One of the defining features of the airline industry is that it is extremely capital-intensive. Even a relatively small regional jet costs tens of millions of dollars, while jumbo jets can cost $150 million-$200 million each, even after big bulk discounts.
As a result, it is very important for airlines to manage their cash wisely. Over the past five years or so, Delta Air Lines (DAL +1.59%) has proven that it is one of the best airlines in the world from this perspective.
Balancing priorities
While airplanes can last for decades, they don't last forever. As planes age, maintenance expenses tend to rise, while reliability may suffer. Furthermore, newer airplanes tend to be significantly more fuel-efficient than planes designed in the 1970s or 1980s. Newer planes are also often more comfortable for passengers.
New planes are expensive, but they are cheaper to operate than older models.
Thus, there are good reasons for maintaining a modern fleet. On the other hand, planes are incredibly expensive, so retiring them earlier than necessary is a big waste of capital.
As a general rule, mature airlines should try to keep capital spending roughly in line with depreciation expense (which represents the gradual loss of value of existing capital assets like airplanes). This would indicate that the capital base is being replenished over time as older airplanes are replaced at the end of their useful lives.
In practice, inflation and growth plans may create the need for capital spending in excess of depreciation expense. On the other hand, if an airline's capex regularly lags its depreciation expense, this indicates that it may be deferring essential aircraft replacement projects.
The numbers
Let's take a look at how Delta's capex stacks up against its depreciation expense. Here are the figures for the five most recent fiscal years:
|
Year |
CapEx |
Depreciation |
CapEx Excess (Deficit) |
|---|---|---|---|
|
2009 |
$1.202 billion |
$1.344 billion |
($142 million) |
|
2010 |
$1.342 billion |
$1.370 billion |
($28 million) |
|
2011 |
$1.254 billion |
$1.389 billion |
($135 million) |
|
2012 |
$1.968 billion |
$1.419 billion |
$549 million |
|
2013 |
$2.568 billion |
$1.478 billion |
$1.09 billion |
|
Total |
$8.334 billion |
$7.0 billion |
$1.334 billion |
Source: S&P Capital IQ.
Over the past five years, Delta's capital expenditures have exceeded its depreciation expense by 19%, or $1.33 billion. This indicates that -- on average -- Delta is spending enough to keep its fleet up to date while allowing for some growth.
Digging a little deeper, it's worth noting that up until 2012, Delta's capital expenditures were actually lagging its depreciation. In fact, Delta's capex was near historic lows for most of the 2004-2011 period, as poor financial results forced it to defer capital projects to conserve cash. (Delta and merger partner Northwest Airlines still had to file for bankruptcy in late 2005.)
Delta Air Lines CapEx vs. Operating Cash flow, 1997-2017 (estimate). Source: Delta Air Lines.
It's only in the last two or three years that Delta has been able to start catching up on this deferred capital spending. The company plans to spend another $2.3 billion on capex in 2014 as it continues to update its fleet.
Keeping capex manageable
Given how far behind Delta fell in terms of deferred capital spending, it's impressive that the company has managed to keep capital spending relatively close to depreciation expense in the last few years. Delta has used two main strategies to keep capex manageable.
First, Delta has used its maintenance expertise to extend the useful lives of its aircraft. Whereas most airlines retire planes after about 25 years in service, Delta continued flying 35-year old DC-9s until earlier this year. This has allowed Delta to spread the cost of replacing its oldest planes over a longer period of time.
Delta's maintenance expertise allows it to keep older aircraft running longer.
Second, Delta has invested in aircraft modifications to make its older planes more competitive. For example, Delta is currently working on a project to add seats to several older aircraft types by installing slim-line seats (allowing closer spacing of rows) and reconfiguring its lavatories and galleys. This reduces fuel burn per seat at a much lower cost than buying a new plane.
At the same time, Delta has added amenities like Wi-Fi, in-seat power outlets, personal TVs, larger overhead bins, and updated lighting on its older planes. Thus, passengers can get all the amenities of a modern plane on an aircraft that may be 20 years old.
Cash is king
U.S. airlines have been haunted by a Goldilocks problem in the past few decades. At times, they have allowed their fleets to age and fall into disrepair, inconveniencing customers. At other times, they have gone on plane-buying binges: spending well beyond their means.
Delta Air Lines has done a remarkably good job in the last few years of balancing the dual priorities of making investments when necessary and keeping capex to reasonable levels. For the foreseeable future, Delta intends to spend a little more on capex than its annual depreciation expense. This will allow it to catch up on deferred capital spending while growing modestly.
Delta's judicious capital spending has helped it maintain its position at the top of the U.S. airline industry while generating substantial free cash flow to pay down debt, fund its pension plans, and return cash to shareholders through dividends and buybacks. As a result, it's no surprise Delta has been one of the best-performing stocks in the S&P 500.
