- Land & Naval Defence Electronics: the land defence electronics market is characterised by a growing demand for: (i) integrated, interoperable solutions for the upgrading of C4ISR systems, also by means of the digitalisation of the battlefield and Network Centric Warfare (NCW) solutions; (ii) fast-deployable Active Electronically Scanned Array (AESA) radar systems for both air defence and countering missile threats from Tactical Ballistic Missiles (TBM); (iii) Counter-IED (Improvised Explosive Device) solutions for peace-keeping and peace-making missions; (iv) Radio Frequency (RF) systems which can be easily integrated in Command and Control (C2), Electronic Warfare and Communication solutions. In the naval defence electronics market there is growing demand for (i) multi-functional fixed or rotating panel AESA radars for warships and anti-submarine warfare; (ii) CMS systems and sensors for coastal patrol ships on terrorism and illegal immigration countering missions; (iii) logistical support services for military units (Life Cycle Management);
- Security & Information Systems: the market shows an overall value of about €bil. 1,000 over ten years, with a growth rate of about 3%. The main trends in the Sector arise from the growing need (i) to enhance the security of critical sites and infrastructures (Energy & Utility, Oil & Gas, Airports); (ii) to monitor land and sea borders; (iii) to provide services and solutions which create a collaborative and interoperable information environment for companies operating both in the Defence/Government and in the Industrial areas. Cyber security goes across all segments;
- Defence Systems: the target market shows a total value of about €bil. 340 over ten years, with a growth rate of about 5%. It is estimated that the land segment of this market will show an overall annual average growth rate of more than 20%, mainly as a result of the review of the Armed Forces’ technical requisites, due in turn to the evolution of the international operational scene, in which there are both conventional and hybrid conflicts. In this context, some segments (tracked vehicles) will be characterised by even higher rates (+33%). The naval segment is characterised by lower growth rates, which can be estimated at around 10% per year. The land vehicles and weapons segment is worth about €bil. 80; in the short-term the business segments that expect an improved growth trend are those of Tracked Vehicles (above all for an improved contact patch and the possibility of operating on difficult terrain) and of MBT (for the higher firepower and an improved protection). In the naval weapons segment (with a value of €bil. 13 over ten years), the greatest opportunities are tied to the development of guided munitions systems to be used, above all, in coastal operations, which can guarantee a degree of accuracy comparable with that of a missile but with considerably lower costs. The value of the conventional munitions segment is about €bil. 27 over the next ten years, plus an estimate of about €bil. 14 over ten years for the guided munitions market (for sea and land use). The value of the underwater systems segment is €bil. 20 over ten years and includes heavy (launched from naval platforms) and light (also launchable from air platforms, particularly rotary wing aircraft) torpedoes, ATDS counter-measures and sonar systems on board surface ships. Finally, the missile systems market will experience a slight increase, worth an estimated total of about €bil. 210 over the ten years. The primary application segment relates to air defence systems, both land-based and on-board naval platforms, to counter conventional and/or nuclear air threats. The need to have new systems that provide greater versatility and interception precision and to also protect urban areas and high-value civilian and military infrastructures are the main drivers in this market. The market for effectors to counter surface attacks, from both air and sea platforms, is another strong component of the market (25-30%) which is rising both in terms of demand for high-performing and/or flexible products and for more conventional systems which are required in big volumes and employed in large quantities in the current conflicts.
The demand in the sector of space systems and services shows an overall value of €bil. 970 over ten years, about 60% of which consists of manufacturing (satellites and probes, launch and space access systems, orbiting infrastructures). The development trend in the sector is diversified, with growth rates of about 1% for manufacturing, supported by civil and military government investment programmes, and of about 7% for services. The private component of investments in the sector continues to mainly involve the replacement of in-orbit assets of satellite operators, although some projects initiated by start-ups or new entries to the sector which look in the direction of constructing innovative infrastructures (among which constellations of small satellites stand out) are becoming increasingly concrete; another development is the procurement of services offered by commercial aerospace transport companies and companies which refuel the International Space Station.
The industrial growth continues to mainly depend on institutional programmes that are promoted and operated by space agencies and governmental entities, including both national (e.g. NASA, Italian Space Agency, Ministry of Defence) and international (ESA, EU) entities. On the contrary, the component of demand for services in the aerospace sector is mainly generated from the commercial sector, in particular for telecommunications (TV Broadcasting, broadband, mobility services, etc.). Globally speaking, the development of aerospace capacity and infrastructures is still one of the priority objectives of emerging countries in addition to that of the more developed countries. On one hand policies for developing aerospace activities support national defence or security programmes while on the other hand, through the formation of national agencies, they develop the expertise (also by means of technology transfer projects) necessary to create their own national industry. The continuity of secure strategic telecommunications systems, and, above all, of observation systems, is at the heart of demand for military equipment. Demand from the institutions is also based on programmes for scientific, exploration, meteorological and navigation applications, which may be also based on the use of mini-satellites. In the space services segment, there has been growing verticalisation of telecommunication activities. Specifically, it is seen that satellite operators are supplementing their traditional work of providing satellite capacity by providing users with integrated systems which deliver end-to-end services together with applications solutions based upon the acquisition and processing of data from a variety of sources (satellites, traditional and unmanned aircraft, ground-based systems) or different technologies (broadband satellite communications, digital terrestrial, communication networks, etc.).
Competitive positioning of Leonardo
With reference to the scenario described above, Leonardo sets itself to strengthen its positioning in the more attractive markets in which the portfolio of its products can benefit from its specific competitive advantage. An analysis of its present competitive position, based on these two dimensions (an attractive market and the portfolio’s capacity of penetration), leads to the following considerations regarding the various business sectors.
In the military aircraft segment, the Eurofighter is strengthening its position in export markets, following the Kuwait contract and new developments (E-SCAN) which tend to contribute to an increase in operational capacity and performance, while the M346 aircraft is confirming its leading position in the trainer aircraft segment, thus supporting the launch of new versions and developments (Dual Role M346, M346 FA) and new models (M345 HET), as well as the evolution of supply towards complete training systems. In the tactical transport sector, note an optimisation of production activities to the benefit of more competitive costs, with interesting prospects of new developments, including in the dual use segment. In the civil aircraft segment, ATR is still the market leader in the segment of regional transport aircraft, with the objective of strengthening the positioning with a continuous improvement in products and customer support, while the aerostructures segment is reaping the results of the action that has been taken to increase industrial returns in an attractive market, with a medium/long-term visibility.
The Group is still the leader in the Intermediate class of civil/dual-use Helicopters and is also making gradual progress in the Light Intermediate and Medium classes as a result of the completion of the concept of “product family” (AW169, AW139 and AW189) and is also laying foundations for the strengthening of the Light segment. In spite of a lack in major acquisition programmes in the military segment on export markets, important commercial targets were successfully achieved on domestic markets, which are further strengthened by a complete range of services and training and by the development of the new exploration and escort helicopter for the Italian Army (NEES), which uses the AW149 dynamic systems mentioned above. A critical success factor is to enrich the product portfolio by developing new versions, exploiting dual-use solutions and technologies (AW169M, AW139M and AW609 tiltrotor) and working on unmanned and optionally piloted aircraft.
Electronics, Defence & Security Systems
In the sector of Airborne & Space Systems, the leadership has been gained in some segments, such as Radars and Electronic Warfare, thanks to valuable collaboration projects in domestic market countries, which can be utilised to maximise profits and help expansion in neighbouring countries and to foster outlets on international markets. In the segment of Naval Systems and Defence Systems Leonardo has benefitted from major developments linked to the Naval Law, which has entailed an extension and a considerable updating of the existing product portfolio and the overall system capability, thus improving the company’s positioning in the related market segments. In the Information Security Division Leonardo has strengthened its role as an international player in solutions concerning security inside and the protection of vital infrastructures, taking advantage of the Command and Control expertise and has also strengthened its position as a main operator in the Cyber Security sector, thus expanding this business through new services, such as analytics & intelligence, but also through the development of native cyber embedded solutions within its proprietary products.
The Space sector in the segment of services is present in markets in which satellite telecommunications and geo-information services on the whole are expanding, while the system operation segment is rising at a lower growth rate. Telespazio has consolidated its position as leader in the management of the big European systems’ operations, starting from its leadership in Italy. Last December it won the European tender for the selection of the Galileo System Operator (GSOp) against competition from the other main European operators in the sector. In the telecommunications sector, Leonardo’s position is one in which there are opportunities for growth by offering a range of services based on high-capacity satellite systems. In the geo-information sector opportunities for improving its position come from the consolidation of its role as supplier of applications solutions for priority vertical markets, in particular the new applications for defence/security purposes, which are able to build on the capacity of the new-generation Cosmo constellation and the development of data access infrastructures and platforms.