United announces new plane orders

Wrapping up a six-month long RFP process, United Airlines announced this morning firm orders for 50 new wide-body aircraft and options on 100 additional planes.  The order is split right down the middle between Airbus and Boeing, with the initial selection of the A350-900 and the B787-8 types.  While it seems that such an order might be a function of inability to decide which single type is better for the carrier, United sees it a smart compromise, being able to choose the right-sized aircraft for the particular destination at hand and that the numbers from taking that approach are better than a single aircraft type.

Right-sizing the fleet

The most striking number from the new order appears to be the average plane size.  Specifically, these planes are a lot smaller than the ones they are replacing.  Even if United keeps the same frequencies on all of their current routes they will be drawing down passenger capacity by about 19% as these planes are smaller than the ones they are replacing.  And there will be similar cargo reductions as well.  Cargo capacity on a route-specific basis is a significant contributor to profitability so that all has an impact.  The executives answering questions this morning suggest that such limitations will be overcome by offering direct flights to more destinations rather than connecting passengers and cargo through hubs and stops along the way, though no specific destinations or routes were discussed.  The executives also suggested that they are planning for “capacity discipline” (an oft-repeated term) for the down cycles in the industry rather than the upswings.

Is this a short-sighted move?  Certainly having an airline planning for max capacity at the highest peak makes no sense.  After all, the industry rarely spends extended amounts of time in that position.  But planning to build an airline that is right sized at the bottom of the market seems to lack a bit of foresight and optimism.  It certainly doesn’t seem like a growth strategy.

Delivery Dates

United expects to take delivery of the initial order of planes starting in 2016 and extending through 2019.  The 2016 date is an interesting one.  The 50 new planes are expected to come online over a four year period starting seven years from now.  Why commit now to such an order so far out?  Apparently because Boeing and Airbus were willing to make some deals during the downturn in the economy.  United felt that the time was right to negotiate on these deals and to commit to them.  The actual cash outlay numbers are pretty low – only $60MM over the next 3 years and $152MM over the next 5 – so the initial commitment isn’t all that significant.  And they were also able to negotiate “significant deferral flexibility and substitution rights” on the orders so there does seem to be some upside to the move today.  It also commits them to actually making the move, something that is good for the company in the long run.  With the minimal initial cash outlay and the backstop financing that they received from both carriers they should be on reasonably solid ground in that regard. 

Costs and Savings

One of the more interesting numbers shared in the conference call was $400MM.  That is the amount that United estimates they would save annually on fuel if they flew the existing 767 and 747 routes with 787s and A350s.  That is a lot of money to save and demonstrates just how significant the efficiencies of the newer aircraft are.  But it also belies the fact that the newer planes will carry 19% fewer passengers.  The cost savings are nice but there are going to be some inherent revenue losses as well so that does not necessarily translate over directly to the bottom line.

From a pilot contract perspective the new fleet-types are covered under the existing contract through a clause that mathematically figures the new rates for those pilots.  That being said, the deliveries are not going to start until 2016 so there is plenty of time for future negotiations to happen.

One significant open question is how the planes will be configured.  Currently there are a number of 767s and 777s (which these new planes are also eventually going to replace) configured for domestic service.  They are mostly used between the hubs and for service to Hawaii.  There is no real indication as to whether some of the new birds will also be pressed into domestic service and as of now the folks in the PR office don’t have an answer to that question.

In the mean time, it seems reasonable to express cautious optimism when looking at United’s plans.  New planes are good and having more of them (potentially 150 versus ~90 wide bodies today) is also good.  Of course, they are smaller and the airline seems to be planning in a retrenchment mode rather than a growth mode which seems to belie the mantra of longer, thinner routes so who knows.