Alaska Disposal Underlines Fragility of Values

The accelerated retirement of MD83s by Alaska Airlines [ALK] points to severely impaired market conditions for the aircraft in view of the shortage of narrowbody aircraft.

Alaska had intended to retire the 26 MD83s by of 2012 but is now advancing this by four years. The aircraft were built in the early to mid 1990s. The airline now intends to retire five in 2006, six in 2007 and the remainder by the end of 2008. Three Boeing [BA] B737-200ADVs will also be retired during 2006. By the end of 2008, the airline intends to be operating 40 B737-400s, 20 B737-700s, 42 B737-800s and 12 B737-900s. The net increase in the fleet from the end of 2005 will therefore be four units.

The rationale for the accelerated retirement profile stems from the desire to achieve lower maintenance and operating costs. The airline expects to save $115 million a year in operating expenses by retiring the MD83s. By operating a single type, albeit 40 first generation Stage 3 B737-400s, it is possible to reduce costs.

The airline currently leases 11 MD83. Early termination of existing leases is expected to result in cash penalties to lessors of between $150 million-$170 million. This could decrease to $80 million-$95 million after tax. This equates to approximately $14 million in penalty payments per aircraft, which suggests that current lease rentals are in excess of current market rates. Lease terms on some MD83s were earlier reported by the airline to run through to 2013.

The airline expects to record a non-cash impairment charge during the first quarter of 2006 associated with its 15 owned MD-80 aircraft to reduce their carrying value to fair market value. Although the amount of the special charge has not yet been fixed, the airline expects the amount to range between $130 million-$150 million before tax ($40 million- $95 million after tax). The pre-tax charge amounts to over $9 million per aircraft, suggesting that the aircraft have a current book value in excess of this amount. Current market values for early 1990 vintage MD83s are fortunate to exceed $5 million.

The retirement of the MD83s by a prime MD80 operator points further weakness in values of the aircraft. With the backlog for the B737-800 and the Airbus A320 well in excess of 1,600 units, the demand for the MD83 would have been expected to be reasonably strong. The current market should have firstly persuaded operators to retain existing MD80s, secondly for surplus units to be easily placed and thirdly for values to exhibit a measure of improvement. The values of the B737-300 and -400 have exhibited such characteristics and the need for financial institutions to contemplate distressed sale pricing on the B737-300 and -400 has all but passed. However, all members of the MD80 family have experienced significant problems with respect to values and lease rentals in recent years. The potential for a recovery in MD83 values has not materialized despite this acute shortage of Stage 3 narrowbody capacity. This contrasts with the majority of aircraft types that experience at least one period of recovery.

The placement of the MD80 series with secondary operators has proved exceptionally difficult, although the more experienced lessors and owners have managed to make some progress. Even offering the aircraft at heavily discounted rentals have failed to elicit much interest. The relative inefficiency of the engines during this period of high fuel prices and the rise in maintenance costs has made the aircraft type unattractive to myriad low-cost carriers that have emerged in the last two years. Such operators require reliability and equipment that will offer sufficient competition to other carriers. The limited pool of MD80 pilots, the need for access to spare parts, the restricted support infrastructure, and the cash and operating costs associated with more frequent engine overhauls all play their part in dissuading operators from acquiring the aircraft despite the low prices and lease rentals. With the values and lease rentals failing to recover during this most buoyant of market conditions, there is little likelihood of any improvement in the future.