Delta, General Electric Partner To Grow Jet Engine Repair Revenues (NYSE:DAL)

The Boeing Company (BA) and Delta Air Lines, Inc. (NYSE:DAL) just announced an order for 100 Boeing 737 MAX 10 aircraft at the Farnborough International Air Show, one of the premier aviation events in the world. There are plenty of reason why the order was significant, including that Delta had no active Boeing orders prior to placing this order; all of Delta’s orderbook before Monday consisted of aircraft from every active Airbus SE (OTCPK:EADSF) commercial aircraft family, including the A220 which Delta originally ordered from Bombardier.

While there are many reasons why Delta has recently bought its aircraft exclusively from Airbus, the overriding common theme on all of Delta’s Airbus orders is that Delta has engine overhaul rights for every aircraft it has on order, not just for its own aircraft but also for other airlines operating models with the same engines. Boeing’s ability to sell the MAX to Delta hinged not just on the MAX but also on General Electric Company (NYSE:GE), half owner of CFM International, manufacturer of the LEAP engines which power MAX aircraft:

“We are proud to work with Delta as both an airline customer and as a highly-qualified provider for the expanding LEAP MRO network,” said Tom Levin, vice president, Aftermarket Strategic Solutions, for CFM International parent company GE Aviation. “LEAP shop visit demand will grow rapidly in the next five to ten years due to the volume of engines in service. This agreement is another critical step to expanding our open MRO network support.” – from CFM’s press release on the deal with Delta

Boeing met Delta where both had needs

There are three major Western commercial aircraft engine manufacturers, of which General Electric is the largest. General Electric produces engines for every current Boeing widebody aircraft model, but GE does not provide engines for either the A330NEO or A350 programs; Airbus chose Rolls-Royce as the exclusive supplier for those aircraft models, and Delta has won the engine overhaul rights for those engines. General Electric, in partnership with CFM International, which is an equal joint venture with Safran, is the exclusive provider of the LEAP engines for the Boeing 737 MAX family. CFM also produces engines for the A320NEO family, but Delta selected the Pratt and Whitney Geared Turbofan for its A321NEO aircraft, which also powers its A220s; Delta also has the engine overhaul rights for the Pratt and Whitney GTF. Winning an order from Delta seemed to require having CFM grant Delta overhaul rights for the LEAP engines.

Boeing and Delta had good reason to need each other more than ever right now. Boeing has trailed Airbus in the large narrowbody segment, which has handedly been won by Airbus via the A321, an aircraft that has been in production for nearly 30 years. The A321 is a stretch of the A320 that typically seats up to 195 passengers in U.S. mixed cabin configurations and even more for low cost carriers. More significantly, the A321 became the best competitor to Boeing’s 757, the first modern large narrowbody. Boeing developed the narrowbody 757 in tandem with the widebody 767; Delta became and still is the largest operator of both models. The success of the A321 is due its much lower fuel burn than the B757; the 757 is one of the highest performance commercial aircraft but that extra performance comes with higher fuel burn. The B757 was heavily purchased by U.S. airlines while the A321 has become a much more global aircraft. Boeing produced 1050 757s and ended production in 2004. The largest member of the 737 family prior to the MAX 10 was the 737-900/ER and the -MAX9 which seats about 180 passengers in mixed cabin configurations.

The MAX 10, then, is the first Boeing narrowbody aircraft to come close to replacing the passenger capacity of the 757. For airlines, including Delta, that are focused on increasing the capacity of each aircraft in order to increase fuel and labor efficiency, the MAX 10 will help save fuel while also increasing the number of premium seats compared to previous 737 models. The MAX 10 is a must-have part of the Boeing family in order to market to airlines that want to provide the best per-passenger economics.

Boeing certified the first version of the MAX family, the -8, five years ago, and the next size up in the four model family shortly thereafter. A number of airlines wanted a larger aircraft to compete with the A321 while Southwest particularly wanted a smaller version of the MAX to seat up to 150 passengers and to replace Southwest’s (LUV) 737-700s, the most common model in the all 737 Southwest fleet. Southwest is the largest customer for the 737 MAX 7, while United (UAL) is the largest customer for the MAX 10, each with more than 200 of each version on order.

Boeing’s need right now is not just to sell proven aircraft such as the 737 but also to get the largest and smallest members of the MAX family, the -10 and -7, respectively, certified. Certification of both models was delayed by the grounding of the MAX and the subsequent investigations into Boeing’s certification process. Boeing expects to certify the MAX 7 later this year and begin deliveries to Southwest and other customers. The chances of certifying the MAX 10 before the end of the year are much lower; current U.S. law requires that all aircraft certified in 2023 and beyond must include systems which no member of the 737 family has.

Boeing’s CEO has threatened to cancel the MAX 10 if it is unable to get an exemption to the certification requirements. Thus, Boeing and Delta are signing their contract with the knowledge that the MAX 10 could not be certified and could indeed be cancelled. Boeing’s willingness to sign a contract with Delta not only allows it to go to Washington, D.C. with orders from two large U.S. airlines – in addition to orders from foreign carriers – but undoubtedly also involves having Delta and United help Boeing’s case in the certification process.

Delta is recognized as one of the most shrewd and opportunistic aircraft buyers in the airline industry. Its most recent order for Boeing aircraft was for the 737-900ER. Delta received some of the last 737NGs, the predecessor 737 family to the MAX and undoubtedly received end-of-production-line pricing. As the only large 737 operator in the U.S. that does not have MAXs on order, Delta was a prime candidate for a MAX order.

Boeing estimates the MAX10 will have operating costs in the low single digits better than the A321, largely because of the narrower fuselage of the B737 compared to the A320 family. Because Delta has been heavily buying large narrowbodies with 180 plus seats, the MAX 10 seemed like a slam dunk for Delta – if Boeing could come up with the right terms. But Delta’s insistence on doing its own engine overhauls and in gaining the right to do so for other airlines meant that Boeing had to push on CFM, half owned by General Electric, in order to close a MAX deal with Delta.

General Electric helped seal the deal

Between one-third and one-fourth of the total price of a commercial aircraft is for the engines and engine maintenance makes up a significant part of the cost of maintaining aircraft. While airlines did engine maintenance by their own employees for much of aviation’s history, the complexity of modern aircraft engines and the expertise necessary to maintain them means that there are a relatively few number of entities that can maintain modern aircraft engines. Smaller airlines simply cannot invest in the resources to support all of their aircraft engines while many large airlines choose to have the manufacturer maintain their engines. All three of the western global manufacturers are selective about who they allow to work on their engines and also make billions of dollars on service and parts after the sale.

As the largest commercial aircraft jet engine maker, GE Aviation is the conglomerate’s largest and most profitable division. Generating double digit margins, GE Aviation is growing its aviation services business. The LEAP has been a commercial success, with more than 5000 installed and spare engines with the number expected to triple in the near future.

General Electric is the primary driver of the CFM partnership in North America and has service facilities throughout the U.S. and Mexico. However, until today, it has not designated any other entity outside of General Electric as an authorized repair station for LEAP engines. Not only does CFM/GE have the confidence that Delta can cost-competitively and technically deliver the services that the engine manufacturer needs for the LEAP program, but GE can limit its capex and own internal costs by a authorizing a third party provider to service LEAP engines.

GE and CFM have a long history with Delta. Delta operates a fleet of over 200 737NG aircraft, including the 737-800 and -900ER. Delta provides engine overhaul services for the CFM engines on those aircraft as well as the rest of the 737NG family. Delta also operates GE’s large jet engines on some of its B767s and A330s. In addition, General Electric, along with American Express (AXP), provided critical financing for Delta during the post 9/11 period.

While the terms of the deal between CFM and Delta won’t be publicly known, Delta will have the right to repair a certain number of LEAP engines outside of its own fleet. Delta has chosen to overhaul its own engines in-house rather than send them to vendors both to help reduce costs by minimizing transit times but also to use its expertise in repairing its own aircraft and engines as a source of high margin revenue. Delta’s higher margins compared to its direct peers is due in part to its involvement in businesses that generate returns higher than transportation revenue. Engine overhauls for narrowbody aircraft can easily cost a couple million dollars per engine.

While modern jet engines are designed to remain on the aircraft for years at a time, the sheer number of engines in service and on order means that Delta could grow its revenues at Delta Tech Ops, its maintenance division, by hundreds of millions of dollars per year. Revenues from Delta Tech Ops essentially subsidize Delta’s own fleet.

Under the agreement with CFM, Delta will be one of a select few maintenance, repair and overhaul providers worldwide for the LEAP-1B. In addition, with the CFM partnership, Delta TechOps will become one of few global MRO providers servicing all next-gen engine platforms. Delta TechOps provides world-class aircraft and engine maintenance, repair and operations work not only for Delta’s fleet but for a range of other aircraft owners as well, providing an important source of revenue for the company. – From Delta’s press release on the deal with CFM

Revenue and margin growth for two industry leaders

Delta Tech Ops and GE Aviation are both leaders in their respective industries. The latest deal helps expand production and margins for each other using the highest margin business lines for each company. Building on their long relationship with each other, General Electric and Delta will grow their own footprint in the commercial aviation industry.