While the airline industry has infamously been a death trap for investors for decades, the last few years have really seen that turn around.
In this segment from Industry Focus, analyst Sarah Priestley and Motley Fool contributor Adam Levine-Weinberg dive into one company that stands apart from its peers: Delta Air Lines (NYSE:DAL). Find out why Delta's labor cost structure is so beneficial for both the company and its workers; how Delta has the best reliability of the biggest carriers, and what this means for its bottom line; how Delta is ahead of the curve with its aircraft models; what investors need to keep an eye on with this company; and more.
A full transcript follows the video.
This video was recorded on Sept. 14, 2017.
Sarah Priestley: You touched on the employees being less unionized than a lot of their competitors. I think I like the way that they run their business with regards to their employees. They have a profit-sharing program -- they hand out the profit-sharing checks on Valentine's Day, which I think is great. And obviously, that shows benefit in their bottom line, the fact that they don't have to deal with a lot of these unions that have traditionally caused labor prices to go up, as we talked about with the pilot union. Do you think this is something that makes them stand out from the other two that we've discussed?
Adam Levine-Weinberg: Just to dig in a little bit there, Delta's pilots are unionized. As I mentioned, pilots do represent a pretty high proportion of the overall cost. So they do have that cost pressure there. And they've also been giving quite generous raises to the rest of their employees, as well, because they want them to keep up with the rest of the industry, frankly because they know that if they're giving inferior pay to their employees, then they will be unionized soon enough. So it's not that they're getting huge cost savings from bullying their employees who aren't unionized, but it gives them a lot of flexibility. With a union contract, there's lots of rules and procedures and things that are meant to protect the employees, and when something unusual happens, it makes it harder to react. You have to go, renegotiate the contract, say that facts have changed and we need to change the process, and it can sometimes take years to do that. It may have to wait until the next round bargaining is scheduled for a new contract. So for Delta, just being able to change the work rules in a more streamlined way has definitely been good for them. If you look at, for instance, their maintenance personnel, most people who follow the industry would agree that Delta has the best maintenance -- tech ops team is what they call it -- in the industry. For years, Delta has had the oldest fleet of any major airline in the country, and yet it also tends to have the lowest maintenance costs on an available-seat-mile basis.
Priestley: That's incredible.
Levine-Weinberg: So it basically shows that they know what to do. They also have the best reliability of the three top carriers. So they've figured out ways to basically innovate and make sure they can provide a reliable product without having to spend a lot of money on updating their fleets. And this is a big reason why American and United are so far behind in terms of free cash flow. Part of it is the lower earnings, but part of it is because they're putting tons of money into fleet updating projects, especially since they've started to become profitable in the last few years. But the result is, they're putting basically all their money into these fleet projects. A narrow-bodied plane could cost you $40 million. A wide-bodied plane is going to cost you maybe $150 million. When you look at the capital spending, American Airlines has been spending about $6 billion a year, which is 15% of its revenue, just on fleet and other technology and capital spending of that sort.
Priestley: And Delta is starting to invest a little bit more in their fleet. Is that right?
Levine-Weinberg: Yeah. Delta has started to accelerate some of the retirement of its older aircraft types. It has a lot of McDonnell Douglas MD-88s, which were built in the late '80s and early '90s. So those planes are now, on average, a little over 25 years old, and that's generally considered the beginning of the end for planes in the airline industry. You can keep them running longer, but the maintenance costs tend to go up. It becomes less efficient. They're also, in terms of fuel efficiency, the technology is 1980s technology, so there's definitely much better technology available today. So they've started to retire those planes, and they also have some other, older models that are coming out of the fleet over the next five years or so.
Priestley: But they're doing that from a much better basis than the other two, right? A much better solid platform.
Levine-Weinberg: They're starting with better cash flow. Instead of trying to get the newest, most fuel-efficient, best-ever planes, they've been trying to, not bottom fish, but they're looking for deals -- what planes are manufacturers trying to sell? Bombardier, which is a struggling Canadian plane maker, they're coming out with a new plane that just became available within the last year, the C Series, and they were really struggling to find a flagship customer. So this is considered one of the most revolutionary planes to come out in the last decades, but Delta got a really good price, to the point where Boeing actually filed a complaint with the government, saying that Bombardier was dumping these planes in the U.S., selling them for too low a price. So Delta got this 75 plane order at a really good deal, which will be very useful for their routes with lower traffic. Then they've been buying a bunch of planes from Boeing and Airbus, their largest narrow-bodied models, the 737-900ER and the A321, which have very good unit costs, but they're outgoing models. It's basically like buying last year's model at the auto dealer. You get a big discount because they're looking to get rid of them before they bring the new models in.
Priestley: Yeah. And I think a lot of airlines have the flexibility to do that. Newer airlines and newer airline engines are getting more fuel efficient, and I think there was a huge push in the aerospace industry to get the most fuel-efficient jet engines possible when oil prices were high. Oil prices have obviously come down since 2014, and now they have the luxury of running older models for longer because the fuel price is OK if it's less efficient. And also, as you said, not getting the most efficient model, which was really the main reason why people would be buying this year's version.
Levine-Weinberg: Yeah, and you have to balance the additional capital cost of buying a newer model, it might cost you $10 [million]-$15 million extra up front because there's massive wait times for these newer planes, whereas you can get the older ones on a much shorter lead time at a big discount. So you have to weigh that cost savings against the longer-term fuel-cost savings. And right now, it seems like, for many airlines, the older models look like a better long-term deal because you're not saving enough money on fuel to justify upgrading and getting the 12% or 14% fuel-efficiency gain from getting the latest technology.
Priestley: OK, awesome. So, bottom line on Delta, you think it's worth a second look by investors based on the fact, solid balance sheet, great long-term leadership. I think Ed Bastian taking over was a great move for a continuation of what had already been happening. Any other points you want to make to anyone of the investors out there?
Levine-Weinberg: I think free cash flow is the main thing to keep an eye on with Delta. They're obviously going to be ramping up their capital spending a little bit in the next year or two, but they're going to get some significant long-term benefits, and the capital spending should moderate after 2021, or thereabouts, as they go back to a more normalized pace of fleet replacement. So as long as that happens, I think Delta Airlines looks like a really compelling investment opportunity right now.
Adam Levine-Weinberg owns shares of Delta Air Lines. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.