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Delta's fleet strategy under scrutiny after RFP on narrowbodies

Delta Air Lines CEO, Richard Anderson
Delta Air Lines CEO, Richard Anderson

Delta Chairman Richard Anderson told analysts at the of last year the airline does not really need to re-equip its fleet but rather retire older aircraft and buy used, mostly the MD-90 it is amassing.

Consequently, Friday’s news that Delta has issued an RNP to acquire between 100 and 200 narrowbodies with options for 100 more, caught the industry by surprise. The aircraft set for replacement total 270, including 34 DC-9-50s, 69 A320s and 167 757-200s. The move has investors wondering whether Delta management isn’t going back to the industry’s bad old ways.

That is a good question. "The questions I’m getting from investors include ‘is it all over; is this just like airlines to buy planes; what does this do to the debt-pay-down story and to the balance sheet'," Dahlman Rose analyst Helane Becker told CAPA. “They will get to USD10 billion in debt at year-end 2012 and then leverage up again (of course, airlines always do this), and they will probably take aircraft at the bottom of the cycle! We expect they will finance these aircraft through a mix of internally generated financing, lease financing, EETCs, or they may sell equity.”

With questions like these, it is little wonder people are worried and it is likely more colour will be added during Delta’s discussion on Tuesday of its 4Q2010/year-end results. Delta has been saying for some time its goal is to shave another USD5 billion in debt by 2013 to get to the USD10 billion figure mentioned by Ms Becker.

But Avondale Partners Bob McAdoo, who spoke with Mr Anderson on Friday, suggested the airline is really just testing the waters.

Mr McAdoo indicated Mr Anderson acknowledged the company has not changed its goal of paying down debt. Mr McAdoo suggested Mr Anderson just wants to know what his options are. Mr Anderson further indicated any purchases would come out of cash flow, rather than debt, reaffirming its intention to reign in debt. He also acknowledged letters went out to all the usual suspects – Boeing, Airbus and Bombardier – but also to Chinese manufacturers.

“Delta sent the RFP to Airbus, Boeing, Embraer, the Chinese, Sukhoi and Bombardier,” said Ms Becker, “and asked manufacturers to come up with a plan of different narrowbody aircraft given Delta’s domestic route structure. We believe they will retire the really ancient DC-9s this year and continue flying the A320s and B757s for the next three-to-eight years. We are estimating the aircraft order to between 100 and up to 400 aircraft between USD50 million to USD60 million for the most expensive of the 737-800NGs or A320neos for total programme costs between USD7 billion at the low end to around USD15 billion at the high end. In addition, we believe the timing for delivery is the second half of 2013 through 2020/22 timeframe and that, in no one year, will capital spending be greater than USD1-1.5 billion.”

Mr Anderson also told Mr McAdoo that he was interested in used aircraft. The analyst mentioned there were still ex-Mexicana aircraft going wanting. In addition, the 717, he said, is similar to the MD-90 fleet Delta is building. While Southwest said it intends to operate the 717s in AirTran’s fleet, they could ultimately be an option should the Dallas-based carrier change its mind.

“I don’t think it is a slam dunk that they will be buying anything,” Mr McAdoo told CAPA. “They are pretty flexible and really want to see what might come out of the woodwork. What they are saying is we don’t have to but if we can find the right deal at the right time ... They may do nothing but they may because airplane salesmen always find something that can work. It is consistent with what they have been saying, especially since they are throwing used aircraft in the mix.”

The carrier now has a huge fleet of 790 mainline aircraft. It also has 255 regional jets owned and operated by subsidiary Comair and recently spun-off Mesaba and Compass which are being acquired by Pinnacle and Trans States airlines, respectively.

The news that Delta is planning to replace its old narrowbody fleet, did not come as a surprise to some, given the fact it is the oldest in the US industry. It is still flying DC-9s built in the 1960s inherited from Northwest.

Bloomberg broke the news that Mr Anderson penned a note to employees saying the company has sent a Request for Proposal (RFP) to manufacturers to acquire between 100 and 200 narrowbody jets with options for another 100. That could make it the largest order in history.

In addition, its choices have broadened beyond the Boeing/Airbus arena to include Bombardier’s CSeries which would be an ideal replacement for the DC-9s which are about the size of today’s mid-range regional jets.

Ms Becker noted that the cost of the Delta fleet compared with its peers is minimal in terms of added fuel requirements. However, maintenance adds USD0.02 to CASM, she told CAPA. Fuel costs are rising, however, but even so she does not think it will not have a disproportionate impact on Delta compared with its peers.

Acquiring new aircraft will ultimately save on fuel and maintenance costs but there is no estimate as to how much at this point.

Speaking on an IAG podcast Collateral Verifications Vice President for Commercial Aviation Service Gueric Dechavanne said the order was not much of a surprise, given the fleet reductions in the past few years, a slow recovery and the goals set for environment improvement in the aviation sector.

“Put together, the environment justifies this large type of order,” he said. “Delta won’t be the only one. I expect American will need to do something as well to replace their MD-80 fleet. For US airlines, as well as for global major airlines the issue is ensuring that whatever they buy will be good for 25 to 30 years. A big part of this is the big push for product differentiation.”

Mr Dechavanne said an obvious choice for Delta would be the Bombardier CSeries 300 saying that, unlike its competitors such as the A319NEO, is designed specifically for the mission now done by the DC-9s. He rejected the Embraer EJets as too small for the seating capacity Delta is trying to replace, unless, of course, it wanted to reduce seats in favour of increased frequency. Mr Dechevanne also indicated that with the move to dual-class seating, airlines are opting for larger aircraft than even the E-195. He also said that the 737-700 was not selling well and airlines were opting for the larger 737-800.

He suggested that the CS-300 may be part of a solution that also included the neo since the two use the Pratt & Whitney PurePower geared turbofan engine and added the 737NG was not as modern for the 2013 delivery date. The A320neo would also provide commonality with its current A320 fleet which would reduce training costs. On the other hand, Boeing is positioned to be able to undercut everyone else’s price on its economies of scale.

Mr Dechavanne echoed Ms Becker in his discussion of financing but added that, knowing that a new narrowbody is coming in the 2020 decade, any purchase would need to take residual values into account. He asked whether financing for the newer aircraft will be as attractive as those for the older aircraft.

He discussed the high motivation for Boeing and Airbus to win the deal. Boeing would be able to replace Airbus in Delta’s fleet, while for the same reason, Airbus would be very competitive. Airbus also provides a solution at the 757 level which makes for more commonality meaning Airbus equipment would go up against the 737-900ER.

“It is my understanding the A321neo with sharklets will do better,” he added. “Boeing will have to work pretty hard to get orders and it may ultimately come down to the price. This is the right time to do it from a pricing perspective and Boeing is in a better position for that. Delta is in a great position to get some fantastic deals.”

Finally, Mr Dechavanne indicated that Delta’s timing is good given their leverage of having three competitors at the bottom level. However, he did not discuss the response of Delta’s RFPs to Chinese manufacturers or Sukhoi in the market.

When asked what the three different manufacturers have to do to win the order, Mr Dechavanne said Bombardier will not just have to make the pricing attractive, it would have to show it can meet expectations for performance and delivery. This echoed Bombardier officials who said in the autumn that they get the most questions about exactly that, given the problems at Boeing and Airbus. He also said that the neo would probably get only half of the 15% performance improvement promised by Bombardier, echoing others who commented when the neo was announced.

Commonality is Airbus’s ace, he said, along with the newer technology against the 757. Boeing can play the price card and emphasise that all other products are new and they may be buying into teething problems compared with a reliable, established Boeing product.

As of September 30, Delta was operating 42 DC-9s averaging 34.3 years old. It also has another 25 in storage. There are 164 757-200s in the fleet with an average age of 17.6 years. The 737-300s number 16 at 7.6 years. It also has 69 A320-200s at 15.6 years and 57 A319-100s at 8.7 years. Its 117 MD-88 average 20.2 years, while MD-90s number 19 at 14.6 years. It also flies the 737-700 and -800 with 10 and 73, respectively, with an age average of 1.7 and 9.7 years, respectively. Delta is selling A320s now, using the proceeds for up to 76 MD-90s.

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