Loftleidir steps up AM leasing for more predictable returns

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There is no picture of when everything for Loftleidir changed. But if there were, it would look something like this:

The heads of its parents company, Icelandair Group, huddled together in a meeting room during the early morning hours, debating how to shelter the business from a fragile aviation market and a heavily devalued krona after Iceland, unusually, refused to bail out its financiers after the collapse of the country’s banking system. Black and white film might capture the mood of uncertainty.

That was 2008.

Fast-forward five years and Iceland’s economy is on the mend, with seven straight quarters of GDP growth, and unemployment below 5% - after overcoming the worst economic meltdown in Europe since WWII.

The group may have flirted with bankruptcy; however, like Iceland, it dealt with the crisis in its own, unique way.

Along with multiple changes at the airline, the group’s other businesses were streamlined or cut.

All holdings in wet-leasing provider SmartLynx and freighter division Bluebird Cargo were divested, and the group’s stake in Czech carrier Travel Service was reduced.

Loftleidir Icelandic remained core to the group, but its management was forced to rewrite the company’s strategy in order to secure a steady flow of cash in an extremely volatile operating environment.

Changing direction

“In hindsight, it is easy to say we made some really good decisions, but what we did is react to the markets at the right time,” says Guðni Hreinsson, managing director of Loftleidir Icelandic in an interview with Flightglobal.

“There is no forecast for this part of the market, like you see in almost all others, so we need to adapt quite quickly when we do move."

Following the crisis, Loftleidir now accounts for the second largest revenue producer in the Icelandair Group, and has ambitions to keep it that way.

"The number one goal, as always, is to secure positive returns,” says Hreinsson.

During the past several years, Loftleidir has been reworking its leasing products, and focusing less on wet leasing and more on AM (aircraft maintenance) agreements where the lessee outsources all of the maintenance risk, normally intrinsic in a dry lease, back to the company.

Hreinsson believes by repositioning itself more heavily in AM leases, Loftleidir was better equipped to ride through the crisis.

“Had we not taken the decision to focus on the AM side, I would be surprised if we were still running ten aircraft, as a lot of our competitors in the pure wet-leasing business have gone away.”

Fuelling the change to AM leases initially was a slowdown in demand for wet-leasing products due to weak air traffic stemming from the financial meltdown, followed by increased competition from new entrants.

“When times are good, obviously there is demand for wet leasing, but when times are tough it is one of the first things to go,” says Hreinsson.

Also competitors that “seemed to have showed up out of nowhere" put pressure on the business.

The best example, he says, was a recent move into wet leasing by Virgin Atlantic.

"Here is a carrier you would not have targeted as a potential customer, but last spring it decided to go after the UK and short-haul European markets with wet leases," he says.

The project ended with Aer Lingus – yet another scheduled carrier that “you wouldn't have put on your radar as a possibility", he says, adding: "This shows how ever-changing the market is with two highly unlikely players showing up almost overnight."

Longer leases

By increasing its AM business, Loftleidir created a more predictable business model.

"With AM leases we have entered longer-term leases, and this has prevented us from being in a situation where if demand just disappeared over night, we had to find work immediately, which is typical in a pure wet-lease deal."

The move was a radical shift as Loftleidir’s business had been built upon short-term leasing. However, the financial crisis made it clear that the company must secure contracts that are “back to back” to avoid gaps in its aircraft placements and ultimately, its cash flow.

“This is something we really started focusing on in 2008 – we saw there was less demand, we saw Icelandair had a need to reduce its schedule, so we needed to react."

Instead of allowing Icelandair to park aircraft, or endure a period of low utilisation, Loftleidir was able to take over these aircraft and put them into revenue-making AM leases.

"Through that development, we decreased our dependence on one- to 12-month leases, and today we have three- to eight-year AM leases."

AM leasing involves more than "eliminating the 'CI' from the typical ACMI (aircraft, crew, maintenance and Insurance) lease, he explains.

"We sell the aircraft with a full maintenance service agreement and that means we are doing everything from daily checks, to heavy checks and overhaul, and keeping all the necessary documents.”

If a carrier has an unscheduled maintenance event, such as a bird strike, that cost is assumed by Loftleidir. “We take the bill as such an event is built into the pricing."

Similar to an ACMI lease, the parties agree on a fixed amount each month, based on the number of hours the customer is operating the aircraft, he says.

Loftleidir has Boeing 757-200 and Boeing 767-300ER aircraft on AM programmes with Yakutia Airlines in the Republic of Sakha in Siberia Russia, Santa Barbara Airlines in Venezuela and Air Niugini in Papua New Guinea.

Growth regions

Another important decision Loftleidir has taken in order to secure a more predictable business has been to turn its emphasis to the emerging markets.

“The global credit crunch wasn't impacting the emerging markets, as there was another economic cycle going on with GDP growth, so we put our focus there.”

However, the move “beyond Europe and the USA” started before the crisis back in 2006.

He acknowledges, from a group perspective, diverting Loftleidir’s focus on emerging markets “played an important role in risk management” and making sure the group had steady cash flow during the crisis. “This move supplemented the group quite well."

Better risk management, ultimately, was what drove the formation of Loftleidir back in 2002.

“We wanted to see if we could better allocate our resources over the slow months, so we created Loftleidir.”

Initially Loftleidir focused on trying to source work through mostly seasonal jobs.

“We started with the charter market in Iceland, and then we moved into Scandinavia, and then seasonally we worked for a lot of years in the US as well.”

Loftleidir began operations with one aircraft in and now manages a total of 10 units – three 757-200, four 767-300ER and three Boeing 737-800 aircraft. It owns two aircraft and leases the rest.

Hreinsson says Loftleidir is considering a 757 replacement, but acknowledges with fading demand for the type, the company can source “good deals” in the used market.

The company also is looking to grow its 737 Next Generation product offering, but he rules out a speculative order. “We will continue to lease.”

Last year Loftleidir introduced its first 737-800 aircraft and hopes to take its first 737-700 by the end of 2013.

Luxury flights

Demand for VIP flights disappeared in 2008, as discretionary spending on travel suffered a severe blow, before slowly returning in 2011, says Hreinsson.

“It [demand] took a lot longer than we expected. We put a lot of effort into this market, so we decided to maintain emphasis during the downturn to let customers know ‘we are ready, when you are ready’.”

To help mitigate the chances of another long another recess in VIP operations, Loftleidir has secured a long-term agreement with Intrav, a US travel group, which is now the company's largest VIP customer.

Loftleidir has developed a VIP product for the group where it takes a typical 757 out of the Icelandair fleet and "rips out all the seats and replaces them with 52 new lie-flat seats." It also is responsible for the design and implementation of the total product offering.

“This, obviously, is a highly demanding segment of the market. We bring in all our chefs from the Hilton hotel and offer five-course meals. We also offer seven attendants, instead of the typical five on a flight, and also an extra pilot," he says, adding: "Sometimes we have professors from the Smithsonian and speakers from the National Graphic."

At an average cost of $100,000 per seat, Hreinsson acknowledges this segment of the market has been “highly successful” for Loftleidir.

In 2014, for the first time, Loftleidir will dedicate a single aircraft from the Icelandair Group for VIP flights only. Hreinsson admits the long-term goal is to grow into a full-year VIP operation, but Loftleidir is still researching potential customers to sustain 12 months of service.

Lessor Play

Loftleidir sees its next opportunity in the operating lease market where lessors are responding to increased demand from airlines, particularly those in high-risk regions, that are increasingly looking to lease rather than own their fleets.

“We are seeing interest from lessors that may have an opportunity to place an aircraft in an environment that they are not comfortable with, and they have reservations about how the paperwork would look once they get the aircraft back,” he says. “We can step in, provide the maintenance and the lease the aircraft to the customer, and take the risk of paperwork out of the loop.”

Moving into operating lease contracts with lessors would be another step towards securing more predictable cash flows, as it would mean longer lease terms, compared with wet lease agreements.

Also, operating leases would “obviously” be cheaper than ACMI leases, says Hreinsson, because the customer would put the aircraft on their own AOC and crew the aircraft themselves. Loftleidir would not have the extra cost of supplying travel and accommodation for crew and “this means a lot savings”, he says.

For now, Loftleidir will continue to watch for opportunities and do what it has been doing – “identifying projects and then bringing in the aircraft, rather than the other way round.”

And things are looking up; demand is starting to improve for the ACMI side of the business.

"Since the credit crunch, this summer has been the busiest one so far, but we are still waiting for the market to fully recover,” he says, adding: “We know, very well, our market is all about timing.”