It's hard to believe now that just three years ago, regional jet manufacturer Embraer's (NYSE:ERJ) order backlog was shriveling up. At the end of 2012, Embraer had only 185 firm orders left for its E-Jet aircraft family, representing less than two years of production.
By contrast, Embraer closed out 2015 with more than 500 firm orders on the books thanks in part to a surge of fleet renewal efforts among U.S. regional airlines. Embraer is set to continue this momentum in 2016 and could be close to securing a big order from a relatively new customer: Alaska Air (NYSE:ALK).
Alaska fends off a bigger rival
For many years, Alaska Airlines dominated the air travel market in its hometown of Seattle. However, it has recently faced a strong challenge from global giant Delta Air Lines (NYSE:DAL).
As Delta has added domestic flights in Seattle, Alaska Air has focused on maintaining its market share. At Alaska's investor day in December, management pointed out that the company had a stable seat share in Seattle from the end of 2012 to the end of 2015, at 51%.
One way that Alaska has looked to keep pace with Delta Air Lines is by adding new destinations to its route map. However, some of these routes don't have enough traffic to support mainline flights on a 737.
As a result, in 2015, Alaska began adding 76-seat Embraer E175s to its fleet. (These planes are actually operated by regional airline SkyWest.) Alaska likes the E175 because it has an effective range of about 1,700 miles, enabling "long-and-thin" routes. Management sees more long-and-thin growth opportunities, so it is looking to increase the regional fleet size.
There is a second aspect to Alaska's growing interest in regional jets. Delta Air Lines has touted its "all-jet" service when trying to win customers in Seattle. By contrast, Alaska's in-house regional airline subsidiary -- Horizon Air -- operates a fleet of about 50 Q400 turboprops for short-haul regional flights.
While the Q400 has very low operating costs for short-haul flights, its slower cruising speed makes it uneconomical for longer routes. Furthermore, customers find jets more comfortable than the Q400, which feels cramped by comparison.
Alaska's reliance on the Q400 puts it at a disadvantage vis-a-vis Delta in some markets. The management team recognizes this. On the company's recent earnings call, CFO Brandon Pedersen stated, "Our competition, frankly, is using [regional jets] in many of our markets and I think we want to make sure that we are staying on par or better with the customer experience side."
More regional jets needed
Alaska's rivalry with Delta in Seattle is thus pushing it strongly toward growing its regional jet fleet. On the earnings call last month, management announced tentative plans to order 30 regional jets this quarter. Wholly owned subsidiary Horizon Air will operate these aircraft, now that its pilots and flight attendants have ratified new long-term contracts.
There are only two serious competitors in the 76-seat jet market today: Embraer's E175 and Bombardier's CRJ900. However, the E175 is almost universally preferred by travelers because it has a wider and taller cabin. This has helped Embraer win the lion's share of new regional jet orders in the past three years.
Given that Alaska's management specifically cited the customer experience as a key reason for adding more regional jets, picking the E175 would be almost a no-brainer.
If Embraer does win this order, Alaska wants deliveries to begin in 2017. Most of the deliveries would probably occur in 2018, though, as Alaska has 15 Q400 leases expiring that year.
This is great timing for Embraer. The company's order book for 2016 appears to be completely full. It has filled most of its 2017 delivery slots as well, but there is still some availability. Embraer's biggest need for new orders is in 2018. It plans to deliver the first of its next-generation E2-series jets that year, but current-generation models will still likely account for most of its production.
Snagging a big order from Alaska Airlines could go a long way in helping Embraer bridge the gap until production of its next-generation jets fully ramps up around 2020. This should enable Embraer to deliver steady revenue and profit growth over the next several years.