Premium #127 – Delta and the A380

The A380 and the North American market have not been a match so far. But is change in the winds? Mark Lapidus, CEO of aircraft lessor Amedeo, believes that he can sell Delta on the A380, despite its management stating that they think the airplane is too large for their route structure, and is not something they are currently considering. Is it wishful thinking at Amedeo or is there something to these statements? European competitors, including Delta’s SkyTeam partners are flying the A380 successfully to North America. Air France operates A380s from Paris to New York, Los Angeles, Washington DC and Montreal. Korean Air operates A380s from Seoul to New York, Los Angeles, and Atlanta. China Southern operates from Guangzhou to Los Angeles. Delta code-shares on many of those flights. Virgin Atlantic, in which Delta holds a 49% stake, has A380s on order that will also likely be used on North American routes, if delivered. Delta is looking to replace its 747-400 and 767 fleets with new aircraft. If the A380 makes sense for others, why wouldn’t it make sense for Delta? The answer might be found in an analysis of traffic, the mix of premium traffic in each market, yields, and operating costs. Delta’s current fleet of 747-400s, which they inherited from Northwest post-merger, consists of 16 aircraft. Routes served by these aircraft are the natural targets for any potential A380 deployment. Several of Delta's 747-400 routes have high traffic demand, and could likely accommodate A380s. These routes include New York JFK-Tel Aviv and New York JFK-Tokyo Narita, Detroit to Tokyo Narita, and Atlanta- Tokyo Narita. We think Delta may need to acquire a very large aircraft (>400 seats) where they find themselves slot constrained. The obvious airport for this is Heathrow. Amedeo points out that 70% of the world's megacity airports are slot constrained already - Heathrow being the most constrained. Indeed within Europe, 99 airports are slot controlled already, as are 13 in North Asia and 35 in the rest of the Asia Pacific. On these grounds, given that Delta is one of the world's mega-carriers, discounting deployment of a very large aircraft at may be premature. According to the UN, urban populations will swell from 54% to 67% of the global population. This means, says The Economist, “for the next 36 years the world’s cities will expand by the equivalent of six Sao Paulos every year”. AirInsight is confident that airport capacity growth will not match this level of growth - meaning ever more crowded airports with rising slot constraints. The need and demand for larger aircraft will grow accordingly. The question is when, rather than if, as traffic doubles over the next two decades. Let’s examine some of the pros and cons of an A380 in Delta’s network, and the relative costs when compared with other aircraft. Frequency versus Capacity One of the arguments for the A380 is that it consolidates traffic from multiple flights and saves money on a route. The British Airways schedule from London-Los Angeles is an example, where it replaced three daily 747 operations with two A380s. From an economic perspective, this works. The following chart from Airbus shows how compelling the logic is. Similarly, one could argue that markets like New York-London, with multiple daily flights, would benefit from consolidating frequencies. But are there competitive dynamics in these markets that make frequency a key decision factor for business travelers? Airlines depend on premium traffic with their corresponding high yields for profitability on international operations. There are currently 20 daily flights between Heathrow and JFK. Thirteen daily flights are flown by the oneworld alliance (BA and American) while Sky Team alliance (Delta and Virgin) operates six daily flights. The case for these two alliances consolidating frequencies at peak times seems straight forward. The A380 is probably the best aircraft to accomplish this. A competitive dynamic in certain markets is having flights at the "right time". And that right time even includes morning departures from the US arriving in the evening in Europe, as well as the traditional overnight flights, and both morning and late evening flights back to the US for business travelers who may need to put in a full work day before leaving for the US. Traffic volume certainly exists for A380 flights between New York to London, but is the market ready to give up some frequency for efficiency? We think a strong case can made for the A380 in New York-London market. There is also the issue of optimization of valuable Heathrow slots to consider. An A380 makes better use of a valuable Heathrow slot than smaller aircraft, and if consolidating flights to an A380 frees up a slot for another potential market, a new opportunity is created for additional revenue or market development. The following chart (source: Amedeo) of the Los Angeles-Tokyo market shows that this market, as well, has an opportunity for flight consolidation and optimization of Narita airport and especially the rare Haneda airport slots. As consolidation among US airlines evolved, capacity control has been the industry watchword. By limiting capacity and increasing yields, US airlines are now leading the industry in profitability. The big four US airlines are carefully adding capacity at a deliberate rate, typically by replacing smaller narrow-bodies with larger ones. Such as 737-700s to -800s at Southwest, and replacing 50-seat CRJs with 110-seat Boeing 717’s at Delta. By replacing 376-seat 747-400s with 350-400 seat super twins, Delta will save operating costs with new technology aircraft. Further, it would not risk potentially lower yields by adding another 100-200 seats into markets on a daily basis with an A380. However, the choices for Delta to offer equivalent seating to the 747-400 are few. Moreover, staying with equivalent seat capacity does not support market growth. Would replacing the 16 747-400s with, perhaps, eight to twelve A380s and four to eight super twins better enable market stimulation? Clearly fleet decisions require careful analysis of the tradeoffs to find the optimal risk/reward. We suggest the A380 may actually offer Delta more flexibility than super twins for certain markets. Is there enough of those markets to justify a sub-fleet of A380s? An important consideration is that Delta has made it clear it will not buy new technology aircraft until they are mature. Delta is alone among big airlines in buying older aircraft, some already out of production (i.e. MD-90), because they are inexpensive and offer highly predictable service, and an economic advantage when capital, as well as operating, costs are considered. Plus Delta has one of the finest MRO operations to support these aircraft. Consequently, are the aircraft choices Delta can select from more restricted to match that philosophy? For long-range flights, Boeing's 777-300ER is an outstanding and proven option, as is the Airbus A330-300 and also the A380. Boeing will also likely offer attractive pricing as it wants to close the bridge between current 777s and the 777X, as would Airbus to extend the A330 program. Airbus' A350 is not mature, and so the only other Airbus option is the A380, which is much bigger and more expensive to fly than either the 777-300ER or A330-300. Even so, Amedeo makes a compelling argument in the following chart. They show the A380 economics to be highly competitive against the 777-300ER and even the forthcoming A350-1000. Since Delta's management has demonstrated their focus on economics rather than the promise of next generation aircraft, these numbers provide an interesting contrast. Note that with a three-class configuration of 602 seats, the A380 would be 60% higher in capacity than the 376 seat 747-400s in Delta configuration, clearly not a one-for-one replacement. Today, Delta currently operates 777-200s at 9 abreast in economy, with an 18.5 inches seat width. At 10 abreast, the seat width shrinks to 17 inches in width. With an A380, the choice would be 10 abreast in economy with a 19 inches seat width, or 11 abreast in economy, with a seat width of 18 inches. We believe a comparison of 9 abreast for the 777 versus 10 abreast for A380, or 10 versus 11, respectively is fairer, and could change the seat-mile analysis in an “apples to apples” comparison. Cabin Mix One of the advantages of the A380, according to both Airbus and Amedeo, is that it offers opportunities to optimize cabins, including premium economy, to maximize revenues. The key is whether Delta could generate additional premium demand with its product. Delta offers a combined First/Business product, and a new Economy Comfort product. A four-class service, as offered by some A380 operators, does not fit at Delta. Delta could configure an A380 cabin with extended premium seating, perhaps using the entire upper deck. Of course, it could also bulk up premium seating on a 777-300ER too, if premium traffic is available to fill the seats. Passenger Preference There is little doubt that passengers prefer the larger cabins of the A380 and 747 over smaller aircraft. But is that preference differential enough to draw traffic from competitors? Airbus touts high load factors for its A380 operators to support its thesis that the A380 attracts traffic. The next graphic, supplied by Amedeo, further demonstrates the attraction of the A380 by comparing load factors for various aircraft types. Of course, airlines have been careful to place A380s on high-density routes, introducing a bias. The 747 also showed high passenger preference when it first entered service. Iconic aircraft attract traffic. Amedeo makes a strong case that even though the A380 is much larger than the other aircraft, it does not appear deploying these aircraft is as risky as some might believe. Economics and the Bottom Line Then there is the view that economics of a four-engined jet, even the A380, are merely competitive with today’s twins, and will be inferior to the economics of the next generation super twins. Hence the talk of an A380neo. Detroit-Tokyo, about 5,581 nautical miles, is a typical Asian route for Delta. In the following analysis, we compare the economics of several aircraft on a cost per seat-mile and cost per air mile basis to examine what might be the best aircraft for this route. The contenders from Boeing include the 747-400, 747-8i, 777-300ER, 777-9 and 787-10, and from Airbus include the A380-800, A350-1000, A350-900 and A330-300, and the potential A330-300neo. Airbus cites Emirates as an example of the A380's compelling economics. Delta, and any other mega-carrier, cannot dismiss Emirates' experience. Emirates has demonstrated enviable growth, and has developed inroads into previously cozy markets wherever they fly. They have shown the A380 is highly disruptive and has demonstrated an ability to move passenger choice. Our economic analyses are based on information gleaned from the aircraft manufacturers and airlines operating the aircraft. Our operating cost assumptions are normalized for uniform operating conditions, uniform rates for flight crews and landing and navigation fees. Fuel burn and maintenance costs are computed for the route length. For seating capacity, we utilized Delta configurations, including nine abreast economy seating for 777-300ER and 777-9. While ten abreast is possible in this aircraft, Delta has maintained nine abreast on their 777-200LRs. We have assumed a First/Business, Economy Comfort and Economy configuration, and as a result, seat counts may not match typical three class configurations from Boeing and Airbus. Our summary of operating costs for the Detroit-Narita route are as follows: The next table compares the operating cost per aircraft mile and operating cost per seat mile for various candidates to replace the 747-400. On a cost per seat-mile basis, several of the newer aircraft, including 787-10, 777-9, A350-900, A350-1000, and the A330-300neo, beat the A380. Delta can minimize its risk by flying lower capacity aircraft on certain routes, while maximizing revenue through increasing the premium/economy seating ratio and constraining supply to enable higher yields. Given the risk aversion of Delta management to new aircraft types, the A330-300neo appears to be the logical choice to replace 767s. But that covers the North Atlantic market. What should replace Delta's 747-400s? Adding capital costs to operating costs paints a better picture of relative economics. Since Detroit-Narita is a 13.5 hour route, an airplane will typically make one trip per day, or 30 trips per month, on average. Using current lease rates for existing models, and estimated rates for new models, we calculate a total cost estimate to compare each aircraft. Adding capital costs to the equation changes the picture somewhat; now the more fuel efficient new technology aircraft are the most expensive. Our estimated lease rates are based on data from aircraft appraisers and a Delphi method among industry experts regarding new technology aircraft. Examining the total cost per seat, the new technology aircraft are in the lead, followed by A330neo and A380, with the 777-300ER and 747-8, each in less than maximum seating configuration, ranking last. Does this mean the A380 has a shot a Delta? It clearly depends on traffic volumes. If traffic on a route can support 565 daily seats, in an assumed Delta configuration, the A380 does make sense. But if fewer seats are needed, smaller aircraft could fit the bill better. Of course the wrinkle is that Delta is unlikely to consider aircraft to the left of the A380 in the chart above because none of these is "mature." For routes in which flight consolidation is a possibility, the economics change. For example, a market with two frequencies, with an A330-300 could be accommodated with a single A380 flight. Comparing the economics above shows that a single A380 would reduce costs by nearly $400,000 per month in direct costs. The indirect costs, however, for slots, gates, and crew training can also make a significant economic contribution, and would likely quickly make-up the difference in transition costs to support a sub-fleet of A380s. Amedeo points out that a fleet of 12 A380s is the equivalent capacity to 22 A350-1000s, 23 777-30ERs or 21 777-9. As a result, flight crew requirements are reduced significantly, and the savings from flight crew and technician payrolls will more than cover the transition costs needed to introduce the A380 into the fleet, as shown below: Amedeo points out, and their CEO made this clear during a call with AirInsight, that Delta could reduce its costs by having fewer aircraft. For example, it does not need to replace 16 747-400s with 16 A380s. Eight A380s could do the job for appropriate routes with better economics and much greater revenue upside. A key driver for selecting an A380 is traffic growth and airport constraints. If traffic continues to grow and more airports become constrained, larger aircraft are required. How big is this problem? It may not be significant now in many markets, but it is certain to become more of a problem. Once again, this uncertainty could be an advantage for the A380. Could Delta engineer a short-term lease for A380, until the new super twins mature? A leased A380 fleet buys Delta flexibility, where it can be deployed without locking up capital in the event the next generation super twins deliver as promised. Another wrinkle to consider is that by keeping their cash in the bank, Delta could be ready to pounce during the next downturn when orders are cancelled and aircraft prices become more attractive. Based on Delta’s aversion to unproven aircraft, we believe Delta will select A330s or possibly the A330neo to replace its 767 fleet. The question remains, what will replace their 747-400s? Could Amedeo pull off an A380 deal and can the make the case that the aircraft is compelling at Delta for certain routes? We don’t have the traffic, growth projections, or knowledge of yields to analyze those facts in detail. But, for certain routes, such as JFK-LHR, an A380 may make sense. Could those routes potentially be code-shared using the existing Virgin Atlantic A380 aircraft on order? Could creative financial arrangements by Amedeo or Airbus, with perhaps help from the European Investment Bank (which should be a special delight for Delta) tip the balance in the A380s favor? And if so, when? The jury remains out.

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