A year ago, West Coast-focused airline Alaska Air (NYSE:ALK) won the bidding for its smaller rival Virgin America. This immediately raised the question of how the two carriers would harmonize their fleets. Alaska Air exclusively flies Boeing (NYSE:BA) 737s in its mainline operations, while Virgin America is an all-Airbus (NASDAQOTH:EADSY) carrier.
Alaska Air's fleet decision is particularly important for Boeing, which could be in line for a huge number of incremental 737 orders if the carrier decides to phase out Virgin America's Airbus fleet. However, Alaska Air has indicated in the past week that it is keeping the Airbus planes -- at least for now.
Merging two fleets
The Alaska Air-Virgin America merger made sense in many ways, particularly because the combined company is now the biggest airline on the West Coast. It wasn't an ideal pairing in terms of fleet compatibility, though, given that both carriers have lauded the efficiency benefits of operating a single aircraft type.
On the one hand, it would make sense for Alaska Air to return to a single fleet type as soon as possible. On the other hand, such a move could be quite expensive in the short run, as it would entail replacing Virgin America's relatively young fleet. Last year, Alaska Air indicated that it would run the numbers and finalize its long-term fleet plan during 2017.
The Airbus planes are here for a while
At Alaska Air's investor day on Wednesday, the company confirmed that it will keep the A320 fleet for quite some time.
Virgin America has 63 planes right now, of which 53 are leased. Those 53 leases expire between 2019 and 2025, with the bulk of expirations in the 2021-2023 period. Alaska Air's management has concluded that it would be prohibitively expensive to get out of the leases early.
However, Virgin America only has 20 aircraft committed to its fleet after 2025. Ten of those are A320s that the company has bought in the past two years. It will also receive 10 A321neos on lease over the next year and a half. (Alaska Air is trying to work out a deal with the lessor to take fewer than 10 of the A321neos, though.)
Alaska Air plans to retrofit Virgin America's A319s and A320s starting next fall. It will add more first class seats, install new extra-legroom "Premium"-class seats, and standardize the planes' configurations. This investment solidifies Alaska's near-term commitment to keeping the Airbus fleet around.
The big decision is still ahead
This is only a short-term plan, though. Alaska Air is still thinking about transitioning back to an all-Boeing 737 fleet over the next decade. With most of Virgin America's Airbus fleet coming off lease between now and then, the cost of making a gradual shift like this would be very manageable.
At its investor day, Alaska Air estimated the incremental annual cost of operating a second mainline fleet type at $20 million to $25 million. That's not chump change, but it represents less than 2% of Alaska's pre-tax earnings. Furthermore, operating a mixed fleet could lead to lower aircraft acquisition costs, as Boeing and Airbus would have to fight for each order.
Alaska Air will need to finalize its long-term fleet strategy by year-end because Virgin America has 30 A320neo orders scheduled for delivery between 2020 and 2022. Right now, Alaska Air would only lose $26 million in deposits if it canceled the orders. But it would need to begin making pre-delivery payments next year, locking itself into the orders.
Is Boeing ready to deal?
The Boeing 737 and Airbus A320 families both have huge order backlogs. However, Airbus has been winning the order race. As of the end of February, Boeing had more than 4,400 unfilled 737 orders, but Airbus had nearly 5,600 unfilled orders for A320-family planes.
Alaska Air's upcoming fleet decision represents a rare opportunity for Boeing to gain share at Airbus' expense. Additionally, with order activity slowing down while production rises, it would be good to pad the backlog as much as possible.
Based on the comments made by Alaska Air's management this week, it seems that pricing concerns are the one thing going in Airbus' favor right now. Considering the long-term stakes -- Alaska Air could be in the market for 250 or more jets between now and 2030 as it modernizes and expands its fleet -- Boeing should offer the carrier aggressive discounts to seal this deal.