(Updated Dec. 20, 8:40 A.M. ET)
After recently completing its first year flying parcels for DHL Express, Mesa Airlines will add another narrowbody freighter to its fledgling fleet early next year as it looks to expand its cargo division and realize greater economies of scale for the DHL business.
Mesa Airlines began operating two Boeing 737-400 converted freighters for DHL in October 2020, entering the air cargo market for the first time after years providing regional passenger air transport for United Airlines (NASDAQ: UAL) and American Airlines (NASDAQ: AAL). Mesa is scheduled to add another all-cargo jet during the first quarter of 2022, according to parent company Mesa Air Group’s (NASDAQ: MESA) fiscal fourth-quarter earnings report last week that showed an overall $7.5 million loss, and doesn’t plan to stop there.
Chairman and CEO Jonathan Ornstein said on a call with analysts that the goal is to have eight to 10 cargo jets providing service to DHL to ensure reliability, reduce unit costs and achieve profitability. The target fleet size, however, is taking longer to achieve than originally anticipated.
“Clearly we did not enter the cargo business for three aircraft. I mean, it’s just not an efficient operation … . In fact, one of the reasons why we got the third aircraft was just because we were nervous about only having two aircraft and not having a spare,” Ornstein said.
DHL is interested in supporting Mesa’s expansion so it can help meet growing shipping demand, he said. DHL offers international express delivery in the United States. Mesa operates domestic routes between several cities and DHL’s North American hub at Cincinnati/Northern Kentucky International Airport, where transfers are made to and from long-haul transcontinental package jets.
Under their flight services agreement, DHL leases the 737-400 aircraft and subleases them to Mesa for nominal amounts. Mesa provides crew and regular maintenance. It is paid for the number of hours the aircraft operate from gate to gate, with a minimum block-hour guarantee, and is eligible for a monthly performance bonus or subject to a penalty based on timeliness and completion of assignments. Ground support, including fueling and airport fees, are paid directly by DHL, which also reimburses the airline for all costs related to heavy maintenance and major component overhauls.
“We exceeded DHL expectations over the year. So I think that we are very well positioned for growth. … For us to be successful long term … they’ve made clear without a doubt that we have to be larger,” Ornstein said.
Mesa operated 283 flights for DHL in the first two months of the current quarter, a 61.7%, the company reported Dec. 20.
If “we’re below eight airplanes, it’s hard for us to really spread our costs around. And I think that the target for us is to be at least at that number over the next few years. It won’t happen fast. We’ve made a big investment so far, which clearly has impacted our numbers as well. But they have made it very clear that they would like to see us remain in the portfolio and they’re going to help us do that,” Ornstein said.
In August 2020, Ornstein said that Mesa could be operating 10 aircraft for DHL by the spring of 2022 if it performs as expected. The company in February signed a letter of intent to lease a third 737-400 converted freighter and said at the time that it expected it to be available last May.
Executives have previously said Mesa got into cargo to diversify its business and operate bigger aircraft that would help attract and retain pilots. The all-cargo sector is showing long-term strength because of huge growth in e-commerce shipping and structural changes in the passenger airline industry since the pandemic that are expected to reduce capacity for cargo and increase demand for freighter aircraft.
Mesa Airlines is also expanding its cargo business to Europe. It is a partner in Compass Cargo Airlines, a startup based in Sofia, Bulgaria, that was scheduled to start charter service in Europe by the end of the year. The carrier took delivery of its first freighter — a converted Boeing 737-800 — from leasing company GE Telesis in August.
In October, Mesa became the first U.S. airline to enter the drone delivery market, inking a deal with SkyDrop, formerly Flirty, for four delivery drones, with an option for an additional 500 aircraft. Mesa said its drone delivery service will initially target last-mile food delivery in the U.S. and eventually in New Zealand.
Cargo represented 1% of Mesa’s 2021 fiscal year revenue.
Maintenance drags down earnings
The biggest reason for Mesa’s $7.5 millon loss for the quarter ending Sept. 30 was higher-than-expected maintenance costs, as well as employee attrition that requires the company to spend more on training, and labor shortages that prevented it from operating some aircraft.
Cowen analyst Helane Becker said in a research note that a shortage of aviation parts for the CRJ900 fleet, which flies for American Airlines, was a major factor behind the maintenance problems. The manufacturer of the CRJ900 is no longer in business, so finding replacement parts is difficult.
Mesa said it expects losses through the first half of the fiscal year.
DHL Express has experienced a surge in pandemic-induced e-commerce activity and is in the midst of the peak shipping season for the holidays. Becker said Mesa could end up flying more hours than contractually agreed to help DHL meet its delivery commitments, which provide a positive revenue boost in the December quarter.