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Delta Air Lines, Inc. Is Poised for Fuel-Efficiency Gains

By Adam Levine-Weinberg - Feb 14, 2016 at 8:40AM

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By pursuing a selective fleet renewal strategy and adding seats to older airplanes, Delta is steadily improving its fuel efficiency.

In the past few years, some airlines -- most dramatically American Airlines (AAL 3.55%) -- have spent tons of money on new planes in order to boost fuel efficiency. Meanwhile, Delta Air Lines (DAL 1.90%) has made a name for itself by continuing to fly older aircraft and buying up used planes from other airlines.

Delta has purchased quite a few used aircraft in recent years. Photo: The Motley Fool

It's hard to argue with the results. Delta provides extremely reliable service in spite of its older aircraft fleet. Moreover, it has an extremely high return on invested capital thanks to its disciplined capital allocation policy.

However, investors shouldn't think that Delta is ignoring fuel efficiency. In fact, it is on pace to take a big step forward in terms of fuel efficiency over the next two to three years -- while remaining disciplined about capital spending.

American Airlines pays up for fuel efficiency gains
American Airlines is in the midst of a massive aircraft-buying binge. Several years ago, it ordered more than 400 new narrowbody aircraft from Boeing (BA 2.28%) and Airbus. It is also updating its widebody fleet with dozens of new Boeing 777s, Boeing 787s, and Airbus A350s.

In 2014 -- the first full year after its merger with US Airways -- American Airlines added 132 new aircraft to its fleet, including regional jets. In 2015, it received 127 new airplanes. In 2016, it will receive more than 100 new airplanes for the third consecutive year.

American Airlines is rapidly replacing older planes in its fleet. Photo: American Airlines.

This fleet replacement strategy has required huge capital expenditures. American Airlines' aircraft capex exceeded $5 billion per year in 2014 and 2015. The company expects to spend another $4.5 billion on aircraft purchases in 2016.

American's fleet renewal program has driven steady fuel efficiency improvements. Yet the gains have been smaller than you might imagine, given the extent of American's spending. In 2015, American increased capacity 1.2% year over year, while fuel consumption fell 0.2%. That implies a modest 1.4% year-over-year gain in fuel efficiency.

Fuel efficiency on a budget
While Delta Air Lines is roughly the same size as American Airlines, it has learned to get by on a much tighter capex budget. It has spent an average of about $2 billion annually on aircraft purchases in the past three years.

Over the next three years, Delta expects to spend an average of $2.4 billion annually. Even on this relatively modest budget, it will be able to replace about 15% of its fleet with new planes between now and 2018. This consists of 57 new Boeing 737-900ERs, 45 new Airbus A321s, 15 Airbus A350s, and six Airbus A330s.

Just as importantly, Delta is adding more seats to its existing planes to improve fuel efficiency. First, Delta is reconfiguring its domestic Boeing 757s from various setups averaging about 180 seats to a uniform 199-seat configuration. About half of these planned retrofits have occurred just in the past six months, and the project should be completed by the end of 2016.

Delta is adding seven seats to all of its A320s. Photo: The Motley Fool.

Delta is also adding seats to its Airbus A319s and A320s. The A319s will get 132 seats, up from 126 previously, while the A320s will be configured with 157 seats, up from 150 seats previously. In total, Delta's aircraft modification projects will add seats to nearly a quarter of its planes between 2015 and 2017.

Most of the benefit for half the price
Between buying new planes and adding seats to its existing fleet, Delta should be able to improve its fuel efficiency by 4%-5% over the next three years.

American Airlines should be able to achieve a larger fuel efficiency gain in that time period. However, American's capex budget is roughly twice that of Delta. It's only getting a modest incremental fuel efficiency boost compared with Delta's penny-pinching approach.

As a result, Delta will be in good shape even if fuel prices bounce back in the next few years. In the meantime, it will maintain its lead over American Airlines in terms of return on invested capital.

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Stocks Mentioned

Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
DAL
$29.52 (1.90%) $0.55
The Boeing Company Stock Quote
The Boeing Company
BA
$139.84 (2.28%) $3.12
American Airlines Group Inc. Stock Quote
American Airlines Group Inc.
AAL
$13.13 (3.55%) $0.45

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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