Legacy carrier United Continental (NYSE: UAL ) was busy at last week's Paris Air Show. The annual air shows are a forum for aircraft manufacturers like Boeing (NYSE: BA ) , Airbus, and Embraer (NYSE: ERJ ) to show off their latest airplanes and market them to major airlines and leasing companies. Many aircraft purchase deals are typically signed and announced at the air shows each year. This year, United signed two new deals, giving business to both Boeing and Airbus.
Doubling down on the Dreamliner
First, on Tuesday, United became the North American launch customer for Boeing's new stretched version of the 787 Dreamliner, called the 787-10. United upgraded 10 of its existing Dreamliner orders to the new version, while adding another 10 orders for a total of 20. United has now agreed to acquire 65 Dreamliners (across all three versions), six of which have already been delivered.
The 787-10 is larger than the initial two variants of the Dreamliner, and is comparable in size to the Boeing 777-200. United has a fleet of 74 Boeing 777-200 aircraft (including extended range models), the oldest of which is 18 years old. By the time the 787-10 planes begin arriving in 2018, United may be ready to start to retiring its oldest 777s. In other words, the additional aircraft are probably being ordered for replacement purposes, not growth.
Throwing a bone to Airbus
Interestingly enough, the 787-10 is similar in size to the Airbus A350-900, another new technology plane scheduled to enter production next year. Rumors had been floating around in the aviation community since late last year that United was planning to switch its A350 order to the larger A350-1000 variant. Given the similar size of the 787-10 and A350-900, United's 787-10 order seemed to confirm the airline's intention to upgrade its Airbus order.
Indeed, United announced on Thursday that it would be upgrading all of its A350-900 orders to the larger A350-1000 model, and would be increasing its order total from 25 to 35. The A350-1000 will replace the Boeing 747 in United's fleet after deliveries begin in 2018. United currently has 23 747s, with an average age of almost 18 years, and these planes will be ripe for retirement by the end of the decade.
In a series of previous articles, I have argued that United has become a little too free with its capital expenditures recently. United is spending billions of dollars each year to buy state-of-the-art, new airplanes and upgrade IT systems, whereas competitor Delta Air Lines (NYSE: DAL ) has managed to "do more with less", allowing it to begin returning cash to shareholders.
At first glance, United's latest move to upgrade its Boeing and Airbus orders to larger (and more expensive aircraft) while taking an additional 10 planes from each manufacturer seems to be another step down this path. United recently disclosed that its total capital commitments have ballooned to $23.6 billion, up from $17.7 billion at the end of March.
However, under the new terms of its aircraft orders, United will delay some capital spending and get more use out of the planes in its fleet today. Whereas United's capital commitments had previously peaked at $3.0 billion in 2016 before dropping off slightly to $2.5 billion in 2017, the company now has $2.4 billion in capital commitments for 2016 and just $1.4 billion in 2017. Capital spending will now ramp up in 2018, and some of the aircraft ordered last week will not be delivered until as late as 2024.
It's not immediately clear whether or not last week's deals reflect a conscious change in United's strategy. One possibility is that United is only pushing back aircraft deliveries because the larger airplanes will not be available until 2018 and thereafter. Indeed, United will be one of the first customers for the 787-10, and the A350-1000 is not expected to enter service until 2017.
On the other hand, it is possible that United was actively looking to push back some of its capital spending. On several recent occasions, the company's management has talked about moving to a balanced capital allocation policy, which would include smoothing out capital expenditures over time. United's recent transactions will improve free cash flow generation for the next several years, while allowing the company to gradually replace older aircraft with more fuel-efficient models.
I am still concerned about United's massive capital commitments -- the $23.6 billion already committed works out to an average of $2 billion per year for the next 12 years -- but last week's transactions definitely seem like a step in the right direction. United now has a few more years to improve its profitability and cash flow in order to support these heavy investments. Yet, Delta still seems like a more attractive investment due to its superior profitability and cash generation.
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