Leasing vs Purchasing
Aircraft acquisition strategy highly depends on an airline’s current financial stature and its future growth strategy. If an airline can sustain the capital involved in purchasing an aircraft with a strong monetary backing from its business and shareholders, will prevent the heavy expenditure involved from weighing down its balance sheet, an aircraft purchasing may prove to be profitable in the long term.
Even so, more airlines have been leasing rather then purchasing. Leasing an aircraft albeit its many potential cost-benefits, has a certain number of risks involved. Therefore, before an airline decides to lease or purchase there are many factors to consider with respect to its internal structure such as its business model, future plans (economic strength) and even the airline’s operating environment (competition, government-aid (national carrier) etc.)
Lease is what we do: South African Airways (SAA)
SAA, an airline riddled with financial difficulties with 6 years of consecutive losses and liabilities exceeding assets by US$1.26 billion as reported in 2017. With a current fleet of 54 aircrafts of which majority is leased South African Airways has no plans of future aircraft purchasing but instead to continue leasing. Their main reason for continued aircraft leasing is due to the financial struggles the airline is undergoing.
Largely run by money from the government South African Airway’s turnaround plan with respect to their fleet decision to lease rather than purchase is due to factors such as reducing maintenance cost, limiting further debt, lowering fuel cost and immediate route expansion/termination plans.
South African Airways flies the A340-600 variant on their long-haul routes to destinations such as London, New York and Perth. This fuel inefficient fleet largely impacted on the airline’s operating cost. The airline decided to switch to a more fuel-saving initiative and purchase A350s to replace the A340s, unfortunately the South African government rejected their fleet renewal plans as the government felt that the airline’s decision to purchase aircrafts was not well supported by their future growth strategy. Since aircraft purchasing will result in a payment through an increase of debt on the airline’s balance sheet the government thwarted the decision.
This resulted, in delays and the airline had to renegotiate and extend leases on its A340s with its lessor, International Lease Finance Corporation (ILFC). The airline succeeded in reducing lease cost for some of their A340s in 2015 and are begun the process of looking to extend leases on more of its A340s. Taking advantage of reduced fuel price and rental cost, their A340 fleet may stay in operation till 2020. All may seem rosy till fuel prices rise again.
With respect to reducing maintenance cost, South African Airways in 2002, initially planned to purchase 20 A320s to replace older B737-800s. This decision was overturned due to a lack of capital and the order was transferred over to a lease agreement with Airbus instead, this allowed the airline to save on an approximate R$603million which would have been paid as pre-delivery payments to Airbus. The airline plans to have an all Airbus fleet. Such leasing agreements, allows the airline to offload major repairs/maintenance cost to its lessor. Having a uniform fleet will greatly reduce training and maintenance complexity for the airline.
As for wide-body aircrafts, the airline stated that purchasing comes with a higher risk compared to narrow-body aircrafts which otherwise will be tagged to the lessor, a risk they cannot bear. Reselling of a wide-body aircraft will be more challenging due to a smaller second-hand market.
South African Airways has extensive turnaround strategies to see black figures on its balance sheet by 2019.This includes plans for rapid expansion of their route network, vital for generating traffic and competing with Middle-Eastern carriers such as Emirates. To enable growth in such a limited time financial flexibility and immediate aircraft acquisition is required and the airline believes it is only capable through aircraft leasing.
As for the airline’s future aircraft acquisition strategy, it will continue to lease due to their poor balance sheet and the demand of cash flow required for an outright purchase being too financially exhausting for the airline. South African Airways has also highlighted that new accounting regulations will enable the airline to recognise leased aircrafts as though it is owned in its financial statement by 2019, further encouraging leasing over purchasing.
Purchase is what we do: Delta Air Lines
Delta Air Lines unlike many other carriers prefers purchasing over leasing. The airline group has a fleet strategy of purchasing a mix of new and used airliners. The group analyses 3 main factors along with others before deciding; The cost of the aircraft, fuel efficiency and maintenance cost.
Economic sustainability of the purchase is a vital deciding factor for the airline. Thus, Delta has a strong fleet of purchased used aircrafts. Unlike leasing an aircraft, where the lessee has less control over the quality over the aircraft, and tailoring specific interior designs will be tougher to individualise, Delta has benefited. In the past the airline has purchased used MD-90 jets, and 88 used B717 from the merger of Southwest and AirTran airways and did nose to tail refurbishes. The group purchases used aircrafts, and taking advantage of their own maintenance, repair and overhaul facility (Delta TechOps) are able to maintain and retrofit each aircraft with their own interiors providing the passengers with a “brand-new” feel.
Delta has been fortunate with a strong balance sheet. Currently the group is under a fleet renewal process where they have made purchase of 200 A321new jetliners and 75 CS100s to replace their ageing MD-88 and B757 fleet, unfortunately delays are expected before they are to receive their new fuel-efficient airliners. A silver lining for the airline is that the MD-88s and B757s in their current fleet were purchased, simply improving maintenance efficiency will allow Delta to extend the aircrafts lifespan covering for the delay. Leasing otherwise, would have increased substantial operational cost for the group.
With more advanced aircrafts entering the market such as the A350s, lessees of the prior wide-body aircrafts like the B777-200ER will be looking to end their leases and shift over to the more economical options. These aircrafts will end up with lessors trying to be offloaded. Thus, increasing the availability of such used wide-body aircrafts in the market, supply will increase considerably and prices will decline. Taking such a situation to their advantage and acquiring such used aircrafts at a much affordable cost will be Delta Air Lines.
With such an analytical aircraft acquisition strategy in place, Delta Air Lines has commercially benefitted by savings from airline purchasing over leasing such as escaping from short-term leasing (rising interest), high-insurance cost, and asset depreciation (purchased aircrafts) allowing for tax shield. The group was able to clear more than $10billion in debt.
South African Airways and Delta Air Line has strong and contrasting reasons for their decision to lease or purchase aircrafts respectively. For both airlines the decision mainly resides on the factor of economic stability, when acquiring its aircrafts, the group must maintain its profitability and not slump after the purchase (amounting debts).
As for South African Airways (SAA) due to their poor and weak balance sheet, purchase is simply not viable. Especially since the group is mainly funded by the government, expenditure will be further limited and scrutinized. SAA’s main goal is to limit spending, have substantial financial flexibility and to expand growth as fast and quickly as possible. Hence, leasing seems to be a more economical and immediate option due to its high growth plans.
Unlike SAA, Delta Air Lines has backing from its strong balance sheet. Allowing them to neglect leasing and its associated risks. Utilizing their own MRO facility has greatly benefitted the group allowing them to successfully purchase and maintain used aircrafts, reducing overall cost. New aircraft delays were also subdued with limited financial harm. Accurate timing of aircraft purchase has also aided the group. It has since thrived financially with respect to its aircraft acquisition strategy.
In conclusion, although leasing has its immediate cost-friendly benefits purchasing might prove to be a more successful option in the long term with reduced risks involved as Delta Air Line has shown. Unfortunately, as with the analyses of South African Airways, airlines will also have to factor in the financial state of the group along with its business ambitions, its operating environment and the forecasted timeline for improvements. Risks involved should be weighed with the group’s economic sustainability and its long-term plans.
The decision to lease or purchase should complement the overall growth strategy of the airline, which could just mean the difference between bankruptcy and solvency.