Boeing (BA 1.31%) has seen extraordinary demand from airlines across the world for its new 737 MAX. This updated version of Boeing's best-selling jet is scheduled to arrive in Q3 2017, bringing double-digit fuel efficiency gains. Boeing has already racked up more than 3,000 firm orders.
However, Boeing still needs to keep its 737 production line busy until it completely switches over to 737 MAX production in late 2019. As Boeing looks to sell the last remaining current-generation 737 delivery slots, it is getting help at home from airlines like Southwest Airlines (LUV 0.56%) and United Continental (UAL -1.49%).
Southwest Airlines keeps upgauging
On Thursday, in conjunction with their earnings reports, Southwest and United Continental both announced orders for current-generation 737s.
Southwest Airlines has ordered an additional 33 737-800s for delivery between 2016 and 2018. It also converted its last 25 737-700 orders to the larger 737-800 model, as expected. The company now has 89 firm orders for current-generation 737s, as well as 200 firm 737 MAX orders.
These new orders will allow Southwest to completely retire its fleet of about 130 "737 Classic" models by 2018, compared to a previous plan to retire them by 2021. These planes are more than 22 years old, on average.
Southwest's move to accelerate the retirement of older 737s may have come as a surprise to some industry observers. The conventional wisdom has been that the sharp drop in oil prices would cause airlines to keep older planes around longer.
However, the 737-800 has about 25% more seats than the older planes Southwest is replacing. That means it has significantly lower non-fuel unit costs, in addition to being more fuel efficient. Southwest Airlines has been steadily growing its 737-800 fleet in recent years for just this reason. The low fuel price environment has given it ample cash flow to buy more new planes, allowing it to capture these cost savings sooner.
United Continental replaces regional jets
United Continental topped Southwest by announcing an order for 40 current-generation 737s, with deliveries between mid-2017 and 2019. United opted for the smaller 737-700 model, but its goal is ultimately the same: upgauging to larger aircraft.
The difference is that United Continental has a big fleet of 50-seat jets operated by regional airlines. These planes are expensive to maintain and the regional airlines that fly them face a crippling pilot shortage. Moreover, customers don't like 50-seat jets. These planes feel cramped and lack amenities like first class and premium economy sections, Wi-Fi, and inflight entertainment.
By adding smaller mainline planes like the Boeing 737-700 to its fleet, United Continental will be able to dump more than half of its 50-seat jets by 2019. That should improve customer satisfaction and open up new ancillary revenue opportunities while holding unit cost growth in check.
United's 2016 fleet plan also calls for adding 14 new 737-900ERs this year. Boeing's current backlog only reflects two firm orders for that model from United. Some of these additional 737s may already be in Boeing's backlog for "unidentified customers" but at least some are probably not in the official backlog yet.
Locking down the last few orders
Boeing probably gave Southwest Airlines and United Continental sizable discounts to wrap up these two orders. However, the 737 produces very high cash margins, so Boeing has plenty of wiggle room.
The 73 orders announced on Thursday (not counting any of United's 737-900ERs that may be new orders) represent a substantial portion of the remaining current-generation 737 delivery slots. By getting firm orders locked up, Boeing has reduced the risk of not finding buyers for the last current-generation 737s off the line.
Additionally, with these orders in hand, Boeing has more flexibility to work with customers facing demand weakness. It can afford to defer some 737 deliveries to 2020 or later to support future production increases. No matter what comes next, these orders from Southwest and United represent a great start to the year for Boeing.