Transport Equipment Sector Report & Analysis

Faster production has increased deliveries and reduced backlogs

SENSITIVE RISK FOR ENTERPRISES

Last Update: July 2024

Strengths & Weaknesses

High pricing power since there are few manufacturers capable of engineering and building tailor-made transportation equipment, particularly in aviation (an oligopoly with very few well-recognized players).
Lot of growth potential for the transportation sector in general, especially for the rail transportation market, with governments looking to encourage green mobility.
In some cases, construction contracts are signed with governments (state-owned transportation companies), which gives greater reliability of repayment.
Construction periods for transport equipment tend to be long (several years), allowing companies to anticipate production capacity and forecast income in advance, and therefore better manage working capital.

Very capital-intensive sector as it is necessary to invest both in R&D (design and engineering of state-of-the-art models) and in capex and infrastructure for the construction and assembling of the equipment to be sold.
Highly leveraged sector. Given the large size of contracts and how expensive manufacturing is, companies require a high level of disposable working capital over the construction period as in most cases they will be fully paid only on delivery.
As steel and aluminum are the main metals used for the manufacturing of trains, airplanes and vessels, profitability is vulnerable to commodity price volatility, though sales are agreed on a fixed-price contract basis.
A market that demands high precision, high-quality finished products and safety. Any failure of a structural component, manufacturing defect or accident can have huge negative consequences for both the operator and the manufacturing company.
Cyclicality: demand tends to accelerate in economic boom periods when transportation companies can afford to enlarge their capex, while investments decrease significantly during economic slowdowns.

Sector Overview

What to watch ?

Stricter environmental regulations: In a society that is increasingly aware of the need to reduce CO2 emissions, the transportation sector is facing stricter international regulations (as it is responsible for around 25% of global CO2 emissions). For transport operators to achieve the green transition, transport-equipment manufacturers must invest even more in innovation so that they can create greener ships and aircraft. As a result, we expect new hydrogen-based or electric models to be launched in the aviation sector in the coming years, intensifying competition in an oligopolistic market where no player wants to lose market share.
Easing of supply chains: Industry-wide supply-chain bottlenecks have eased substantially in the past quarters, allowing for the faster delivery of transport equipment. Financially speaking, this is positive for companies’ fundamentals given that the backlog is transformed into finished products faster, meaning companies can enlarge their operating cash flow. Nevertheless, the aviation segment is still struggling on this front as some suppliers have been failing to cope with increasing demand, causing plane-makers to to fall short of their delivery targets.
Commodity prices: Prices of most metals gradually declined over 2023 (from the peaks of 2022) due to the gloomy economic outlook. However, there is still a lot of price volatility in the spot market. While steel and nickel prices have corrected significantly, aluminum and copper prices have been climbing recently. These cost fluctuations could have considerable repercussions on the sector's margins in the short-term.
Labor market: The “great resignation” movement and staffing issues observed in 2022 and 2023 (difficulty to find and recruit engineers and skilled workforce) have eased in 2024. However, in the aviation industry, raising labor costs have become a new challenge, with companies having to raise salaries to retain competent employees.
Disinflation: Concerns around persistent inflation have been declining, with some improvements on both sides of the Atlantic. In the US, we expect inflation at 3.0% in 2024 (from 4.1% in 2023), and in the Eurozone 2.4% (from 5.4%). Nevertheless, higher-for-longer interest rates could affect companies’ financials as this sector in particular tends to be highly leveraged.
Space race: We expect the competition to develop spacecraft to intensify in the coming years, with new Chinese players entering in the market as well. Countries with high investment capacity in innovation and R&D such as the US, Europe, Russia and China will continue running the race to find solutions that will allow transportation to the space/moon.
Growing defense market: Companies in the aviation and maritime sectors have been increasing their market share in the defense segment (military helicopters, jet fighters, aircraft carriers, submarines, etc.). The US, Russia and China spend the most on military equipment.

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Aviation: Commercial aircraft deliveries have improved in 2023 (+10% y/y) and are expected to climb by +12% in 2024. Although narrowbody airplanes are the best sellers in volume terms (accounting for 81% of annual global deliveries), widebody planes posted the highest growth rate in production last year (+15% y/y). However, aircraft makers are still far below the delivery levels seen prior to the pandemic as supply-chain challenges have persisted for longer, while Boeing has been struggling with quality/safety problems. This lower production capacity of brand-new planes has been positive for companies in the aftermarket, who have seen demand for parts and repair services soar.

Vessels: Ship prices continue rising in 2024 (tankers: +11% y/y, bulkers: +12% y/y and containerships: +6% y/y), thanks to robust demand as the global merchant fleet is aging (the average age of commercial ships exceeds 20 years). Old ships are not only less fuel-efficient but are also more polluting. As a result, shipping companies with old fleets are unable to comply with the stricter international standards for CO2 emissions. In the past two years, vessel sales have reached record highs and further growth is on the horizon, with revenues for 2024 and 2025 expected to remain above USD50bn annually, thanks to the large-scale fleet renewal that is in the pipeline. Indeed, shipyards around the world have announced that they are operating at their maximum capacity.

Trucks OEMs: Supply-chain constraints have improved, accelerating production rates and boosting delivery volumes after years of poor output due to a lack of supply. In Europe, for instance, new heavy truck registrations grew by +13.5% y/y in 2023. However, as new orders are not increasing at the same pace as the output, backlogs have been declining. Still, we can expect demand to start to increase for electric trucks as companies have to shift away from diesel-powered trucks.

Market practice in purchasing contracts: The manufacturing process of transport equipment is costly and time-consuming as it can take about 2-4 years to design and build a brand-new vessel, airplane or train. Because of the long duration of projects, there are risks throughout the process and a lot can go wrong. Therefore, purchase contracts often go hand-in-hand with insurance bonds (bid bonds, performance bonds and advance payment bonds). In many cases, the transportation company places an order for several units, which considerably enlarges the size of the contract. This is why we tend to see transactions backed by an export credit agency (ECA).

Backlogs: The large increase in capex of companies in the transportation industry during 2021 and 2022 led to a backlog in 2023 not seen before. However, backlogs have declined significantly in 2024 as output has improved, with companies delivering more and faster. In parallel, the weak economic context has caused new orders to slow down, making it hard for the backlogs to increase again.

New orders could increase in H2 2024. The weak economic outlook, notably for the US and Europe, has deteriorated business confidence. As a result, new order volumes have remained relatively weak in the past quarters, with transportation companies being cautious in terms of cash utilization. However, new orders could start to jump in the second half of the year in anticipation of interest rates cuts that could have a positive effect on the overall economy. For the mid to long term, the pressing need to decarbonize the transportation sector will keep orders rising, especially in the shipping and airlines industries.

Subsectors

Aircraft manufacturers (aeronautics): Companies involved in the design, engineering and assembly of any kind of vehicle that is manufactured to fly in the air, including planes (commercial and cargo planes, private jets, military jets and propeller planes) and helicopters (civil and military). The US and France are the world's largest producers of aircraft.
Shipyards: Companies that build and repair any type of water-transport vehicle, such as yachts, cruise ships, container and dry bulk vessels, military vessels, oil and chemical tankers, ferries, ice-breakers etc. By revenue, this market is vastly dominated by South Korean, Chinese and Japanese companies, followed by European companies.
Rolling-stock manufacturers: Companies involved in the entire process of designing, manufacturing, assembling and testing rolling stock. Wagons/trains can be used for both passenger and cargo transport and can be high-speed or not. This market is led by China and Europe.
Trucks OEMs: Manufacturers of trucks or camions, which are normally used for cargo transportation, for carrying other vehicles or dry-bulk commodities. Trucks vary in size, power and configuration. While most are still powered with diesel fuel today, electric trucks are gradually being introduced to the market.

Contacts

Maria Latorre

Sector Advisor

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Transport Equipment Industry Report