Aerospace and defense suppliers are facing increased financial stress driven by growing demand for weapons systems and critical defense capabilities as Middle East disruptions from the Iran War continue, according to a white paper by financial health data and analytics firm RapidRatings.
The U.S. military’s rapid scaling has placed increased pressure on domestic suppliers as they work to maintain operational readiness with the resources, materials and finances required to meet the demand. At the same time, the Strait of Hormuz blockage has contributed to rising costs and created a volatile energy market.
RapidRatings conducted a stress test on 3,112 public and 1,197 private aerospace and defense suppliers across 30 manufacturing industries, including aerospace, semiconductors and other electronic components, computer systems design and related services, and bolts.
The stress test resulted in high and very high risk rising from 17.6% to 20.3%, a 2.7-percentage-point deterioration across all aerospace and defense suppliers, according to the white paper.
When it comes to public versus private companies, private companies are “significantly more stressed,” with the share of high- and very-high-risk companies increasing from 22.1% to 26.7%. Public companies saw 15.9% to 17.9%.
However, specific energy-intensive and materials-dependent sectors bear the heaviest stress: Petroleum and coal at 21.9% and iron and steel at 26.1%. Whereas nonresidential construction’s stress exhibited “catastrophic” high risk and very high risk escalation at 30.8%
At the same time, the aerospace products and parts manufacturing sector demonstrated “meaningful” deterioration at 6.1%, rising to 29.5% and placing it in the high-risk category.
One of the scores RapidRatings assessed is the core health score, which looks ahead two to three years at how efficiently a company is running, James Gellert, the firm’s executive chairman, said in an interview.
The firm looked at a supplier’s efficiencies, such as cost structure, working capital upstream and downstream and tallied up the score on a 100-point scale, Gellert said. The company took that score and modified it for other factors such as leverage, liquidity, earnings and performance to create a one-year, forward-looking measure of default probability, which is also on a 100-point scale.
“We’re looking at a portfolio of companies, [and] the percentage distribution across the different risk categories is very important, and the evolution of risk in that portfolio over time is extremely important,” Gellert said. “So if you look quarter to quarter to quarter and you see a degradation of the overall risk profile of one company's portfolio, or some group of companies, that's obviously concerning and something that needs to be looked at really carefully.”
From there, RapidRatings organized the scores across five categories: very low risk, low risk, medium risk, high risk, and very high risk.
Companies that score 20 points and below are at very high risk, while those that score 40 points and below are considered high risk, according to the white paper.
“A company that’s rated in that zone doesn’t mean they’re going to fail, but it does mean that they are at a much higher risk and that the characteristics of the business are riskier,” Gellert said.
In the stress-testing case, RapidRatings saw risks increase across public and private companies, shifting from mostly medium risk to high or very high risk, Gellert said. However, there’s a greater risk for private companies.
Still, it’s “not all doom and gloom,” Gellert added. “The percentage of companies that are low risk or very low risk increased, and that’s something we can hang our hat on.”
Communication and clarity
Defense companies that are the closest to the government, budget allocation and specs need to communicate with their suppliers “more than they ever have before,” Gellert said.
“This is paramount,” Gellert said. “They have to be able to say, ‘This is what we’re anticipating, and this is how we are going to help you to surge if we need you to surge.’”
This involves working capital, he added. Some of the supply chain problems RapidRatings has seen over the last few years involve cash conversion cycles that have been pushed out as much as 40 to 45 days.
“That means the private companies in the middle market have been the shock absorbers for working capital over the last few years,” Gellert said. “So their end customers, the bigger buying businesses, need to communicate and need to help with working capital and not overorder, and they need to be helpful with inventory and inventory storage.”
Clarity also needs to come from the Department of Defense, which Gellert said is “the most rare commodity” in the current market around the defense and aerospace industries.
“The Department of War is not going to be clear unless they're told to be clear,” Gellert said. “And the White House is not going to be clear unless they know what the objectives are and are being fed the right information to get to a conclusion quickly.”
Another solution that could help the aerospace and defense suppliers: “Ending the war,” Gellert said.
Correction: This story was updated to reflect the points denoting high- and very high-risk measurements in RapidRatings’ report.
