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Analysis of Delta’s Widebody Replacement Options for 767-300ER and 747-400

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Analysis of Delta’s Widebody Replacement Options for 767-300ER and 747-400

Analysis of Delta’s Widebody Replacement Options for 767-300ER and 747-400
April 15
08:30 2014

MIAMI — Delta Air Lines released a request for proposals (RFPs) for the replacement of fifty widebody aircraft from its fleet a few weeks ago. According to a report from Aviation Week, the carrier is looking to replace a significant proportion of its Boeing 767-300ER and 747-400 fleets..

Several reports state that Delta will consider the Boeing 787 family, the Airbus A350 family (-900 and -1000 only), the Airbus A330 family, and an Airbus A330neo – if launched based – on an email to employees. Additionally, while company CEO Richard Anderson ruled out an order for the recently launched Boeing 777X, calling it an “experimental airplane,” he did allow for a possible order for the current-generation Boeing 777-300ER. In particular, Anderson was also complimentary of the A330neo, stating,  “I hope they (Airbus) do offer an A330NEO… There is a huge need for a small widebody. We really need Airbus to step up and re-engine.”

Delta currently has a widebody order book of 28 airframes, including an order for ten Airbus A330-300 aircraft, as well as one for 18 Boeing 787-8 aircraft. The order for 18 787-8s was inherited in Delta’s 2008 merger with Northwest Airlines, and was initially scheduled to be delivered between 2010 and 2012.

However, in October 2010, Delta deferred delivery of these aircraft to occur between 2020 and 2022. Delta also held 50 purchase options for additional Boeing 787 aircraft, but these were cancelled or otherwise lapsed, and no longer appear in Delta’s SEC filings. Delta currently holds purchase options for six Boeing 777-200LR aircraft, which could, in theory, be converted to firm orders for the larger Boeing 777-300ER.

The Boeing 787-8 has been used by several airlines around the world as a Boeing 767-300ER replacement, usually in seating configurations of between 200 and 250 passengers. Delta currently operates 58 Boeing 767-300ER aircraft seating between 208 and 226 passengers, and 16 Boeing 747-400 aircraft seating 376 passengers. The expensive D-checks on Delta’s 747 fleet will occur near the end of this decade, naturally leading Delta to look to replace the fleet prior to that.

Delta A330-300. (Credits: jplphoto)

Delta A330-300. (Credits: jplphoto)

Before analyzing the replacement options for Delta, it’s instructive to understand what is behind Delta’s overarching fleet strategy after the Northwest merger. The reason Delta tends to buy used or old generation aircraft is rather simple: They are cheap. There’s a certain element of risk mitigation in that new aircraft programs like the Boeing 787 and Airbus A350 have been overrun with delays, cost increases, and in the former case; severe reliability issues. But the rationale is overwhelmingly tied to reducing capital expenditures by purchasing cheaper aircraft.

The reduction of capital costs has two effects. On the operating costs side of the ledger, it is reflected in direct operating costs through depreciation. It is also reflected on the cash flow ledger as an increase in free cash flow. The two effects are tied together in the following manner. On a long haul route of the type operated by a typical Delta 767 or 747, capital costs represent on average about 15-25% of the overall operating costs for an aircraft. Fuel represents upwards of 60% of operating costs at present prices, and that figure rises or falls based on the price of jet fuel.

In short, Delta has basically placed one massive bet since 2008 that the price of fuel will be low enough that the much lower capital costs on its fleet will offset their fuel burn disadvantage against newer aircraft. And moving forward, Delta is betting that the combination of conventional hedging, the Trainer refinery, and the explosion of shale oil production in the US will stabilize or even depress jet fuel prices, which will allow Delta to apply the same principles that led to the purchase of the MD-90s, the ingestion of the 717s, or the A321/A330-300 order to this RFP.

If Delta bets right (and the combination of its present track record of superb margins and macroeconomic factors imply that it is betting right), then it allows Delta to boost its free cash flow, one of the most important metrics used by investors to evaluate stocks. Delta’s major ambition currently is to be treated as a high quality industrial stock with investment grade credit ratings. That’s what’s been behind everything from its aggressive debt retirement to its push to be included on the S&P 500. Cutting back on aircraft capital expenditures allows Delta to continue its push for that status while not hurting profits too much due to lower fuel prices.

With that framework in mind, we can now turn to analyze Delta’s two replacement tracks. Starting with the 767-300ER, Airways’ analysis found that the 787-8 has about a 12.3% CASM advantage on the 767-300ER (including capital costs) and about a 7.4% CASM advantage on the A330-200 for a typical 4,000 nautical mile route. By 2015, assuming a 10,5% fuel burn reduction for the A330neo vs. the A330-200 and a 2.5% PiP for the 787-8, that gap narrows to a 3.1% CASM advantage for the 787-8, which can be easily offset by more aggressive pricing discounts on the part of Airbus.

Another key element in the calculus for Delta is availability. The Boeing 787 is largely sold out till at least 2020 and continues to sell at rapid rates each year. While the 787 offers excellent operating economics, Delta can likely match it’s economics with the A330neo as mentioned before through discounting, which means that ceteris paribus (all else being equal), the more available aircraft will win the contest. Technically speaking, the A330neo is not yet on offer, but we project that it will be soon with EIS for 2018 as Airbus looks to fill the production gap. Pressure is already mounting on Airbus from airlines around the world to launch the A330neo, so it is likely that the type will be a major player in the Delta replacement RFP.

Looking at the flight profile of the 767-300ER in Delta’s fleet, it is mostly used on trans-Atlantic flights to Europe/Africa, flights to South America, and (on a much smaller scale) routes from the West Coast to East Asia. The only place where the 787-8 would be relatively more useful from a network construction perspective would be in its superior ability to open long and thin routes.

Up-gauging from the 767-300ER to hold down CASM is also a potential option which would appear to favor a potential A330-300 sized neo over the A350-900 for many of the same reasons (availability and lower purchase price). This option would make sense, especially to replace flights to Latin America and Asia, which are seeing growing traffic demand (and could thus handle the larger aircraft). Indeed, a mix of A330-200 and A330-300 sized neos (the former for Trans-Atlantic and long/thin flights) would be our best bet (assuming Airbus launches the A330-200neo – if not, then it would be mostly the larger aircraft), followed by the much less likely option of ordering the current generation A330-200 and/or A330-300. We do not see a further 787 order as likely at this time though it remains a small possibility.

Turning to the larger aircraft, this is a competition between the A350-1000 and the 777-300ER for 747-400 replacement. We have already presented our views on the relative operating costs of the 777X versus those of the A350-1000 in our analysis of ANA’s order for 20 Boeing 777-9X aircraft. We now turn to comparisons of operating costs for the 747-400, the 777-300ER, the 777-9X, and the A350-1000. Boeing 747-400 cost data is sourced from Department of Transportation (DOT) Form 41 data for Delta specifically, 777-300ER cost data is sources from cost reports of in-service fleets of the type, and A350-1000/777-9X data is based on Airchive’s models. The data is for a 5,500 nautical mile route, and fuel prices are calculated based on IATA’s North American jet fuel price monitoring. We caution readers that the A350-1000 and 777-9X are still paper airplanes, which means that our estimates and models are subject to a margin of error. We assumed a 25% discount for the A350-1000 and the 777-9X versus a 50% discount for the 777-300ER. Boeing needs to fill the production gap and the average Boeing discount in 2013 was 45%, while the A350-1000 is a new build aircraft with soaring backlog – so these figures make sense.

That being said, we’ll start with analysis of operating costs excluding capital costs. Here, the impact of fuel is clearly seen, and the trip cost breakdown is as one would expect (much higher on the part of the 747-400, and the 777-300ER not competitive with the A350-1000.

Trip Costs for Delta 747 replacement options. (Credits: Author)

Trip Costs for Delta 747 replacement options. (Credits: Author)

CASM wise, a similar picture emerges, with a nearly 11% CASM gap between the 777-300ER and the A350-1000.

(Credits: Author)

(Credits: Author)

 

However, when you add in capital costs, a different picture emerges.

(Credits: Author)

(Credits: Author)

Our full analysis is displayed below.

Aircraft Boeing 777-9X A350-1000 Boeing 777-300ER Boeing 747-400
Fuel Cost $92,739 $80,619 $95,937 $116,084
Maintenance Costs $13,837 $12,282 $16,687 $20,859
Crew Costs $20,447 $19,257 $19,257 $19,257
Navigation and Landing fees $11,286 $10,791 $11,039 $11,694
Total Operating Cost $138,309 $122,949 $142,920 $167,894
Cost per Aircraft Mile $25.15 $22.35 $25.99 $30.53
Number of Seats – 3 Class 407 350 360 376
Operating Cost per Seat Mile $0.0618 $0.0639 $0.0722 $0.0812
Capital Cost $41,387 $37,037 $24,780 $12,181
Total Operating Cost $179,696 $159,986 $167,700 $180,075
Total Cost per Aircraft Mile $32.67 $29.09 $30.49 $32.74
Total Operating Cost per Seat Mile $0.0803 $0.0831 $0.0847 $0.0871

What should be made clear by all of these charts and figures is that Delta can, in fact, operate the 777-300ER competitively against the A350-1000s and/or 777Xs of United and foreign carriers on a CASM basis. The other, and underrated, aspect of this comparison is that the 777-300ER clearly offers savings versus the 747-400. On an annual basis, assuming that the 777-300ER operates one flight per day (747-400 utilization for Delta averaged 11.7 hours per day in the first nine months of 2013, similar to the block time for a 5500 nm route – assuming slightly higher utilization for new aircraft), it will save Delta $4.5 million in operating costs annually. Multiplied across a fleet of 16 airframes, that figure is $72 million, to say nothing of the 777-300ER’s superior cargo revenue potential.

A 777-300ER order would fit with Delta’s general fleet strategy, and we see this as the most likely outcome, with the odds 70-30 in favor of the 777-300ER versus the A350-1000. Overall, Delta’s fleet strategy occupies an increasingly rare space in the US industry, and this RFP is only likely to reinforce that trend.

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A Global Review of Commercial Flight since 1994: the leading Commercial Aviation publication in North America and 35 nations worldwide. Based in Miami, Florida.

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