Costly Oil, Slumping Dollar Spell Trouble For Airlines, Aerospace Companies

In many ways, it's the best of times for the global aerospace, defense and airline industries. Production lines are humming at Boeing, Airbus and business aircraft manufacturers as they book orders at a record pace. U.S. defense spending has defied predictions of a slowdown. Almost every U.S. aerospace company outperformed Wall Street's profit expectations in the third quarter. And airlines are flying packed aircraft and generating profits.

But economic headwinds are blowing into this idyllic landscape, introducing tough challenges for key segments of the industry. In the U.S., record oil prices are threatening to short-circuit the airline industry's recovery, which might force carriers to further defer purchases of new aircraft. "If oil really is going to be at $100 a barrel, we've got to look at restructuring of the [industry] yet again," US Airways CEO Douglas Parker told investors this month at a Goldman Sachs conference. "I'm not certain that where we are today as a business we can handle $100 oil."

In Europe, the pressure is on aerospace manufacturers and suppliers, which sell their products in U.S. dollars but pay their employees in local currencies. In the midst of soaring sales and deliveries, Airbus's parent company, EADS, recently lowered its profit forecast for 2007 by $580 million—to zero. The dollar's decline has subtracted nearly $19 billion from the value of EADS's backlog during the past year.

The impact is even more painful in the export-dependent Canadian aerospace industry, where an unexpectedly rapid appreciation had the Canadian dollar trading as high as $1.10 this month, up from less than 90 cents earlier this year and 62 cents in 2002. "We were pushing productivity improvements to position our industry to be able to face parity" with the U.S. dollar, says CMC Electronics CEO Jean-Pierre Mortreux, chairman of the Aerospace Industries Assn. of Canada. "But no productivity plan or process improvement could compensate for a 25% valuation rise in just six months."

Looming in the background is a shaky U.S. economy, which could reduce demand for everything from business aircraft to airline travel and make it harder for carriers to raise fares to offset rising fuel costs. U.S. Federal Reserve Chairman Ben Bernanke is predicting economic growth will slow in the fourth quarter and into 2008, though he downplays fears of an outright recession.

And then there's defense spending. Though immune from economic downturns, conventional wisdom holds that the U.S. military will at best keep pace with inflation after President Bush leaves office in 14 months. "The base budget is likely to flatten out and wartime spending presumably will start coming down," says Steven Kosiak, vice president for budgetary studies at the nonpartisan Center for Strategic and Budgetary Assessments in Washington.

Put that all together, and it's not difficult to see why angst is rising in corporate suites on both sides of the Atlantic, despite sturdy airline profits and robust demand in commercial aerospace and defense. But the "pain points" vary widely by region, industry segment and company size. Among the key challenges:

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