In June, Delta Air Lines announced plans to buy another 40 new 737-900ER jets, along with 20 used 98-seat E190 jets, from Boeing . The order was conditional on having Delta's pilots ratify a new contract that the company had just finished negotiating.
Yet in July, Delta's pilots soundly rejected the tentative contract, by a 65%-35% margin. Delta has now confirmed the apparent implication of this development -- it no longer plans to place an aircraft order with Boeing. Instead, it will go back to a tried-and-true strategy: refurbishing older planes to keep them flying as long as possible.
Hanging on to more 757s
Delta recently informed its pilots that it plans to refurbish and continue operating 14 Boeing 757-200 planes that previously had been scheduled to retire by the end of 2017. These planes will partially fill the need that the new 737-900ERs would have met.
Delta will keep some of its 757s longer than originally planned. Photo: The Motley Fool.
These planes will be added to an ongoing fleet modification project that Delta announced in early 2014. At that time, Delta stated that it would refurbish 49 domestic 757s by the end of 2016 to make them more customer-pleasing and more profitable.
The changes include power outlets in every row, in-seat video with access to satellite TV, larger overhead bins, and new LED cabin lighting. From a profitability perspective, the most important change is that the 757s will be outfitted in a common configuration, with 199 seats. Delta previously had a wide variety of 757 configurations, with an average of about 180 seats.
A confluence of factors
The pilots' rejection of the proposed contract clearly had some impact on Delta's decision to walk away from its tentative deal with Boeing. However, I don't think Delta dropped the order just out of spite for its pilots.
First, in the new 199-seat configuration, Delta's Boeing 757s make more efficient use of pilot labor than its 737-900ERs, which each have 180 seats. Delta's top-of-scale 757 pilots are paid about 4.3% more than 737 pilots, which is significantly less than the 10.6% difference in seating capacity between the two models. If Delta needs to give pilots bigger raises to get a new contract ratified, maximizing pilot productivity will become even more important.
Second, the biggest advantage of the 737-900ER over the 757 is its lower fuel consumption. In the spring, when Delta was contemplating the new aircraft order, oil prices seemed to be recovering quickly. Since then, oil prices have fallen much further. Today, many experts expect a "lower for longer" scenario.
The 737-900ER is much more fuel-efficient than a 757. Photo: Delta Air Lines.
In this context, spending about $2 billion upfront to acquire more fuel-efficient planes is much less financially attractive. That's particularly true for Delta, which is very good at maintaining older planes.
Third, airfares have been under pressure this year because of overcapacity in some markets. Delta has been a leader in cutting capacity to rebalance the market. If these trends continue, Delta simply may not need as many new planes in the next five years as it had originally expected.
Boeing looks for new buyers
With Delta now apparently out of the running to purchase additional 737s in the next few years, Boeing must find other buyers for some of the last current-generation 737s to be produced.
Boeing will be competing with its 737 MAX and Airbus' next-generation A321neo, as well as with cheaper used 737s and A320s. It needs to find airlines that are willing to spend enough to buy new planes, but not enough to get the latest technology. Boeing can certainly find buyers at some price -- the question is how much it will need to discount the end-of-line planes to sell them. The lower fuel prices are in the next few years, the easier its task will be.
Placing the used E190s will be a trickier task. Boeing agreed to buy these 20 planes from Air Canada to land a big order for 737 MAX jets. But E190s have fallen out of favor because of their higher unit costs relative to 737s and A320s, higher-than-expected maintenance costs, and the impending arrival of next-generation E190s in the first half of 2018.
Delta was one of the most likely prospects for placing these E190s, because of the carrier's industry-leading maintenance team and its focus on keeping capital costs down. Boeing may need to sell these planes at a significant loss just to get them off the books. Alternatively, it could try to lease them out through its Boeing Capital subsidiary.
Fortunately for Boeing, an order for 60 planes -- including 20 used ones -- is just a drop in the bucket. As of the end of September, it expected to deliver 755 to 760 commercial aircraft this year and had a backlog of nearly 5,700 planes. Boeing's ultimate value depends mainly on the success of its newer aircraft programs: the 737 MAX, 787 Dreamliner, and 777X.
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The article Delta Air Lines, Inc. Tweaks Its Aircraft Plans originally appeared on Fool.com.
Adam Levine-Weinberg owns shares of The Boeing Company and is long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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