By SUSAN CAREY
The Wall Street Journal
ATLANTA—A jetliner parked in a cavernous hangar here boasts a gleaming paint job, 160 pristine blue leather seats and a new-airplane smell. But this latest addition to the Delta Air Lines Inc. fleet isn't new.
Not by a long shot. The twin-engine MD-90, acquired from China Southern Airlines Co. is more than 13 years old. It is one of 49 used McDonnell Douglas MD-90s Delta is rehabbing after scooping them up from global airlines that were thrilled to get rid of a plane that no longer is built by a manufacturer that long ago was taken over by Boeing Co.
Most large carriers prefer fuel-sipping new planes with the latest high-tech gadgetry. But Delta, which has one of the oldest fleets in the U.S., is making a habit of succeeding by zigging when its rivals zag.
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The nation's second biggest carrier stunned the industry by becoming the first airline to buy an oil refinery, in a bid to trim its highest and most volatile operating cost, aviation fuel. It runs a huge maintenance subsidiary that tends to its own planes and does third-party work, while other airlines have scaled down or bailed out of that business. And the Atlanta company has retained its status as the only major U.S. airline that is mostly nonunionized, giving it more flexibility than its rivals even as it pays most workers more.
Today, Delta is in the catbird seat as the U.S. industry undergoes a much-needed transformation to become more like other businesses that produce steady profits and returns to shareholders. After decades of boom-to-bust overexpansion, profligate spending and chasing market share instead of profitability, the new flight plan calls for pricing tickets to cover costs, pulling back in markets that don't make money and—above all—controlling spending with an iron hand.
Oddly enough, that cost-cutting effort has focused on an asset most airlines avoid: older planes. Though some safety experts once fretted about them, most now say that, with careful maintenance, older jets can fly safely. According to data compiled by Boeing, only 12 of 36 commercial jetliner accidents in 2011 that destroyed planes or caused substantial damage involved aircraft 20 years or older.
Besides the MD-90s, Delta is picking up the leases on 88 Boeing 717s with an average age of 11 years from Southwest Airlines Co. LUV +0.40% The discount king was so eager to shed the leases it inherited in its purchase of AirTran Airways that it took a $137 million charge to retrofit them for Delta. Yet even with the planes' higher fuel and maintenance costs, Delta figures it is saving at least $1 billion on the MD-90 purchases, compared with buying new planes, making them roughly 10% cheaper to operate per seat than new 737s. It won't say how much the 717s are saving, but its fleet strategy executive said he is "thrilled about the deal we got."
These bets could go south if fuel prices take off, the planes require more maintenance than expected or run into safety problems. But so far, Delta is thriving in its penny-pinching, and using the money it is saving to pay down debt, upgrade aircraft interiors, invest in new terminals and add passenger perks such as Wi-Fi in its cabins.
The company is in its third consecutive year of profitability and is on track to cut its net debt—liabilities minus cash—to $10 billion in 2013 from $17 billion in 2009. Fitch Ratings in June raised Delta's debt rating by two notches to B-plus due to "a quick turnaround in their credit profile and operations," said Sara Rouf, the Fitch analyst. While B-plus isn't investment grade, she said she considers Delta "to be currently the strongest player in the much improved airline industry in the U.S., as it continues to march ahead of its peers on many fronts."
For its customers, meanwhile, "older" hasn't meant "later" in terms of flight performance: the carrier ran 86.3% of its domestic flights on time through the first three quarters of this year, fourth among the top 15 U.S. airlines, and the largest to be so punctual, according to the most recent government figures.
When the company entered bankruptcy-court protection in 2005, Delta shared the problems the rest of the industry faced. The U.S. had too many carriers and too many planes. The largest airlines were staggering under towering costs and low productivity while nimbler low-cost carriers were growing quickly and siphoning off domestic passengers. Fuel cost was on the rise.
To be sure, the measures under court protection that followed were painful to many of its employees, such as the airline's decision to terminate its underfunded pilot pension plan, leaving the federal Pension Benefit Guaranty Corp. to pay retirees at often-smaller amounts. But the carrier used its time in court protection to excise $2 billion in annual expenses and launch a big international route expansion. It also fought off a hostile takeover bid from US Airways Group Inc. LCC -2.61% The year after it emerged from Chapter 11 in 2007, it acquired Northwest Airlines Corp., which had stepped out of court protection around the same time, cleansed of costs and debt.
The combination is headed by Richard Anderson, a 57-year-old lawyer who worked at Northwest for 14 years, including the final three as CEO, before leaving the airline industry to become a senior executive at UnitedHealth Group Inc. UNH +0.98%
Mr. Anderson said he learned a lot from the health-benefits company's CEO, Stephen Hemsley. "He had a razor focus on how you use cash and invest cash and return cash to shareholders," said Mr. Anderson, who still speaks with a bit of twang from his native Galveston, Texas.
Mr. Anderson returned to Delta in 2007, first as an outside director and then as CEO. His first order of business was negotiating the 2008 acquisition of Northwest, and help Delta successfully work through a multiyear integration process, giving it a head start on rivals still embroiled in that exercise. It remade smaller Northwest almost entirely in its mold, taking special care to bolster Delta's collaborative culture and stamp out Northwest's legacy of testy labor relations. But Mr. Anderson did bring a few Northwest concepts to Atlanta.
One is that some older planes are worth hanging onto. "You don't see hotel companies invest in hotels and then tear them down after 10 years," he said. Another idea is that it is preferable to own planes rather than lease them "so when you hit softness or an economic downturn, you don't (have to) fly empty planes with high monthly payments," he said. Delta owns 75% of its fleet.
Mr. Anderson learned this from experience. In the mid-1990s, cash-strapped Northwest decided—with input from McDonnell Douglas and aging-aircraft experts at the Federal Aviation Administration—to keep 183 DC-9s, then 25-years-old on average—flying until they turned 40. The company even went out and bought 40 more from other airlines. Around that time, Mr. Anderson was the head of technical and flight operations at Northwest.
There is no consensus about how old is too old when it comes to a plane. The FAA and industry safety experts generally believe planes can fly for 30 or more years, as long as they are well-maintained and the carriers follow all the manufacturer and regulatory directives that require more frequent inspections and fixes as the planes get older. "Age really doesn't play much of a factor if the airplane has been maintained," said Kevin Hiatt, chief operating officer of the Flight Safety Foundation, adding that planes are generally retired for economic, not safety, reasons.
Today, Delta's fleet is both old and complex. It has 10 different models in its 725-aircraft mainline fleet, and the fleet's average age was 16.6 years at the end of September. The last of its 19 DC-9s, which came from Northwest, clock in at more than 34 years old, and are expected to be put out to pasture in the next year or two.
This compares with an average fleet age of about 12 years for United Continental and US Airways. Southwest's fleet is 11-years-old on average while JetBlue Airways Corp.'s planes are six years old. American Airlines has a 15-year-old fleet, but the company recently ordered 460 new aircraft.
Some analysts do see problems, of course, with the old-jet approach. Most of Delta's rivals already have fewer aircraft types or aim to simplify their fleets further because that reduces the cost of training, maintenance and spare parts. They also are chasing every incremental reduction in fuel costs that new aircraft promise to deliver.
John Enders, an aeronautical engineer and aviation safety consultant, allowed that airplanes "have no practical end date." But older planes require an "extremely careful inspection and maintenance system," he said, and older fleet types might require a carrier to keep more "spares" in its inventory, meaning planes that would be at the ready if ones that were slated to fly had problems and had to be taken out of service for repairs.
The used-plane strategy even helped Delta win over its 12,000 pilots, its only major unionized group, to a new labor agreement reached over the summer. The 110-seat ex-Southwest 717s will be flown by Delta pilots, not aviators at regional carriers that fly on Delta's behalf, meaning more jobs and upward mobility for the Delta cockpit crews. This will clear the way for Delta to save money by culling the number of money-losing 50-seat regional jets that its commuter partners now fly and letting the 717s fill much of that need. "Both sides saw the advantage of not doing things the old way," said Buzz Hazzard, a spokesman for the Air Line Pilots Association.
At the heart of Delta's older fleet strategy is its 2.7 million-square-foot complex of maintenance hangars and shops at Hartsfield-Jackson Atlanta International Airport, part of a unit that employs 10,000 people across the country. Delta TechOps, as the unit is called, can repair engines, paint aircraft, modify airplanes and overhaul landing gear. Last year, the profitable unit racked up $650 million in revenue, up from $25 million in 1995. Clients include the U.S. military, aircraft leasing companies and domestic and overseas carriers.
With its mechanics having 19 years of experience on average, Delta believes it has the built-in expertise to cosset its older birds. Doug Worley, a 23-year Delta mechanic in Atlanta, works on all variety of the carrier's domestic aircraft. The McDonnell Douglas planes like the DC-9s and MD-90s are "workhorses," he says. "They're pretty reliable."
New or old, planes use a lot of fuel. Even with hedging and fuel conservation programs, Delta last year spent nearly $12 billion gassing up the fleet, its single largest expense. At the prodding of the airline's board, executives more than a year ago began studying the component parts of its fuel costs: crude, refining costs, refining margin, taxes and transportation.
They discovered a disconnect between refiners saying they couldn't make any money and the soaring refining margins Delta was paying on its jet fuel purchases. When the company learned that an idled Conoco refinery in Trainer, Pa., was for sale for $150 million, it took the plunge. It hired refinery professionals and signed contracts with two big oil companies to supply the crude and sell the gasoline and diesel output from the plant in return for supplying Delta's jets with aviation fuel at airports around the country.
Delta figures it can save at least $300 million a year, supply 80% of its domestic fleet's fuel needs and avoid the punishing refining margins it is paying today.
The facility restarted in September after being upgraded to produce a larger proportion of jet fuel. Delta is even exploring purchasing crude from the Bakken formation in the Dakotas and sending it by rail to Trainer, if that would be a better deal than taking crude shipped in tankers from Europe and the Middle East.
"I don't like to hear anyone at Delta say fuel is out of our control," said Mr. Anderson. "You might as well send up a white flag."
Delta isn't blind to the attractions of new aircraft, of course. Last year, it ordered 100 new Boeing 737-900s to replace older planes that will be retired. But it didn't take the newest version, which Boeing expects to roll out in 2017 with more efficient engines.
Instead, Delta bought from the end of the current production cycle, getting a better price. "It's just math," said Nat Pieper, Delta's vice president of fleet strategy and a veteran of Northwest. "Our fleet strategy is one of opportunism."
Source: http://online.wsj.com
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