0

MRO Market Update & Industry Trends

Presented by:

Jonathan M. BergerVice President Aerospace & MRO Advisory

jberger@icf.com

2016 Annual Conference

October 26-27, 2016

Orlando, Florida

11

Today’s Agenda

Bizarro Aviation The “CRABS”

Meet the Frackers

These are the Good Old Days

Follow the Money

Amazon the Air Cargo Disruptor

March of the Middle East Titans

A New Golden Age of Aircraft Cabin Interiors

MRO & OEM Alternative

Material Forecast

22

“Bizarro Aviation”

33

Four external

macro-economic

forces are having a

significant impact

on the aviation

industry and the

MRO supply chain

Source: ICF analysis

The “CRABS”

44

The dramatic increase

in oil & gas market

supply and reduceddemand for

commodities has led

to a strong US Dollar

Partially offsets the positive impact of low fuel costs for operators

Increases the cost of dollar based flight hour agreements (and parts/material in general)

Cost of labor for in-country MROs is cheaper driving up margins for US dollar based contracts

Buying/leasing aircraft becomes more expensive

FOREX Impact

Source: USForex, ICF analysis

The “CRABS”: Countries with economies that are

heavily dependent on commodity exports

Global Currency Exchange Rates vs USD% Value Change, September 2014 – September 2016

Russian Ruble-37.6%

Brazilian Real-24.6%

S. African Rand-19.1%

Can Dollars-15.3%

Aus Dollars-12.5%

Euro-11.7%

Indian Rupee-7.8%

Chinese Yuan-7.8%

-50%

-40%

-30%

-20%

-10%

0%

10%

B

R

A

SC

55

Commercial aircraft

OEM production

backlog remains at

historical record

levels driven by:

Source: CAPA, ICF Analysis

Commercial Aircraft OEM Production Backlog

0%

10%

20%

30%

40%

50%

60%

70%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Order

Backlog

Backlog/

% Active Fleet

Emerging market growth

Low interest rates

Previously high oil and

commodity prices

Introduction of new

technology aircraft/engines

66

Low fuel costs

appear to be

reversing aircraft

retirements trends

Source: CAPA, Airline Monitor, ICF analysis

Industry Impact:

MRO Suppliers - Positive:

Increased spend on older

airframes & engines

Surplus Market - Negative:

Reduced part-out “feed

stock”

- OEMs: Improved new

part sales

- Distributors: Improved

used part values /

pricing

- Operators: Increased

material costs

Commercial Air Transport Annual Aircraft Retirements

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

0

200

400

600

800

1,000

1,200

# Retirements

Retirement as % of installed fleet

% Installed

Fleet

1991-1999 Average: 203

2000-2009 Average: 473

77

Airline return on

invested capital

(ROIC) is clearly

correlated with the

drop in fuel costs

Source: IATA, ICF Analysis

Fuel Price as a % of Airline Operating Expenses

17%

22%

28% 30%

36%

28% 28%31%

33% 33% 32%28%

20%

0

20

40

60

80

100

120

0%

10%

20%

30%

40%

% of Airline

Operating

Expenses

Crude Oil

Price/BBL

88

Airline return on

invested capital

(ROIC) is clearly

correlated with the

drop in fuel costs

Source: IATA, ICF Analysis

Fuel Price and Global Airline Return On Invested Capital (ROIC)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

$0

$20

$40

$60

$80

$100

$120

$140

Jet Fuel Price ($/barrel) Airline ROIC (%)

Airline ROIC

Jet Fuel Price

$$$

99

Driven by low fuel

costs and

consolidation,

airline the industry

is on target to

achieve record

profitability in 2016

of almost $40B USD

Source: IATA, ICF analysis

These are the “good old days: - for

some airlines…

Global Airline Profitability, 1996 - 2016F

-$30

-$20

-$10

$0

$10

$20

$30

$40

$USD

Billions$39.4B

Asia Pacific, $7.8B

North America, $22.9B

Europe, $7.5B

Middle East, $1.6B

Latin America, $0.1B

Africa, ($0.5B)

1010

However, profit

margin

improvement has

been largely limited

to carriers in North

America

Source: IATA, ICF Analysis

-1.8%

-4.7%

0.1%

2.3%1.0%

-0.9%

3.4%4.7%

0.7%1.5%

3.0%

-0.4%

15.4%

8.4%

5.6%

2.6% 2.8%

-1.1%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

2008

2012

2016F

Global Airline EBIT Margin by Region

…but not all – many airlines continue

to struggle

1111

Brexit has clearly

had an impact on

European airline

stock performance;

specifically UK

based carriers

Source: Company websites

Share Performance of European Airlines Since Brexit

23 June 2016 – 13 October 2016

SAS, -6.3%

Lufthansa, -15.2%

Ryan Air, -16.2%

Norwegian, -16.5%

Wizz, -23.2%

Air France-KLM, -24.8%

IAG, -28.1%

Easy Jet, -41.5%

-50% -40% -30% -20% -10% 0%

1212

Follow the Money:

Airlines are

spending their hard

earned profits in

three primary areas

Source: Company Reports, ICF Analysis

Airline Profit Spend Analysis

Labor, 20%

Capex,38%

Investors, 42%

Profit Sharing15%

Wage Increases

5%Fleet23%

Equity Investments

5%

Other capex10%

Debt Repayments

16%

Stock Buy-Back &

Dividends26%

1. Labor ~ 20%:

Profit sharing

Wage increases

2. Capex ~ 38%:

Fleet renewal & cabin

upgrades

Facilities, offices, lounges

Equity partner investments

3. Investors ~ 42%:

Stock buy-backs

Dividends

Debt repayment

1313

After positive signs

in 2014, air cargo

supply continues to

exceed demand

Source: IATA, ICF Analysis

0.4%

-0.9%

0.6%

5.0%

2.3%2.1%

6.0%

3.0%

3.7%

5.4%6.3%

6.3%

-2%

0%

2%

4%

6%

8% Traffic (FTK)

Capacity (AFTK)

Global Freight Traffic (FTK) and Capacity Growth (AFTK)

Year-Over-Year Percent Change

(- $$$)

1414

$0

$5

$10

$15

$20

$25

$30

$35

$40

Amazon Quarterly Revenue

Amazon is very well

positioned to lead a

major disruption of

the air cargo industry

Source: Amazon SEC Filings

Amazon’s Growing Revenue & Shipping Costs

0%

2%

4%

6%

8%

10%

12%

14%

Shipping Costs as a Percentage of Revenue

$B

USD

1515

March of the Middle

East Titans:

Middle East carriers

have been very

effective in

capturing valuable

business passenger

traffic from

European secondary

airports

Source: OAG Data, ICF Analysis

European Secondary AirportsAverage Number of Seats per Departure in 2016

“…Lufthansa’s Frankfurt hub has lost nearly a 3rd of its market

share on routes between Europe and Asia since 2005, with

more than three million people now flying annually via Gulf

hubs” – The Economist

363

408 400 400 394

370

343

400 400

306

180

148128

146

121

163149

117135

149

100

150

200

250

300

350

400

450

500

Gulf Carriers Non-Gulf Carriers

1616

Trend Watch:

A New Golden Age of Aircraft

Cabin Interiors

1717

Modifications growth

is driven by airlines

seeking differentiation

in the cabin and

customer experience

Modifications demand includes labor and material spend

*Passenger-To-Freighter Conversions

**Airworthiness Directives / Service Bulletins

Source: ICF analysis, constant 2015 US$

MRO modification market

growth drivers include:

Premium lie-flat seats are

now the minimum standard

Premium economy

Wi-fi, on-board connectivity

Coming soon: ADS-B Mod

program

Capacity (ASM/K) increase

Commercial Air Transport Modifications Forecast

$2.7

$4.9

$0.6

$1.1

$0.4

$0.5

$0.4

$0.4

$0.3

$0.5

$0

$1

$2

$3

$4

$5

$6

$7

$8

2015 2025

AD/SB**

PTF Conversions*

Painting

Avionics Upgrades

Interiors

$4.4B

$7.4B

0.0%

3.7%

6.9%

5.9%

CAGR

5.3% Avg.

3.6%

$USD

Billions

1818

Cabin “densification”

has emerged as cost

effective strategy for

airlines to increase

capacity and drive

bottom line growth

2015 - 2025 Capacity Bridge

0 2 4 6 8 10

2025 ASMs

IncreasedSeat Density

Longer StageLengths

Fleet Growth

2015 ASMs

Available Seat-Miles (ASMs), Trillions

6.2T

8.8T

84%

8%

8%

12 Seats 16 Seats

130 Seats120 Seats

Total = 150 Seats

Total = 164 Seats

Example: Delta A320 Interior

Modification Program

New seats, outlets, IFE, overhead bins

Space-saving galleys to add a row of seats

Source: ICF analysis, delta.com

18 Seats18 Seats

Cabin Upgrades:

Slim seats

Slim lavatories

Slim galleys

Slim coat closets

1919

MRO Forecast

2020

The current

commercial

air transport fleet

consists of over

27K aircraft; over

half are narrowbody

aircraft

Source: CAPA 2015

NarrowbodyJet

WidebodyJet

Turboprop

Regional Jet

27,114

Aircraft

14%

53%14%

19%

By Aircraft Type By Global Region

North America

Asia Pacific

Europe

Latin America

Middle East

31%

27%

25%

8%

5% 5%

27,114

Aircraft

2015 Global Commercial Air Transport Fleet

2121

The combination of

strong air travel

demand and the

need to replace

ageing aircraft will

drive fleet growth at

a healthy 3.4%

annually

Source: ICF analysis: CAPA 2015

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2015 2025

Africa

Middle East

Latin America

Europe

Asia Pacific

North America

27,100

31% 26%

37,900

27%

25%

8%

32%

23%

8%

# Aircraft

3.8%

2.5%

1.6%

5.2%

5.3%

5.1%

CAGR

3.4% Avg.

5%

6%

10 Year Global Air Transport Fleet Growth

2222

Current commercial

air transport MRO

demand is $64.3B;

with Asia equivalent

to North America

and Europe in

market size

Source: ICF analysis; Forecast in 2015 $USD, exclusive of inflation

Engines

Components

Line

Airframe

Modifications

14%

17%

22%

40%

7%North

America

Asia Pacific

Europe

Middle East

Latin America

Africa

29%

28%

26%

8%

6%4%

$64.3B$64.3B

By MRO Segment By Global Region

2015 Commercial Air Transport Global MRO Demand

2323

The global MRO

market is expected

to grow by 4.1% per

annum to $96B by

2025

Source: ICF analysis; Forecast in 2015 $USD, exclusive of inflation

Engine and component MRO markets remain the largest segments

Modifications market will see the strongest growth (e.g. interiors, connectivity)

Airframe market slows due to reduced man-hour intensity and increased check intervals as new fleets are introduced

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

2015 2025

Modifications

Airframe

Line

Component

Engine

40%

22%

14%

17%

$64.3B

$96.0B

2.8%

3.6%

4.3%

4.4%

CAGR

4.1% Avg.

5.3%

41%

22%

16%

13%

10 Year Global Commercial Air Transport MRO Demand Growth

$USD

Billions

2424

There two primary

reasons operators

are aggressively

seeking non-OEM

supplied parts;

Three alternatives to purchasing

OEM-supplied parts:

1. Cost savings

2. Part availability

Source: ICF analysis

PMA

PMA (Parts Manufacturer

Approval) is approval

granted by the FAA to a

non-OEM manufacturer of

aircraft parts

Two types of PMA:

1. Licensed

2. Competitive

DER Repair

DER (Designated

Engineering

Representatives), FAA

approved engineers

who can approve

technical data for

repairs and

modifications outside

the CMM

Design Organization

Approval (DOA), a

blanket approval for an

MRO organization to

develop internal

repairs

Surplus

Three types of surplus

material:

1. Used Serviceable

Material (USM)

2. New Material

3. Used, unserviceable

material

Lower HigherPerceived Risk

2525

The alternative

material market is

concentrated on the

back half of mature

aircraft lifecycle (17-

25 years old aircraft)

and early sunset

aircraft

Source: ICF analysis

* New: CFM56-5B / V2500-A5 / PW6000

Old: CFM56-5A / V2500-A1

MATURE

737-1/200

747-1/2/300

747-8

A380

10 250

DC10

A300

A320*

(Old)

CRJ-1/2/400

777

A340

SUNSETGROWTH

737-3/4/500

747-400

767757

A300-600/310

MD80

ERJ-140

MD11

787

SSJ 100

CRJ-7/9/1000

ERJ-170/190

777-2LR/3ER A320*

(New)

Years since Entry into Service

Limited OEM

Alternatives

Healthy OEM

Alternative

Market

Growth

Phase

737 NG

A350

A320neo

Alternative

Material

A330

Bubble size

proportional

to MRO

spend

2626

In 2015, operators

spent over $32B on

OEM new parts and

an additional $13B

on alternatives

2015 OEM New Material Demand vs. Alternatives

$0B

$5B

$10B

$15B

$20B

$25B

$30B

$35B

OEM new Alternatives

OEM Manual

Repairs

DER Repairs

PMA ($0.54B)

Source: ICF analysis

~ $13.4B

~ $32.4B

$2.2B

$3.9B Surplus

$6.8B

41%“…the OEM’s increasingly tight grip on

the aftermarket means Delta’s spares

costs double about every seven years.”

“Without TechOps parting-out engines

to bolster spares and coming up with

other alternatives to OEM-supplied

support, that increase could be even

steeper…”

…“We’re pretty good at sourcing

outside the OEMs…and we’re always

working to develop those alternatives.”

- Richard Anderson

CEO Delta Air Lines

Keynote Speech, MRO Americas

April 2013

2727

There are nearly 1.1

million total PMA

parts that are FAA

approved, of which

over 75% are for

Boeing aircraft

Source: Federal Aviation Administration

Boeing76%

Airbus15%

Bombardier3%

P&W1%

Other5%

1,077,971

FAA Approved PMA Part Numbers, by OEM

2828

The volume of

PMA approvals has

been steadily

growing since

1990, with over

about 440,000 new

approvals granted

since 2011

Source: Federal Aviation Administration

41,030

85,238

204,570

301,905

420,051

22,421

0

100,000

200,000

300,000

400,000

500,000

FAA Approved PMA Part Numbers, by Year Approved

2929

Surplus material

usage has risen

sharply over the

past few years,

driven by tangible

cost savings and

minimal perceived

risk

Source: ICF analysis

OEM New As Removed /

Unserviceable

Used Serviceable

Surplus

New

Surplus

Typical Material Price Bands, By Part Type%

OEM List

0

20

40

60

80

100

120

PMA

“Surplus parts have increased the

demand for component DER…

because the unserviceable

surplus parts must repaired. The

biggest customer for DER is

ourselves.”

- Major PMA / DER

Supplier

Lower HigherPerceived Risk

OEM Catalogue List Price

3030

Numerous regional

factors influence

operator PMA

consumption to

include:

Source: ICF analysis

Estimated PMA Demand by Major Region

46 - 56%

5 - 8%12 - 18%

28 - 38%

4 - 7%

Virtually every major carrier leverages PMA

parts as an OEM alternative

Fleet age

Mix of lease vs owned aircraft

Technical capability & experience

Airline procurement historical practices and culture

3131

In order to control and reduce material spend, airlines

must have a comprehensive OEM alternative strategy

PMA parts, DER repairs, and surplus material are

valuable material sourcing solutions that drive

tangible cost savings and improve part availability

Safety concerns with regards to OEM alternative

material usage have demonstrated to be meritless;

yet clearly perceptions of risk remain

As long as certain airlines continue to have restrictive

PMA policies, Lessors will continue to include

conservative language in their lease agreements

Continued education is the only solution

In Summary…

32

For questions regarding this

presentation, please contact:

Jonathan M. BergerVice President Aerospace & MRO Advisory

jberger@icf.com +1 404.819.7669

THANK YOU!

2016 Annual Conference

October 26-27, 2016

Orlando, Florida

3333

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