Tuesday, August 30, 2011

New Boeing 737 Engine Benefits Weigh Against Fleet Age And Route Profitability

Kudos to Boeing (BA) for trying to do right by its customers and the environment.  Airlines are sensitive to fuel costs and Boeing wants to stay in their good graces by putting new engines into their 737s that are 12% more fuel efficient.  A quick anecdotal study of one of the industry's biggest customers gives us a glimpse into how far this benefit carries.

United Continental Holdings' (UAL) 2010 annual report named fuel costs as 31% of its total operating expenses.  Theoretically, if UAL replaced every single plane in its fleet with a new Boeing 737, they'd shave exactly 3.72% off their operating expenses by applying that 12% fuel cost savings.  Reality is more complicated.  Not all of UAL's planes are 737s (obviously) and other planes in the fleet may be even more fuel efficient.  Maybe that's why United retired its last 737 in 2009 when fuel costs made them less attractive; any 737s in its existing fleet are probably inherited from last year's merger with Continental (like one unfortunate plane with Continental markings stuck in a sinkhole this past June).  Airlines factor in the age of existing airframes and the need to maintain seat capacity on their most profitable routes when they make replacement decisions.  Fuel efficiency is therefore one of several considerations.   

Perhaps airlines like United are better off with whole engine replacements targeted at their oldest aircraft as a partial solution to their fuel cost headaches.  Hedging with forward contracts can smooth out those fuel costs that can't be minimized cost-effectively with new airframe buys.  Decisions like this are the provenance of CFOs.  Those CFOs who ignore them contribute to the old financial folk tale that the airline industry has not generated one dollar of net income in its history, adjusting for bankruptcies. 

Full disclosure:  No positions in UAL or BA.