The Russian military aviation industry largely depends on a balance of domestic orders and exports providing the companies with a medium and long-term perspective.
Although the full scope of the State Armaments Programme (Gosudarstvenaya Programma Vooruzheniya – GPV) 2018-25 published in May 2017 is unknown, it continues to focus on the procurement of fighter aircraft such as the Su-30SM, Su-34, Su-35, as well as orders for the new Su-57 fighter and MiG-35. Development of a new long-range bomber is also expected while the production of the Tu-160 has been re-launched. The maiden flight of the Il-112V military transporter took place in March 2019 and the upgrade of the Tu-22M3s to the new Tu-22M3M standard with new engines and weapons is ongoing. Exporting combat aircraft abroad is a Russian priority not only because of foreign exchange payments, but also because it ties foreign customers to Russia for decades to come through the training of foreign pilots, after-sales support, creation of a joint MRO, technology transfer (ToT) and know-how, counter-trade programmes, a compensation package, low-interest loans and financial assistance. These are just few of the Russian offers that come along with the sale of fighter jets. Openly available information about combat aircraft exports make Russian top managers proud. At the same time, however, a new law shows that some government officials want to return to the old days of concealing financial data.
Hiding the Balance Sheet
Although the full scope of the GPV is unknown, the Russian decision of 20 December 2017 to hide information about companies and individuals hampers research on the Russian aerospace and defense industry and, in particular, the financial data of the industry. The law was signed by President Vladimir Putin in December 2017 and aims to conceal financial transactions of state defense companies. In particular, the new law allows shareholding companies to not disclose financial information in certain circumstances, as well as limiting information about certain individuals on the internet. Altogether, lack of financial transparency pushes researchers back to the era of the former Soviet Union, when financial data was not disclosed. The financial data for military aviation companies in 2018 was not published yet. Thus, it would be interesting to see the results of the aforementioned concealment law. Still, it is possible to discern what is happening within the aviation industry and provide incomplete financial data.
Consolidation of the Industry
Even though the article focuses on the current state of military aviation industry it is impossible to ignore the civil side of the same industry. Despite many challenges it faces and a low output civil aviation industry , it did not fall apart, and continues to be supported by the Russian government. In addition, it remains an integral part of the consolidation process presented below.
The decision was made in late 2016 to consolidate the entire aviation industry and plans related to its consolidation were finally given a green light on 24 October 2018. President Putin signed an order on that day authorising the incorporation of United Aircraft Corporation (UAC) into the State Corporation Rostec (Rostec). The order states that: “The Russian government’s proposal for the transfer to the State Corporation Rostec, of the government’s holding of 92.31% of shares of UAC.” According to the order, the transfer is to be completed within 18 months (from the signature of the order) and thus effectively puts the aircraft industry into Rostec’s hands. As we will see further below Rostec proved to be very successful corporation despite having about 700 companies, enterprises and research institutes under its umbrella and despite being blacklisted by the United States since March 2014. Therefore, neither the size of the corporation nor the fact that it is blacklisted has damaged the reputation of Rostec. But the truth might be the opposite.
Previous plans regarding consolidation of the entire aviation industry and, subsequent creation of four divisions that were broadly discussed in the open press, were nixed by Sergei Chemezov, CEO of Rostec. Chemezov said in February 2019 that: “UAC is to have two divisions: military technologies and civilian products.” Besides, it is too early to comment on personal changes within consolidated UAC. Earlier announcements related to the personal changes should be taken with precaution. Chemezov added that: “Rostec plans to bring private investors into second division”, since this division requires urgent financial investments.
Chemezov was critical of the UAC financial situation in general and its civil aviation segment in particular. He said that: “UAC requires extra funds.” Chemezov criticism should come as no surprise since over the last two decades officials within civil aviation segment spoke about grandeur that proved to be a pipe dream. Russian officials claim that country’s civil aircraft can compete on par with Airbus and Boeing failed to materialise. In part because of subsidies that Russian government provides for, and in part because of lack of new technologies and lack of healthy competition of the Russian civilian air carriers on the international market. Due to the domestic orders and international sales of military aircraft the aviation industry remained competitive and prosperous over the last two decades.
Thus, making commercial liners competitive on the international market is likely to be the goal of the future head of the civil products division. This is an uphill battle because even companies such as Bombardier and Embraer are a great way off from Russian civil craft manufacturers. The latter have a long way to go to catch up with the four aforementioned companies. For instance, according to the Sukhoi Civil Aircraft Company’s (SCAC) financial report, manufacturer of SSJ100 regional airliner, suffered RUB804.7M (US$12M) net losses in the first half of 2018. SCAC has built just 23 SSJ100s in 2018, 11 aircraft short of 2017 output, and 3 aircraft short of 2016 output. SCAC is a member of UAC.
The commercial motives for the consolidation are fairly clear. About 60% to 70% of the components in UAC’s aircraft are made by Rostec companies (for example, engines, avionics, radio electronic countermeasures and weapon systems), and the helicopter manufacturer Russian Helicopters is also a Rostec subsidiary. Some managers in the aviation industry believe that UAC would benefit from changes in the management structure, as decisions would be taken by the Rostec board, rendering the protracted inter-departmental negotiations required within the UAC superfluous. The merger would also simplify certification procedures. Therefore, consolidating the Russian aerospace industry might help to wipe out cumbersome practices. To streamline inefficient processes and reduce costs, UAC plans to cut management layers and centralise functions. The consolidated aviation industry would be more resilient against economic sanctions imposed on Russia by the West.
Consolidation would create a large aerospace cluster with a revenue of US$15.27Bn, and it would help fund UAC’s large commercial projects which are currently too expensive and continue to drain funds. Chemezov commented on Putin’s decree and said that “this is a crucial moment for the aviation industry”, as “the step involves the creation of a national aircraft company – the largest in Russia”. In addition to the internal consolidation of UAC, namely the merger of MiG and Sukhoi into the military technology division within UAC, Russian Helicopters would now also join the same division. It is also important to remember that after the merger, Rostec would control the aviation industry’s entire export output, as Rosoboronexport, which is responsible for concluding arms deals, is already part of Rostec. Not everyone in Russia is convinced that consolidating the industry under the Rostec umbrella is the right move because the too big to fail formula means that the government will always come in to support the industry.
Rostec not only owns a large share of UAC but it successfully manages about 700 companies, enterprises and research institutes. In 2016, Rostec`s net profit was RUB88Bn and it increased in 2017 to RUB121Bn. According to Chemezov, “in 2018 Rostec forecasts revenues of slightly more than RUB1.6Tn (about US$22.80Bn) with a net profit of about RUB127Bn,” and that despite Rostec being blacklisted by the United States.
The consolidated aviation industry is in urgent need of successful managers, increased sales and steady income while the professional technical and engineering staff needs to be retained and rejuvenated. Rostec seems to be the answer to these needs since financial data indicates that Russia`s aviation industry needs a shake-up with a clearly outlined strategy for putting domestically-produced civilian aircraft on the international market.
The Financial State of the Industry
The UAC revenues reached RUB417Bn, of which 80% was accounted for by the sale of military aircraft. At the same time, the company’s loss in 2016 was RUB4.5Bn. Under International Accounting Standards (IAS), the company turned in a loss of RUB6.6Bn (US$114M) in the first half of 2017 – an improvement over the previous figure of RUB7.3Bn – after increasing revenues by 51% to just under RUB180Bn in 2017. According to UAC`s annual financial data, revenues amounted to RUB451.8Bn, with a net profit of RUB21.6Bn in 2017. Nonetheless, sales of the company`s civil flagship aircraft SSJ100 fell short of the forecast 70. 34 craft were delivered in 2017 and only 23 in 2018. For 2019, total deliveries are expected to be between 20 and 25. This amount is insufficient to keep civil aviation afloat.
Chemezov said in February 2019, “We are currently making a UAC financial audit. To tell the truth, it does not look very good. It requires extra funds of about RUB240Bn to RUB250Bn. The allocated funds should go toward building a brand new airliner MS-21 and modernising the aviation plants.” The cost of the brand-new MS-21 increased and the delivery date was postponed to 2021. As long as the UAC financial audit has not been completed, we need to take Chemezov’s statement with precaution.
In June 2017, Ilya Tarasenko, Director-General of MiG Corporation, said that the “corporate sales reached RUB56.7Bn, while net income was RUB5.2Bn in 2016.” In 2017, corporate sales reached RUB80Bn while net income was RUB3.5Bn. With no new orders from the MoD, and no sales to foreign customers in 2017-19, the company has had to launch the manufacture of the Il-114 regional airliner. It plans to assemble 300 craft, with first delivery expected in 2021. This programme is subsidised by the Russian government.
Aside from companies under the UAC umbrella, the holding Russian Helicopters needs to be mentioned. According to Andrey Boginsky, Director-General of Russian Helicopters, between 2017 and 2030, the holding expects an increase of 3% in the civil segment of helicopters, since “various factors created an unstable situation in the military segment. In many armies around the world, rearmament programmes have been completed which is why the respective share of military sales will to drop below 40%.” To compensate for such a significant reduction in military sales, Boginsky wants to pursue a more aggressive sales policy, targeting commercial operations around the world. At the same time, the Russian government is trying to alleviate the situation by supporting medical aviation in the country, and it allocated RUB10Bn evenly distributed over three years beginning in 2017. Sergey Khramagin, Director-General of the State Transport Leasing Company (GTLK) said in November 2018: “Of the 31 helicopters contracted for 2018, we have signed leasing contracts for 22 aircraft at the moment, and the remaining helicopters have already been distributed among the operators, which means that the programme is of tremendous interest and can be prolonged in 2019.” It remains to be seen whether Boginsky`s idea to pursue a more aggressive sales policy will be successful.
As a result of the reduction in military sales, revenues fell from RUR177Bn in 2015 to RUR165.8Bn in 2016, while just 189 helicopters were delivered. 16 out of 189 were civil helicopters. In 2017, the MoD and foreign militaries bought about 150 helicopters and civilian customers bought 70. Inspite of the growth in helicopter sales, revenues declined by 23% to RUB7.55Bn in the first six months of 2017. Unspecified gross or net profit increased by 9% to RUB93.83Bn for the same period. In 2017, the company generated a profit of RUB27Bn (US$430M) against revenues of RUB228Bn (US$3.6Bn). In November 2018 Boginsky said that the company is to deliver about 220 helicopters which means that the company remained on the 2017 level of helicopter sales.
Under the leadership of Boginsky, the company Russian Helicopter continues to be successful. Boginsky has recognised that military sales alone will not compensate for the lack of civilian helicopter sales. As a result, the company plans to develop after-sales support and expects civil helicopter production to increase from currently 30% to up to 50% of total sales by 2025. In order to reduce costs, the holding began to optimise human resources, reallocate responsibilities and reduce the number of top managers. Time will tell how successful the initiatives will be.
As long as no information on the ongoing audit of UAC has been made public, it is premature to make a judgement on the financial assets of the company. Therefore, we must take with caution Chemezov’s statement about the financial situation of UAC “to tell the truth, it does not look very good”. Although the merger of MiG and Sukhoi is imminent, it remains to be seen whether both companies will retain their own identity within the newly created division. Despite the uncertainty, it appears that both companies would maintain separate operations and brands within a division for reasons of customer recognition around the world. Probably the two companies will work together without unnecessary internal competition. As for UAVs/UCAVs, the international market is currently dominated by the United States and Israel. China is an additional competitor that Russia must take into account. It would take some time for Russia to achieve a breakthrough in the sale of UAVs/UCAVs on the international market. And Russian officials should learn a lesson from their claim that the country’s civil aircraft can compete on an equal footing with Airbus and Boeing.
In order to make Russian commercial airliners competitive on the international market, many things need to be done, but that is beyond the scope of this article. It also remains to be seen whether the current managers of the airlines and the company will be retained or dismissed. So at the moment there are more questions than answers.
Eugene Kogan is a defence and security expert based in Tbilisi, Georgia.