Sales and Leaseback Model: A Profitable Strategy?

The global aviation industry is in crisis right now. Be it the aircraft and pilot shortage or the safety issues with the narrowbody Boeing 737. This all contributes to inefficient fleet management and unexpected losses for the airlines. But if we look in the fastest growing and third largest aviation market, India, we find the problems even more grave where aviation is considered as graveyard with several airlines being shut down in the past two decades and several other like GoAir under insolvency proceedings. No airline except Indigo (Interglobe Aviation) have achieved net profit if we see from the lifetime profit & loss angle. When we study the model of Indigo, the Sales and leaseback model(SLB) comes up again and again in the Indigo’s success story. Let’s analyse what is the SLB?

What is SLB?

In a typical sales and lease back transaction, airlines procure aircraft from manufacturers like Airbus or Boeing in bulk and their bulk orders give them negotiating power, consequently airlines secure trade discount between 20-50% on the list price of plane. Now, they sell it to a lessor generally at a profit, and lease it back from the lessor, generally for 5-6 years. This gives airline 3 major advantages which are:

1. Upfront profit in sales/leaseback model:

• This model allows airlines to realise the value of their assets without waiting for the aircraft to depreciate over time and airlines can access upfront profit, which can be utilised for various purposes such as debt reduction, expansion initiatives, or enhancing liquidity.

2. No upfront payment:

• Unlike traditional aircraft purchases, where significant capital investments are required upfront, sale & leaseback transactions allow airlines to conserve their cash reserves and preserve their financial flexibility.
• By eliminating the need for upfront payments, airlines can allocate their financial resources more strategically, thereby optimising their capital structure and improving their overall financial resilience.

3. Efficient fleet management:

• Leasing offers airlines greater flexibility in managing their fleet composition and sise, allowing them to adapt swiftly to changing market dynamics and operational requirements.
• Through leasing arrangements, airlines can access a diverse range of aircraft types and models tailored to specific route demands or operational needs.
• This flexibility enables airlines to optimise their fleet utilisation, ensuring that aircraft are deployed efficiently across different routes and markets, thereby maximising revenue potential.

Why can’t lessors directly purchase aircrafts from manufacturers?

But why the lessors purchase the aircraft from airlines that too at a premium on what airline actually paid when they can directly purchase it from the manufacturers directly. The primary reason for the same is:

1. Financial Capacity and Negotiating Power:

• Lessors may lack the financial strength to place large orders directly from manufacturers, diminishing their negotiating power.
• This limitation results in lessors acquiring aircraft from airlines at a premium, despite airlines making a profit.
• Airlines, benefiting from stronger negotiating power, may offer cheaper aircraft to lessors compared to manufacturers.

2. Risk Mitigation:

• Acquiring aircraft through sale and leaseback (SLB) deals reduces the risk for lessors as they already have a lessee (the airline) lined up.
• This reduces the likelihood of the aircraft sitting idle, which could lead to significant costs for the lessor.
• Despite potentially paying a higher purchase price, the overall profitability of the lease contract compensates for it.

3. Immediate Portfolio Expansion:

• Aircraft manufacturers often have lengthy waiting lists, delaying aircraft delivery for several years.
• Purchasing aircraft from airlines through SLB deals offers immediate availability to lessors.
• This allows lessors to swiftly expand their portfolio without enduring the long waiting times associated with direct purchases from manufacturers.

Why do carriers like Emirates or Air India don’t use it?

If this strategy is so good and beneficial for airlines, then why full service carriers and other major airlines like Emirates or Air India don’t use this strategy. Well, it is because of the inherent disadvantages of leasing for airlines especially for companies which sell a holistic experience rather than just a mode of transportation. It is because of the following reasons:

1. Aircraft Customisation:

• Airlines like Emirates heavily customise their aircraft, including seating layout and cockpit instrumentation.
• Leasing used aircraft may require costly re-configuration to match airline standards, posing a disadvantage.
• Full-service carriers prioritise offering a unique and premium passenger experience, making customisation essential.

2. Maintenance Costs:

• Used aircraft entail higher operating and maintenance costs as they age.
• Ageing aircraft incur escalating maintenance expenses, potentially making the SLB model less appealing.
• Lessors often impose stringent maintenance requirements, including unnecessary manufacturer maintenance at the lease end, which could be avoided with aircraft ownership.

3. Fixed Monthly Costs:

• Airlines leasing aircraft must pay fixed monthly amounts regardless of flight utilisation or demand fluctuations.
• This fixed payment structure imposes additional financial burdens on airlines, especially during periods of low demand or when planes are grounded.

4. Economic Lifetime Considerations:

• Aircraft typically have an economic lifetime of 20-30 years.
• Leasing aircraft for such extended periods can become costlier in the long run compared to ownership.
• Full-service carriers may prioritise long-term cost efficiency over short-term flexibility, opting for aircraft ownership to mitigate expenses over the aircraft's economic lifespan.

Conclusion

The sales and Leaseback Model is the perfect example of a coin having two faces. It comes with its own inherent advantages and disadvantages. The proper fleet management strategy is highly subjective to the airlines’ requirements and financial condition. While the upfront profit and financial flexibility provided by SLB deals can be advantageous, especially for airlines seeking immediate cash flow and equity release, there are notable drawbacks to consider. The limitations of customization, higher maintenance costs, fixed monthly payments regardless of flight utilization, and the long-term expense of leasing compared to ownership pose significant challenges, particularly for full-service carriers like Emirates or Air India.

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