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Delta Air Lines Is Upgrading Its Fleet Faster Than Ever

Adam Levine-Weinberg, The Motley Fool

In the years following the Great Recession, Delta Air Lines (NYSE: DAL) pioneered a strategy of buying up used jets and extending the lives of its aircraft in order to reduce capital spending. This allowed the company to reduce its adjusted net debt by nearly $10 billion between the end of 2009 and the end of 2014.

However, Delta now has a strong investment-grade balance sheet. Meanwhile, its older planes are becoming more expensive to maintain -- and are far less efficient than the most modern jets. As a result, it has ordered hundreds of aircraft in recent years. This fleet replacement program began in earnest last year, and it is kicking into high gear in 2019.

Delta's fleet is old

As of the end of 2017, Delta Air Lines had 856 aircraft in its mainline fleet, with an average age of 16.7 years. For comparison, American Airlines' mainline fleet had an average age of just 10.1 years at that time.

Furthermore, Delta Air Lines' fleet has a high concentration of models that have been out of production for more than a decade. That includes the McDonnell Douglas MD-88 and MD-90 and the Boeing 717 and 757. (These four models together accounted for 45% of Delta's fleet at the end of 2017.) Aircraft that have been out of production for a long time tend to be expensive to maintain, as it becomes harder and harder to find spare parts.

On the other hand, Delta had 353 firm orders for mainline aircraft by the end of 2017, enough to replace more than 40% of its fleet. Those new aircraft are now arriving at a rapid pace.

A parked Delta Air Lines Airbus A32

Delta has hundreds of aircraft on order, including lots of Airbus A321s. Image source: Delta Air Lines.

Fleet renewal is ramping up

Delta Air Lines was originally scheduled to take delivery of 74 new mainline aircraft in 2018. However, a trade dispute delayed the delivery schedule for its Airbus (NASDAQOTH: EADSY) A220s. Delta ultimately received four A220-100s last year, whereas its original fleet plan called for 15 A220 deliveries. Moreover, it didn't put its first A220 into regular service until this month.

Thus, in effect, the carrier added 59 new planes to its mainline fleet last year. This allowed it to retire 25 MD-88s and 22 MD-90s, while also modestly expanding its domestic fleet.

Delta expects to receive another 80 new mainline aircraft in 2019, according to its recently released annual report, followed by 67 mainline deliveries in 2020 and 60 in 2021. The vast majority of these aircraft on order for the next few years are narrowbodies destined for the domestic fleet -- and nearly all of them will come from Airbus.

Indeed, Delta has 114 A321s and A321neos due to arrive from Airbus over the next three years, along with 54 A220s. It plans to replace all of its remaining 84 MD-88s by the end of next year. Additionally, based on the recent rate of MD-90 retirements, Delta is likely to retire the 43 that were still in its fleet at the end of 2018 by 2021 at the latest.

Look for steady nonfuel unit costs and rising fuel efficiency

The ongoing fleet renewal project represents the linchpin of Delta's efforts to hold down unit costs. First, replacing aging MD-88s and MD-90s with brand-new airplanes should steadily reduce maintenance costs. Second, the A321s and A321neos that account for the majority of deliveries over the next three years have 21% to 30% more seats than the MD-88s and MD-90s they will replace -- but pilot pay rates that are only 6% to 8% higher. That means labor costs will be significantly lower on a per-seat basis.

Last year, nonfuel unit costs increased just 1.4%, as Delta started to benefit from replacing its oldest planes. Management expects nonfuel unit cost growth to slow to about 1% this year as the pace of fleet renewal accelerates, and unit cost trends could improve further in the early 2020s.

Fleet renewal will have an even bigger impact on fuel consumption. Delta's fuel efficiency improved by 1.5% last year. Delta could achieve even bigger fuel-efficiency gains over the next few years as its aircraft deliveries shift toward next-generation products like Airbus' A220, A321neo, and A330-900neo.

The combination of better fuel efficiency and little or no nonfuel unit cost growth sets the stage for future margin expansion at Delta Air Lines. And with the stock currently trading for just eight times forward earnings, any margin improvement in the coming years could drive big gains for shareholders.

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Adam Levine-Weinberg owns shares of Delta Air Lines and is long January 2020 $20 calls on American Airlines Group. The Motley Fool owns shares of Delta Air Lines. The Motley Fool has a disclosure policy.