The long-term advantage for United ($UAL) purchasing 25 new 737 MAX jets
United's purchase of 25 of the most controversial jetliner could very well help their net income over the longterm
When news came out that United Airlines ($UAL) agreed to purchase 25 new 737 MAX planes (revealed in the company’s annual report released on March 1st), many saw it as a “vote of confidence” that the plane’s producer, Boeing, has made adequate safety updates to the planes after multiple incidents of fatal crashes that resulted in settlements paid by Boeing.
While it may be that, it’s also a potential signal to investors that United is doing what it can to boost its net income to bounce back from a rough 2020 (United posted a $7,096 million loss).
Per United’s annual 10K report, (p. 101) the purchase of these aircraft is connected to a settlement with Boeing related to financial loss from the unforeseen grounding of the 737 MAXs that United owned prior to the crashes (emphasis my own).
“The compensation to the Company under the amended and restated settlement agreement is in the form of credit memos to be issued upon the satisfaction of certain conditions related to aircraft deliveries. The Company is accounting for this settlement as a reduction to the cost basis of future firm order Boeing 737 MAX aircraft deliveries and previously-delivered Boeing 737 MAX aircraft, which will reduce future depreciation expense associated with these aircraft.”
While the details are confidential, paying less than fair value on the most material asset used in the day-to-day operations is a positive for United and investors.
For airline companies, depreciation expense (which essentially is used to spread the cost of an asset out over the course of its useful life to properly match revenues with expenses) is one of the most major components of the income statement. With billions of dollars invested in fixed assets (largely, planes) the yearly expense to depreciate those fixed assets can be substantial.
Here is a look at United Airlines yearly depreciation expense (in millions of dollars) as well as a percent of total cost of goods sold:
2016: $1,887 (6.28%)
2017: $2,070 (6.37%)
2018: $2,098 (5.82%)
2019: $2,228 (6.01%)
United is using the settlement agreement as a means to effectively lower the total price of the many aircraft they have just agreed to buy, which means they can make use of these assets without having to recognize as high of a cost (by way of depreciation expense in the income statement) on these planes over their useful life. That theoretically increases the company’s net income, which should be good for shareholders.
The useful life for aircraft is quite long, usually 20 years or more. So the benefits from the reduced depreciation may not be immediately obvious to investors in the income statement (the planes will also not be delivered until 2023), but it will have a long-term impact.
And of course, a larger fleet also means that when widespread travel resumes, United will be prepared to fly the masses.