Analysis – SpiceJet likely to order Boeing 737 MAX, but not immediately

Earlier this week, the Wall Street Journal quoted a report from the Center for Asia Pacific Aviation (CAPA) as saying that India’s largest publicly-traded low cost carrier (LCC), Chennai-based SpiceJet, was “is in advanced discussions to order 30-40 Boeing 737 MAX aircraft, the Centre for Asia-Pacific Aviation (CAPA) has said.” This report was then seized on by several outlets in India, including one that quoted SpiceJet CEO Neil Mills as saying that SpiceJet may consider ordering Airbus aircraft as well.

First, we feel that SpiceJet is likely to order the Boeing 737 MAX at some point. While Mr. Mills may be paying lip-service to the idea of ordering next generation narrowbodies from Airbus, our own internal projections, as well as those of most independent analysts find that the A320neo and the 737 MAX will end up within two percent of each other in terms of operational costs per seat mile, with the primary variables for decisions likely to be pricing and commonality with the current fleet. SpiceJet currently operates a fleet of 35 Boeing 737NGs (29 -800s and 6 -900s), so that would tilt the scales between three to four percent towards the MAX. As a loyal Boeing customer, SpiceJet would also likely get a discount on the MAX of between 35-45% off of list price. The combination of these two factors would require such a large discount from Airbus to overcome that SpiceJet is unlikely to order A320neos (a sentiment supported by our sources at the LCC).

As for the timing of the order, while SpiceJet is in all likelihood discussing a MAX order with Boeing at the moment, the order is unlikely to be finalized any time soon. Furthermore, we do not feel that it would be prudent for SpiceJet to order any new 737s at this time.

The size of the proposed order (30-40 airframes) is smart. When combined with SpiceJet’s outstanding order for 20 737NGs, it would allow for fleet replacement and a limited amount of growth, while not over-committing SpiceJet to new airplanes. The latter is a common outcome for LCCs around the world that ordered large numbers of narrowbodies during the mid 2000s and are now stuck in a cycle of profitless growth. But making the order now would not be a smart move. To start with, financing right now is a challenge for Indian carriers; SpiceJet itself is supposedly having trouble financing the 3 remaining Q400 deliveries and is likewise hesitant to firm up its 15 purchase options for the 78 seat turboprop because of credit constraints. The current environment for financing aircraft deliveries in India is not favorable – the combination of an ever-weakening Rupee and several sectors of prolonged losses have sent interest rates for aircraft deliveries skyrocketing.

More to the point, there is a stock market analogy to explain why SpiceJet should not order the 737 MAX right now. Many industry analysts have concluded (and we agree with this view) that there is currently an aircraft order bubble for narrowbodies. This means that the prices of these aircraft are artificially inflated thanks to higher than normal demand. The general rule of thumb you hear when playing the stock market is to buy low and sell high – this strategy works – if you had purchased stocks in March 2009 at the trough of the recession, today those stocks would have (on average) doubled in value. The same principle applies to assets. Several LCCs (most notably purchased 737s and A320s in the down period while the industry was in post-9/11 doldrums, then made a cash profit on sale-leaseback as aircraft valuations boomed during the latter part of the decade. On the flip side, carriers that purchased large quantities of narrowbodies during the boom times of the 90s had to deal with heavy losses due to depreciation in that post 9/11 period. Right now, conditions for aircraft purchases are similar to those during the 1990s, SpiceJet would thus do well to wait for pricing to become a bit more rational. The 737 MAX is already sold out till 2019 at the earliest – waiting another six months to one year to place an order will not put SpiceJet too far behind the curve.