Cost Savings in Motion at Delta Air Lines

If you're looking for further signs of maturity in the airline industry, consider Delta Air Lines'  (NYSE: DAL  )  plans to lower costs by $300 million a year via a mix of old and new planes.

That savings might not seem significant to an airline with a revenue base of around $37 billion, but investors need to remember that Delta only has a market cap of $20 billion, and annual profits approaching $2 billion.

Delta is currently the second-largest domestic airline, but it is by far the most valuable. The pending US Airways and American Airlines deal would shift it down to third place, but it would only be fractionally behind the leaders. After decades of failure, Delta's bounced back as an investment by apparently focusing more on revamping its airplane alignment than growing routes and market share.

Revamping the fleet

Not surprisingly, its plans call for a partial modernization of its fleet, including both new Boeing (NYSE: BA  ) and Airbus planes. It also struck an unexpected deal between itself and Southwest Airlines (NYSE: LUV  ) to lease the old Boeing 717 planes that Southwest, which favors an all-Boeing 737 fleet, picked up in its merger with AirTran.

In total, Delta's plan calls for a fleet of 100 737-900 extended range models and 88 smaller 717s, for a total of 188 planes that will reduce both fuel and maintenance costs. Both plans were intended to kick off in September, while the airline also started another initiative with Airbus.

The Boeing order dates back to August 2011, with the first delivery taking place on Sept. 27, and expected commercial service in November. The order will be delivered between 2013 and 2018. The fuel-efficient planes will have 180 seats, and each can fly any domestic route at a fuel-cost reduction of up to 20% per seat.

Back in 2012, Southwest agreed to lease the 717s to Delta, and it's spending $100 million to transform the former AirTran planes to suit Delta's needs. That includes upgrading the interiors and removing nine seats to match Delta's desire for a 110-seat aircraft. Delta plans to replace small 50-seat regional jets with these 717s; 16 are scheduled to enter Delta's fleet over the rest of this year, with 36 more added in each of the next two years.

Even longer-term, Delta recently plans to purchase 40 Airbus planes, including both A330-300s and A321s. These updated versions of older planes in production for a couple of decades are more affordable than the newest models, but they won't enter service until 2015 at the earliest.

Airplane manufacturers

The good news for Boeing is that Delta's is increasing the standardization around its planes. The bad news: Delta made its first Airbus purchase in decades. In addition, the shift to the 717s was more of a seized opportunity than a sign that Delta plans to buy more planes from Boeing, which stopped making 717s in 2006. In total, of the 218 aircraft Delta plans to add to its fleet, less than half are new Boeing planes.

The order for both Airbus and Boeing, while important, should mostly be factored into the projections by now, especially in Boeing's case. The deal was announced two years ago, and though deliveries are just now occurring, analysts and investors should already have the sales forecast into profit figures.

If anything, Soutwest benefits the most from the deal. It didn't want the planes anyway, and by leasing them to Delta, it gets to recoup a little cash from its merger with AirTran.

Profit impact

As mentioned above, Delta's cost savings from its updated fleet will be significant, considering the airline only generated $1.2 billion in profits for all of 2012. Analysts expect a sharp increase this year that will push the company closer to annual profits of near $2 billion. But even at those levels, the $300 million in savings would equate to a 15% increase in profits, assuming the airline's cost savings don't lead to pressure for lower fares. 

Bottom line

As long as the airlines stay focused on making a profit, rather than expanding their routes, the sector looks bullish. Delta's deal with Southwest looks like a win-win for both stocks, and if its expected savings pan out, they could definitely boost Delta's bottom line. 


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