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The US Big Three: Contrasting fleet, capex and balance sheet priorities November 2018 Download PDF

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US airlines’ recent round of third-quarter earnings calls showcased an industry that is doing amazingly well financially and has a promising outlook for 2019 — essentially because of success in offsetting higher fuel costs with fare increases and new ancillary revenue initiatives.

The three largest carriers — Delta, American and United — saw their average fuel price soar by 37% in the third quarter; yet, their aggregate operating profit declined by only 14%, from $4.3bn in Q3 2017 to $3.7bn in the latest period. The operating margin contracted from 13.5% to 10.8%.

However, there were major differences in the trends seen by individual carriers. United — hitherto an underperformer for many years — achieved surprisingly strong results, while American — previously in hot pursuit of Delta’s RASM and margin lead — encountered some challenges.

United fully offset the extra fuel costs and grew its EBIT by 2.7% in Q3, to $1.2bn or 11.1% of revenues. The remarkable performance was attributed to its most recent turnaround plan, unveiled in January 2018, which JP Morgan analysts described as the carrier’s “first credible strategic effort for success”.

As a result, United has overtaken American in the Big 3’s operating margin league in 2018 and is projected to retain that lead in the next two years (see chart).

But American’s struggles have also played a part in the reversal of those positions. American had execution issues with new product offerings and saw weak RASM trends, so it was unable to overcome a $750m higher fuel bill and saw operating income plummet by 36.5% to $866m, or 7.5% of revenues, in the third quarter.

It was a disappointing development, but analysts believe that this year’s issues are temporary and that 2019 will see American’s margins bounce back.

Delta — the margin leader among the Big 3 throughout this decade in part because it was the first to complete a Chapter 11 restructuring and a merger in 2008 — performed well in the third quarter, with 8% revenue growth and flat non-fuel unit costs offsetting 85% of the $655m additional fuel bill. Operating profit declined by only 7.9%, to $1.6bn or 13.6% of revenues.

Analysts believe that Delta will probably maintain its margin lead in the long term because it enjoys some structural advantages, including greater hub dominance.

The three legacies are in very different situations regarding fleet renewal, capital spending and balance sheet priorities.

American has been on a major post-merger spending spree, investing $26.8bn on aircraft, product and facilities in 2014-2018, or $5.3bn annually. As a result, it has the youngest fleet among the network carriers but high debt levels, which some investors fear make it vulnerable in the next economic downturn.

But American’s investment programme is now drawing to a close, with total capex falling to $2-3bn annually from 2020. The expectation is that deleveraging will get under way when American starts generating free cash flow (FCF).

In contrast, Delta and United have focused on debt reduction since their respective mergers. They have also had more modest new aircraft order books and have acquired used aircraft more frequently.

Delta reduced its adjusted net debt by almost $11bn between 2009 and 2016, from $17bn to $6.1bn. However, in the past two years its priorities have shifted in favour of increased spending, especially on fleet and pensions.

In 2017 Delta’s adjusted net debt increased to $8.8bn (and it quietly dropped the $4bn target it previously had for 2020) as it took on significant new debt to accelerate pension funding.

Delta’s fleet investment too has moved into higher gear. In December 2017 it placed an order for 100 A321neos with deliveries from 2020. Its aircraft capex is set to increase from $2.8bn in 2017 to $4bn or more in 2018, though in the coming years Delta can be expected to continue its disciplined approach.

United’s capital spending and leverage are somewhere in the middle between the extremes represented by Delta and American. The balance sheet is reasonably strong, especially when taking into account low pension obligations, and the new aircraft order book is quite robust. United has an interesting fleet strategy that includes many opportunistic used aircraft acquisitions and buying aircraft off-lease (more on that in the section below).

The US Big Three’s contrasting capital spending trends are illustrated in the chart. Most strikingly, American is expected to see its capex as a percentage of revenues fall from the group’s highest in 2016-2017 (14%-plus) to the lowest in 2020 (5.8%).

American’s lease-adjusted debt, at $32.6bn on June 30, towers way above United’s $18.3bn and Delta’s $12.5bn (from a recent United presentation, see chart). Also interestingly, if pension obligations are included, United and Delta had almost identical total adjusted debt.

The good news on the pension front is that regular sizeable contributions, good asset performance and rising interest rates have significantly reduced the pension burden for all three airlines.

American: Fleet renewal on home stretch

American accomplished many feats in record time following its Chapter 11 exit and merger: becoming highly profitable, passing key merger integration hurdles smoothly, reaching joint labour deals, signing lucrative credit card agreements, and initiating share buybacks and dividends just six months out of bankruptcy.

Post-merger American also became noted for its significant investment in new aircraft and the product, as it set about to restore itself as “the greatest airline in the world”. Between 2014 and 2017, American brought in 400-plus new mainline aircraft and 100 regional aircraft.

The downside of the spending spree and the aggressive use of cash to repurchase stock was the need to take on significant debt. In September American’s long-term debt and capital leases amounted to $22.3bn, with the net adjusted debt/EBITDAR ratio being 4.5x.

American feels comfortable about the debt level, first, because it maintains a strong cash position — $7.4bn in unrestricted cash and available facilities in September.

Second, most of American’s debt is aircraft-related and at very attractive all-in interest rates (weighted average coupon of 4.59%, which is broadly in line with Delta and United). American has lower credit ratings than its peers, but it locked in long-term aircraft finance when interest rates were at their lowest.

Third, American feels that the new fleet will give it a significant competitive advantage, both in terms of lower costs and a better product.

2017 was officially the final year of American’s “accelerated fleet renewal” programme, which has meant aircraft capex falling from an annual average of $4.6bn in 2014-2017 to $1.9bn in 2018.

But next year will see a spike to $2.9bn, as American takes delivery of large RJs that replace 50-seaters, along with narrowbody aircraft to replace the remaining MD-80 fleet, which will be retired after the 2019 summer season.

After 2019 aircraft capex will decline dramatically, to around $1.2bn in 2020 and $1bn in 2021. Those figures reflect the recent deferral of 22 A321neo deliveries, which reduced 2019-2021 capex by $1.2bn.

American continues to take delivery of A319s, 737 MAXs and 787-9s, and its A321neo deliveries will begin next year. In May American finally cancelled US Airways’ old A350 order and instead committed to 47 additional 787s, which will replace A330-300s and other widebodies.

CFO Derek Kerr noted in October that, in terms of mainline aircraft, “everything is really in place for the next four or five years” but that there would be more large RJs to replace 50-seaters (an order for 15 more E175s subsequently followed).

American has had significant non-aircraft capex ($1.8bn in both 2017 and 2018) because of the need to update the product after a long gap. The investments will continue in 2019 and 2020 ($1.7bn in both years) but will moderate from 2021 onward.

American has made more than $1.5bn in pension contributions in the past five years, which will continue.

The reduction in capex should allow American to start generating significant FCF from 2020, part of which could be used to reduce leverage. At this point, though, the management merely talks about “natural deleveraging” — just paying off debt as it comes due and not replacing it.

American maintains a $7bn minimum liquidity target; anything over that can be returned to shareholders. The board has authorised $13bn in share repurchases since the merger, of which $1.65bn has not yet been used.

Because of the lagging RASM and margins, as of mid-October American’s shares had lost 35% of their value this year. But both the management and Wall Street are quite bullish about the prospects in 2019 and beyond.

One reason for that is that American is still reaping benefits from merger integration and catching up with Delta and United on the product front.

In October American completed a four-year project to move all 27,000 flight attendants into one scheduling system — an integration milestone that will improve operational flexibility, help optimise the network and drive efficiencies. Also, American expects $300m in new cost savings in 2019 under its “One Airline” project.

In addition to the cost savings from new and larger aircraft, American expects to benefit from a reduction in the number of sub-fleets (from 52 to 30) and a harmonisation of aircraft seating configurations.

American has identified $1bn of incremental revenue opportunities in 2019. Much of it will come from product segmentation, namely basic economy refinements and the completion of the installation of premium economy (mid-2019). The latter will be further monetised with new revenue management and merchandising capabilities. American can expect to continue growing its share of corporate travellers.

The management believes that American has unique growth opportunities in three key hubs — DFW, Charlotte and DCA. The opening of 15 additional gates in DWF in early 2019 will enable American to add 100 more daily departures at its largest and most profitable hub.

American has moved aggressively to address higher fuel prices and its own underperformance. It has eliminated unprofitable routes, including Chicago-Beijing (which was reportedly losing $50m annually). It has reduced 2019’s planned system capacity growth by one point to 2%, which is the lowest among the legacies, and much of it will come from DFW incremental flying. American is projecting only 1-2% ex-fuel CASM growth in 2019, similar to this year’s 1.5% increase.

And it will help not having to pay cash taxes until (probably) 2021. At the end of last year American still had $10bn in federal Net Operating Loss (NOL) carry-forwards, which will last longer because the December 2017 tax reform.

Delta: Accelerating fleet spending

In the ten years since completing its merger with Northwest, Delta has beaten its US legacy peers handsomely on all fronts, be it profit margins, ROIC, debt reduction or returning capital to shareholders.

It has the strongest balance sheet, with unrestricted liquidity of $5.1bn, long-term debt and capital leases of $8.1bn, adjusted net debt of $10.2bn and a leverage ratio (adjusted net debt to EBITDAR) of 1.28x in September. It is the only one of the Big Three with investment grade ratings (from all three main rating agencies).

Delta is a product innovator (the creator of basic economy, for example) and achieves a RASM premium over the other legacies. It has deployed many unusual strategies, such as buying an oil refinery and acquiring minority equity stakes in multiple foreign airlines.

But the focus on balance sheet strengthening has meant “underinvestment” in the fleet (as one analyst put it). The average age of Delta’s fleet is 16.2 years, compared to United’s 14.3 and American’s 10.1.

Delta is well positioned to operate older aircraft because of its technical expertise (MRO) and commercial skills. And, in all fairness, Delta has had successful fleet renewal, restructuring and upgauging programmes in place for some years. Under its “balanced capital deployment” strategy, Delta reinvests 50% of its operating cash flow in the business, which allows for the replacement of 30% of its mainline fleet in 2017-2020.

But Delta needed to step up fleet renewal at some point, and it seems to have happened this year. Its total capex, which averaged only $2.6bn annually in 2013-2015 and then rose to $3.2bn in 2016 and $3.7bn in 2017, has soared to around $4.9bn in 2018.

Delta has not disclosed this year’s aircraft capex, but with 60 new aircraft deliveries and a recent decision to purchase and finance (at substantially lower cost) $600m of aircraft that were previously slated for operating leases, this year’s aircraft capex is likely to be at least $4bn. That compares with $2.8bn in 2017, $2.4bn in 2016 and $2.2bn in 2015.

The key theme of Delta’s re-fleeting is upgauging. Domestically, so far it has involved replacing 50-seater RJs with larger RJs, MD-88/90s with A321ceos, and 737-900ERs and 757-200s with 737-900ERs.

Delta’s first A220s will enter service in early 2019, mainly replacing 50-seat RJs. From 2020, the A321neos will start replacing the remaining older narrowbodies. Delta recently ordered 19 CRJ-900s to replace older aircraft operated by SkyWest.

On the international front, as part of its highly successful Pacific restructuring, Delta has replaced its 747 fleet with A350s, with A330neos following in the future. The result has been a significant improvement in profitability on the Pacific.

At its December 2017 investor day Delta noted that upgauging had driven nearly $1bn in cost savings over four years, with another $300m savings expected in 2018.

The revenue benefits of upgauging are also substantial, because new and larger aircraft facilitate a better product and have space for more premium class seats.

The leadership said in October that the fleet transformation was “still in the middle innings” and would continue into the mid-2020s. “No carrier has as much opportunity to benefit from upgauging as Delta over the next 5-10 years.”

Delta executives said at a conference in March 2018 that they were actively engaged with Boeing on a potential 797/NMA, which could fit in well as a 757/767 replacement.

The leadership indicated in January that Delta’s $2bn portfolio of airline investments was “essentially complete”. The line-up includes minority equity stakes in Virgin Atlantic (49%), Aeromexico (49%), Air France-KLM (10%), GOL (9%) and China Eastern (3%). The focus now is on deeper integration, as well as building out the more recent JVs with Aeromexico, Korean Air and WestJet.

That said, there may well be further opportunistic airline investments. Many believe that an increase in the GOL stake is only a matter of time.

While Delta’s aircraft spending will increase, it will still be disciplined and within a framework of a balanced capital allocation strategy. The airline is committed to continued debt reduction, maintaining an investment grade balance sheet, funding pension plans to the tune of $500m annually and returning 75% of FCF to shareholders ($2bn-plus in both 2017 and 2018).

Getting to a fully funded status with pensions is considered a priority. The $2.6bn increase in Delta’s adjusted net debt in 2017 was mainly because a decision to take new unsecured debt to accelerate pension funding (Delta is able to access such debt because of its investment-grade status).

Conveniently, Delta may have achieved its debt reduction and pension funding goals by the time it becomes a taxpayer after using up its NOLs, which is currently expected to be in 2020.

Delta is on track to deliver its fourth consecutive year of pretax profits exceeding $5bn in 2018, despite $2bn higher fuel costs. It has maintained strong revenue growth, driven by a surge in sales from premium products, while bringing ex-fuel CASM growth back in check (1-2% this year, compared to 4.3% in 2017).

Delta’s top financial priority in 2019 is to return to margin growth, which is achievable given the strong revenue momentum and positive cost trends. The current plan envisages 3% ASM growth next year, but the management has indicated that it will be reduced if necessary.

United: New orders or more used aircraft?

United’s long quest to realise the full potential of its assets, which include a powerful global network and well-located hubs, and its many setbacks and struggles are legendary (see Aviation Strategy, December 2016). But evidence is mounting in 2018 that United’s efforts are finally succeeding.

The turnaround is a result of a new strategy that has boosted connecting traffic at three mid-continent hubs. The plan envisages system capacity growth accelerating to 4-6% annually in 2018-2020, with domestic outpacing international.

As a concrete example that the strategy is working, in Q3 the three hubs saw a 6.8% PRASM improvement, compared to a 5.6% increase in the rest of the network. And that was despite capacity being up by 9.7% in the three hubs, compared to 2.3% in other parts of the network.

United apparently undertook a complex review of the hubs’ connectivity patterns and then made appropriate changes to schedules and frequencies, especially keeping premium travellers in mind.

It is early days yet, but the turnaround appears to be winning over investors’ confidence. United was the year’s best performing US airline stock through mid-October.

United’s fleet strategy is complicated and the annual capex has fluctuated a lot because of opportunistic used aircraft acquisitions, buying many aircraft off lease and frequent order revisions or deferrals (reflecting the long quest for winning strategies and many management changes).

United’s total capex peaked at $4.7bn in 2017 (after 2016’s $3.2bn) as it took delivery of 19 new aircraft and purchased eight used aircraft and 46 aircraft off lease. This year’s total capex will be $3.6-3.8bn, with 24 new aircraft deliveries and many used aircraft transactions. In 2019-2020 total capex is expected to be somewhere between the 2017 and 2018 figures.

Like American, United has invested heavily in product, technology and infrastructure; its non-aircraft capex amounted to $1.1bn in both 2017 and 2018. Notable projects have included basic economy, Polaris business class, Premium Plus and a new revenue management system (Gemini).

United began taking 737 MAX 9 deliveries in June 2018 and will have received 10 by year-end, with another 51 on firm order. In 2017 100 of the original MAX 9 order were converted to the MAX 10, which will start arriving in late 2020 (among other things, to replace older 757-200s). United also has an agreement to purchase 20 used A319s for delivery in 2020-2021.

On the widebody front, United has orders in place for 45 A350-900s for 2022-2027 delivery (originally an order for 35 A350-1000s with earlier deliveries).

United retired its last 747s in 2017, replacing them with 777-300ERs and 787-9s. Its last 777-300ER will be delivered in the current quarter.

The year-end fleet will include 40 787s, with 24 more on order. Earlier this month United became the first operator of the 787-10 in the Americas and the first airline to have all three 787 variants in the fleet. According to Flightglobal, United will configure the 787-10 to 318 seats and, among other markets, will deploy the type on six transatlantic routes from next summer. The type has 66 more seats than the 787-9 and only a 1,205nm penalty. In total, United has ordered 14 787-10s, 38 787-9s and 12 787-8s.

In Q3 United ordered 25 additional E175s for 2019 delivery and signed a separate deal to purchase 54 ERJ145s off-lease, also in 2019. All will be operated by regional partners.

The E175s are replacement aircraft, because United has reached the maximum limit of 70-seat or larger RJs in its scope clause. The issue is part of the current negotiations with the pilots, whose contract becomes amendable on January 31. United’s scope clause is more restrictive than American’s and Delta’s, and it has become a bigger issue because of the desire to strengthen hubs.

According to the CFO’s recent comments, United is actively looking for additional used aircraft to supplement new aircraft deliveries. The management calls it a “capital-efficient and flexible” way to grow. The strategy also helps de-risk the balance sheet.

The fleet plan has significant flexibility in the event of a downturn. United could reduce its capacity by up to 12% in each of the next two years through lease expirations (31 in 2019 and 43 in 2020) and by retiring “late life-cycle” aircraft (63 in 2019 and 66 in 2020).

United’s balance sheet is reasonably healthy, with lease-adjusted debt of $18.3bn, a lease-adjusted debt/EBITDA ratio of 3.1x and unrestricted liquidity of $7.1bn in June. However, United benefits from relatively low pension obligations. Its credit ratings (Ba2/BB) have been on a gradual upward path in the past two years.

Like its peers, United now returns significant amounts of capital to shareholders via share repurchases (but not yet dividends). The repurchases amounted to $1.8bn in 2017 and $1bn in January-September 2018. Pension contributions have been running at around $400m annually. The minimum liquidity target is $5bn.

This year’s consolidated 4.9% ASM growth (up from 2017’s 3.5%) will help United achieve “flat-to-down-1%” ex-fuel CASM in 2018, while commercial initiatives will also contribute to the quest to offset a $2.5bn higher fuel bill.

Like its peers, United believes that it has the momentum to improve operating margin in 2019. And its ambitious 2020 EPS goal of $11-13 is now more achievable, even though it would still require 20% CAGR in EPS in 2019-2020. United still has to prove that it can consolidate its turnaround.


2017 2018F 2019F 2020F
Mainline A319 125 127 133 133
A320 48 48 48 48
A321 219 219 219 219
A321neo 17 32
A330-200 15 15 15 15
A330-300 9 9 9 9
737-800 304 304 304 299
737 MAX 4 20 40 50
757 34 34 24 24
767-300 24 24 18 5
777-200 47 47 47 47
777-300 20 20 20 20
787-8 20 20 20 32
787-9 14 20 22 22
E190 20 20 14
MD-80 45 30
Total mainline 948 957 950 955
Regional CRJ200 68 35 21 21
CRJ700 110 119 113 113
CRJ900 118 118 132 133
Dash 8-100 3
Dash 8-300 11
E175 148 154 174 174
ERJ140 21 51 49 49
ERJ145 118 118 118 118
Total regional 597 595 607 608

Source: American Airlines Investor Update October 25, 2018


2017 2018F Orders†
Mainline A350-900 45
777 88 92
787 33 40 24
767 51 54
757 77 77
737 MAX 10 151
737NG 329 329
A319/A320 166 166
Total mainline 744 768 220
Regional Q200 7 0
ERJ135 3 0
ERJ145 168 176
CRJ200 85 128
CRJ700 65 64
E170 38 38
E175 152 153 25
Total regional 518 559 25

Source: United Airlines (October 16 investor update and SEC filings). Note: † at year end 2018


Owned Finance lease Operating lease Total Average Age Orders Options
Mainline 717-200 3 15 73 91 17.1
737-700 10 10 9.7
737-800 73 4 77 17.0
737-900ER 65 39 104 2.7 26
757-200 89 9 2 100 21.1
757-300 16 16 15.6
767-300 2 2 25.3
767-300ER 55 1 56 22.3
767-400ER 21 21 17.8
777-200ER 8 8 18.8
777-200LR 10 10 9.5
A220-100 75 100
A319-100 55 2 57 16.6
A320-200 55 3 4 62 23.1
A321-200 35 28 63 1.0 64
A321-200neo 100 100
A330-200 11 11 13.5
A330-300 28 3 31 9.7
A330-900neo 33•
A350-900 11 11 0.7 14
MD-88 80 13 93 28.0
MD-90 49 49 21.6
Total mainline 676 45 151 872 16.2 314• 150
CRJ200 CRJ700 CRJ900¶ E170 E175 Total
Regional† Endeavor Air‡ 42 3 109 154
ExpressJet§ 12 12
SkyWest 86 25 37 37 185
Compass 36 36
Republic 22 16 38
GoJet 22 7 29
Total regional 128 62 153 22 89 454

Source: Delta 10Q (October 11, 2018) 

Notes: † operated by Delta's partners; ‡ wholly owned by Delta; § relationship ends November 30, 2018; ¶ there are orders for 19 CRJ900s for 2018-2020 delivery (for SkyWest); • includes 10 additional A330-900s ordered in mid-November 2018.

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 6% 8% 10% 12% 14% 16% 18% 2014 2015 2016 2017 2018F 2019F 2020F Delta American United Delta American United Delta American United

Note: Forecasts by JP Morgan (October 30, 2018)

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 6% 8% 10% 12% 14% 16% 2014 2015 2016 2017 2018F 2019F 2020F Delta American United Delta American United Delta United American

Note: Forecasts by JP Morgan (October 30, 2018)

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 0 1 2 3 4 5 6 7 2014 2015 2016 2017 2018F 2019F 2020F 2021F US$bn Aircraft capex Total capex Aircraft capex Total capex

Note: Total capex does not include pension obligations.

Source: American Airlines presentation (October 2, 2018)

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 0 10 20 30 40 50 United Delta American US$bn Debt capital leases Aircraft leases Pension obligations gnuplot_plot_4 $14.5bn $9.9bn $24.1bn gnuplot_plot_5 $3.8bn $2.6bn $8.5bn gnuplot_plot_6 $3.4bn $9.1bn $7.1bn gnuplot_plot_7 $21.7bn $21.6bn $39.7bn Debt & capital leases Aircraft leases Pension obligations

Notes: Q2 2018; Aircraft leases capitalised at 7x

Source: United Airlines presentation

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 0 5 10 15 20 2009 2010 2011 2012 2013 2014 2015 2016 2017 US$bn Net debt Net debt $17.0bn $15.0bn $12.9bn $11.7bn $9.4bn $7.3bn $6.7bn $6.1bn $8.8bn

Note: Debt and capitalised leases less cash and short-term investments.

Source: Delta reports and presentations

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250 260 2014 2015 2016 2017 2018 Index (Jan 2014=100) American Delta United American Delta United

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