COVID-19: What it means for the aerospace and defense industry

Practical steps for responding to the coronavirus crisis

The COVID-19 pandemic has plunged the global airline industry into an unprecedented crisis as airline bookings plummet in response to regulation, and business restrictions on travel increase. Safeguarding consumer and workforce health is priority number one among businesses and governments. Toward that aim, continued reduction in air travel will most likely (and necessarily) persist for a prolonged period.

The crisis raises a number of unique challenges. In PwC’s inaugural COVID-19 CFO Pulse Survey, finance leaders in the United States and Mexico shared their top concerns.

Issues:

Airlines will likely face a continued downturn in commercial travel and revenue. They will also likely face cash-flow liquidity challenges and difficulty managing debt obligations. Some airlines may struggle to recover — and even declare bankruptcy — depending on the effectiveness of government intervention, and how long the COVID-19 crisis lasts. 

The tumult in the commercial airline industry may well have secondary and negative effects on producers of aircraft via a decrease in new aircraft orders — or canceled existing ones. Reduced demand for materials and components will likely affect not only the OEMs, but also likely ripple throughout the supply chain to suppliers.

Given the unknown variables in how the COVID-19 pandemic will play out and when containment will be achieved, the commercial airlines should expect to brace for a trying period and plan for a recovery that may not arrive for at least one year, given prior crises the industry has experienced. 

While demand for the products of US defense companies may be protected by government purchasing, they may nevertheless experience supply chain disruptions due to financial impact on partners and suppliers that may have to slow or halt production as in the case of two F-35 facilities in Italy and Japan that paused production.

Steps to consider:

• Assess how profitability, loans, revolving credit and cash flow reserves can support ongoing operations in a low-revenue environment — in light of current (and forecasted) cash operating expenses, taxes and other cash expense items. 
• Review capital and corporate cost budgets to identify not only marginal investments, but also discretionary items that can be cut. 
• Revisit your capital allocation and cash flow plans (and forecasts) to conserve cash during the period of uncertainty, as aircraft and air travel demand will likely be impacted for a prolonged period. This should include reassessing dividend and share repurchase plans.
• Consider divesting non-core or underperforming assets or assessing mergers and acquisitions (M&A) prospects as a potential source of cash.
• Consider refinancing debt.
• Urge and help coordinate government support through a package of initiatives, including guaranteed loans, deferred taxes and similar measures. At the same time, urge relevant government agencies to increase intergovernmental coordination and collaboration to help protect the industry from bankruptcy risks.

Issues:

A&D companies are likely to need to establish immediate and contingent safety measures for their employees and decide which functions can be carried out remotely should an outbreak occur within their ranks.

The sector should also expect a prolonged economic downturn that may require staff reductions and related measures. 

In the event that widening outbreaks of COVID-19 affect workers, A&D companies may need to outsource some corporate functions (e.g., moving IT to the cloud or shifting internal non-core operating functions to contractors). Such changes can lower operating costs as well as eliminate maintenance capital expenditures.

Steps to consider:

• Ensure your employees are safe and know how to protect themselves. Establish (or reinforce) sanitation rules in the workplace and assess mobility policies to encourage remote working where possible and necessary. Require employees who are sick to stay home until they are better. Eliminate nonessential travel.
• Discuss change management and flexible work arrangements.
• Assess strategies and plans to retain and deploy your workforce during the slowdown and establish risk mitigation programs for employees who still need to work on-site.
• Consider ways to automate tasks to minimize person-to-person contact
• Gather necessary data on employees (geography, visas, etc.) and track employee movements during the crisis.
• Outsource functions that can trim operating costs.

Issues:

Commercial aircraft producers should expect continued weakening links in their supply chain, as some vendors and suppliers will likely face operational or financial struggles of their own. Brace for continued supply chain bottlenecks, both nationally and internationally.

Because of existing regulations and controls, US defense companies can expect their supply chains to be less vulnerable to global disruptions compared to producers of commercial aircraft.

As in previous downturns, the industry will likely move quickly to cut discretionary and capital spending to support operations. A key question for all A&D  companies will be: Do you have the financial reserves to successfully ride out — or even capitalize on — the tumult in the industry?

Steps to consider:

• Gain a keener, more real-time situational awareness of your supply chains. Assess all links in your supply chain and identify potentially weak ones — especially in geographies now affected and those that are prone to be impacted by COVID-19.
• Prepare for supply chain pivots that could mean identifying alternative suppliers.
• Improve your supply chain visibility and lines of communication to help detect and remediate potential problems early. If you don’t have digital supply chain transparency solutions in place, create greater transparency through daily self-reporting with all critical suppliers. 
• Keep an open and regular dialogue with your suppliers and customers on how they’re being impacted by COVID-19 and how their experiences could affect your business.
• Seek alternatives that allow you to preserve relationships, co-create solutions and sustain both businesses. It’s possible that a third-party provider may prove to be a critical point of failure in creating a response to COVID-19.

Issues:

If governments don’t provide support to commercial airlines to offset the economic hit they’ll take from COVID-19, they’re likely to face an A&D financial crisis on top of the public health emergency. Expect companies to be working hand-in-glove with both the IRS and foreign tax jurisdictions to mitigate the financial toll tax obligations could place on an already beleaguered industry. 

After 9/11, the US government supported commercial airlines with a $5 billion aid package and $10 billion in loan guarantees. This time around, the A&D industry is not only facing a more prolonged crisis, but also some uncertainty about how the government will provide financial assistance. In light of the uniqueness of this crisis, however, the government may explore options such as extending lines of credit, reducing infrastructure costs, short-term funding, lowering the tax burden and offering supply chain assistance. 

Multinational companies should expect potential cash flow constraints from overseas operations — including cash repatriation complications and irregularities. Cash could also be bottlenecked when goods are paid for but not supplied (due to being  delayed and stranded). Such cash bottlenecks will likely occur in geographies most affected by COVID-19.

Steps to consider:

• Address mobility and immigration issues for employees moving in and out of areas affected by COVID-19. Consider the tax implications of mobility. Depending on where you temporarily host employees, the company — and the employees — may face unintended consequences.
• Prepare and plan for different types of support governments may extend, from emergency funding to state guarantees of new loans to tax incentives or deferrals. 
• Plan strategically. Government assistance in one part of the industry, such as commercial airlines, may help ease pressure on another part of the industry, such as, defense. Assess which countries your company is most vulnerable in — both in repatriating cash and in stranded assets. Monitor and reassess other geographies on an ongoing basis and adjust your cash flow strategies as needed.
•  Carefully consider the tax and transfer pricing components of any global supply chain restructuring.

Issues:

Disruption in the sector will lead to numerous financial disclosure implications. While no sector will likely be unaffected by COVID-19, the impact on A&D could be especially punishing. Stakeholders are making it clear they expect transparency from the industry and disclosures about actual and anticipated impacts and, most important, the risks and vulnerabilities to their business. 

Steps to consider:

• Broaden disclosures to go beyond what’s required in financial statements. For example, you might consider disclosing management’s analysis of the current and future impact of liquidity and a potential credit crunch on the business.
• Consider both direct and indirect effects. The airline industry is part of an extensive ecosystem of suppliers and  partners, as well as businesses supported by airports.
• Plan for disclosures about risks, such as how recent events may impact current and future judgments and estimates inherent in financial reporting (e.g., inventory obsolescence, receivables collectibility, debt covenants, impairments)
• Proactively communicate with lenders and other stakeholders to head off surprises and enable potential rescheduling of debt or alternative financing sources.