In recent years, Alaska Air (NYSE:ALK) has exclusively operated Boeing (NYSE:BA) 737s in its mainline fleet. However, its 2016 acquisition of Virgin America gave it a sizable fleet of Airbus (NASDAQOTH:EADSY) A320 family aircraft.
For the past year or so, Alaska Air's management has been thinking about whether to keep the Airbus planes, or eventually return to an all-Boeing fleet. Last July, CEO Brad Tilden indicated that the company was leaning toward the latter option. The recently passed tax-reform bill makes it even more likely that Alaska Air will place a big order with Boeing in the near future, with the goal of replacing its Airbus fleet over the next decade or so.
The pros and cons of going all Boeing
At its investor day last March, Alaska Air estimated that it could save $20 million-$25 million annually from having an all-Boeing fleet. Most of the cost savings would come from boosting pilot productivity. With a single aircraft type, every pilot would be able to fly every plane in the fleet. As a result, there would be fewer training events for each pilot, and the carrier would need fewer reserve pilots.
On the flip side, returning to an all-Boeing fleet would obviously require spending billions of dollars on new aircraft. Furthermore, Alaska might end up paying more for aircraft over time, since it would be locked into a single supplier.
Why tax reform matters
One key provision of the recent tax-reform bill makes the prospect of buying lots of airplanes in the next few years much more appealing. From 2018 until 2022, companies will be able to deduct the cost of capital expenditures (capex) immediately for tax purposes. This provision will then phase out gradually over the following five years.
This "full expensing" of capex is a boon to faster-growing airlines like Alaska Air. It effectively acts as a subsidy for capital spending. Companies that make big capital investments can defer a substantial part of their tax payments.
Alaska Air already plans to spend at least $2.2 billion over the next two years to expand its fleet, reconfigure Virgin America's airplanes, and complete its merger-integration activities. However, its total aircraft order book is quite modest. At the end of November, Alaska had 46 outstanding firm orders with Boeing. In fact, it has just $1 billion of committed aircraft capex for 2020 and beyond.
Good timing for a fleet renewal project
Alaska Air is scheduled to have 72 Airbus planes in its fleet by the end of this year, of which 62 will be leased. Forty-one of those leases expire between 2021 and 2023, and 53 expire by 2025. The other nine leases are for A321neos, arguably the most in-demand plane right now. This should make it easy enough for Alaska to exit those leases early. The 10 owned A320s would probably have to be sold at a modest loss.
Thus, it would be possible for Alaska Air to replace the bulk of its Airbus fleet in the 2021-2023 time frame. For the first two years, it would be able to fully expense its fleet expenditures, while in 2023, it could expense 80% of the cost.
Including Alaska Air's normal capex costs, this could reduce the carrier's cash tax bill to nearly zero in those years. In other words, the tax bill will make it much easier for Alaska Air to afford a major fleet overhaul in the next few years.
A decision is overdue
Alaska Air has stated that it would decide on the future of the Airbus fleet by the end of 2017. Yet the end of the year came and went with no announcement. (Uncertainty related to tax reform may have forced management to postpone the decision.)
It's quite possible that Alaska Air will announce its fleet plans in conjunction with the company's fourth-quarter earnings report. If so, Boeing could be in line for a big 737 order in early 2018.
Right now, Alaska Air only has enough firm orders for modest growth beyond 2019. If it opts to return to an all-Boeing 737 fleet over the next 8-10 years while continuing to grow at a mid-single-digit pace, Alaska Air could order as many as 150 Boeing 737s this year.