Analysis: After jet slump, Cessna looks for margin lift
WICHITA, Kansas (Reuters) - At Cessna's main corporate jet plant in Wichita, Kansas, workers used to build four wings at a time until an analysis commissioned by new CEO Scott Ernest found it could shave $1 million in inventory and boost productivity by focusing on just two wings at a time.
The change was implemented in March and is an example of the scrutiny Ernest has put on operational efficiency since he took charge a little over a year ago. And it is a big reason why Wall Street is bullish on the turnaround effort at the Textron Inc-owned (TXT.N) unit, even as demand for corporate jets remains far below pre-recession levels.
Ernest and his boss, Textron CEO Scott Donnelly, adopted an approach learned at their former employer, General Electric Co (GE.N): Make sure that even the smallest pieces of a business are responsible for their own profitability.
"When I first got here, I asked: 'Who's got responsibility for the profitability of these products?' And everybody said: 'You do,'" Ernest said in an interview last week. "And I said: 'Wait a minute, there's got to be more people accountable than just me.'"
Improving margins is only Ernest's first challenge. The company has also unveiled two new, larger jets that can fly longer distances, targeting a growing segment of the market where Cessna has lagged behind General Dynamics Corp's (GD.N) Gulfstream and Canada's Bombardier Inc (BBDb.TO).
The jury is still out on whether these two new jets - called the Latitude and Longitude - can help Cessna claw back lost ground, but Wall Street's assessment of Ernest's first year on the job has been largely positive.
When Textron, which also makes Bell helicopters and EZ-Go golf carts, reported a second-quarter profit last month, it beat analysts' forecasts in part thanks to Cessna. The unit reported an operating margin of 4.6 percent of sales - about a percentage point higher than investors expected and up dramatically from an 0.8 percent margin a year earlier - in part reflecting Ernest's focus on profit and loss within Cessna.
"They've been focusing more on P&Ls and how everything they do affects their revenues and their expenses, and thus profits," said Perry Adams, senior vice president of Huntington Wealth Advisors in Traverse City, Michigan, which holds Textron shares. "That's an important piece, in terms of being able to manage their segments properly."
PULLING OUT OF LONG SLUMP
The corporate jet market cratered in 2009, when the recession pounded demand for light jets. Global sales of business jets have recovered slowly, coming in at $15 billion last year, down 29 percent from a 2008 peak, according to a well-regarded market report by Honeywell International Inc (HON.N), which makes engines for business jets.
The slump hurt financial results at Cessna and its rivals, including Gulfstream, Bombardier and Brazil's Embraer SA (EMBR3.SA), and sent cross-town rival Hawker Beechcraft into bankruptcy in May.
Cessna, whose jets were smaller and had shorter ranges than its competitors, was particularly hard hit. Its sales tumbled to $2.56 billion in 2010 from a $5.66 billion peak in 2008 and recovered slightly to $2.99 billion last year.
The company cut thousands of jobs and employs about 8,500 people today, down from a pre-financial-crisis peak of 15,000. Those cuts came before Ernest joined the company. His focus has been on improving operations at Cessna factories to build aircraft in an average of 60 days, rather than in 100.
But even as Cessna slashed its workforce, it did a poor job of tracking how much it was spending on projects such as redesigning latches and other small parts that improved jet performance, but did not really spark customer enthusiasm.
One of Ernest's first moves was to carve Cessna into five units: jets, propeller planes, maintenance and service, military sales and an air-charter unit. Each is run by an executive accountable for whether the unit reports a profit or loss.
"When you get a guy who's responsible on that, pretty soon he's knocking on doors and saying why are you charging my program?" said Brad Thress, who heads the jets business. "Just by having that visibility, we see significant reductions in costs that were previously less controlled than they should have been."
Cessna has also revamped the way it stores parts. Rather than having 33 separate storage locations, some no bigger than a cabinet, scattered across its production floor, it now has a central warehouse and sends parts to the production line in prepackaged kits, with the correct kind and number of bolts, nuts and other pieces needed to assemble a specific section of an aircraft. That shift both speeds production and cuts down on lost pieces, Cessna executives said.
Ernest's other big push has been to move Cessna into large aircraft capable of traveling longer distances. Both the Latitude and Longitude have six-foot-high cabin ceilings, enough to allow an average-sized adult to stand up in the aisle, rather than to stoop as is necessary in most of the company's aircraft.
The Longitude has a maximum range of about 4,000 nautical miles, about a third further than Cessna's other aircraft, making it capable of flying nonstop from New York to Paris.
That is particularly important since much of the growth in the business-jet market, which the Honeywell expects to roughly double to $30 billion by 2021 - representing an average growth rate of 7 percent per year - is expected to come in large jets and those capable of traveling longer distances.
But the knowledge that Cessna will have to invest heavily to develop these two new aircraft, expected to go into service over the next five years, has left Textron wary of committing to higher margin targets for the unit.
The company has forecast full-year operating margin of 3.5 percent to 4.5 percent at Cessna, on $3.4 billion in sales.
Cessna has not disclosed how much it expects to invest on the Latitude and Longitude jets, with respective list prices of $15 million and $26 million, although aviation consultant Richard Aboulafia of Fairfax, Virginia-based Teal Group estimated the costs could be hundreds of millions of dollars.
That is money Cessna needs to spend to keep up with demand for larger jets, Aboulafia said.
"Emerging markets have done a lot better in recent years, and they tend to prefer larger jets," Aboulafia said. "In the U.S., the top part of the economy, the ultra-high-net worth individuals are doing better than the merely rich," and those customers also prefer larger aircraft.
Huntington's Adams said the message to shareholders was clear: The investment in new jets was worthwhile, even if it lowers the unit's margin growth.
"You can only cut so much," Adams said. "Eventually, you have to have decent revenue."
(Reporting By Scott Malone. Editing by Tiffany Wu and Andre Grenon)
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