Flightlines 7: Delta's Strategic Use of Finance Leases
Delta uses innovative leasing strategies to balance financial discipline with fleet modernization, gaining a leg up on their competitors in a challenging market.
Hello, and welcome to this week’s issue of Flightlines. We're coming to you from Anchorage, Alaska, just outside Ted Stevens Anchorage International Airport and the Lake Hood Seaplane Base. The skies here are alive with the buzz of jets, turboprops, floatplanes, and bush planes of all kinds. This week, we're exploring one of the innovative ways airlines are structuring their operations to maximize efficiency and profitability: the finance lease.
Weekly feature
Acquiring the most modern, fuel-efficient aircraft is crucial for an airline's profitability. The ability to transport more passengers farther at a lower cost provides a competitive edge on shared routes. Airlines operate on tight profit margins, with each sold seat earning just over $6, according to the International Air Transport Association (IATA). It only takes a slight 3% swing in costs to erase this profit margin, which is equivalent to a $9 per barrel increase in oil prices.1 One can imagine how any increase in operating efficiency could dramatically affect an airline’s bottom line.
Bound by these incredibly thin profit margins, airlines constantly seek strategies to modernize their fleets while maintaining fiscal discipline. Delta Air Lines, the United State’s oldest carrier, employed a financing strategy in its 2020 agreement with AerCap Holdings, a leading aircraft leasing firm, that allowed them to stretch their fiscal abilities without undue risk. Facing the need to upgrade its fleet with fuel-efficient models to remain competitive, Delta opted for a finance lease arrangement with AerCap for a number of Airbus A321neo (new engine option) aircraft.
The finance lease has the benefits of allowing Delta to access state-of-the-art technology without the substantial capital expense of purchasing an aircraft outright. Through this arrangement, Delta was able to reduce fuel costs across it’s fleet by replacing it’s aging narrow-body aircraft, including the Boeing 757-200 and some older models of the Airbus A320 and A321ceo (current engine option). The A321neo offers 12% better fuel efficiency on a per-seat basis compared to the A321ceo, largely due to its advanced Pratt & Whitney PW1100G engines.2
Under a finance lease, Delta was able to maintain its financial flexibility while enhancing fuel efficiency. This arrangement allowed Delta to acquire new aircraft and integrate them into regular service more quickly, bypassing the extensive Airbus backlog. In some cases, this could accelerate the timeline for deploying new aircraft by years. Globally, the commercial airliner market is dominated by two main manufacturers—Boeing and Airbus—which together account for nearly 94% of the market.3 As a result, airlines are heavily reliant on these manufacturers, and any production delays can impede airlines' efforts to upgrade their fleets and achieve modern fuel efficiency gains.
Despite introducing another party to the transaction, Delta benefits from AerCap's ability to secure financing at lower costs due to its strong credit profile. As one of the world's largest aircraft leasing companies, AerCap often enjoys more favorable borrowing terms than individual airlines because of its diverse portfolio and strong balance sheet. This advantage allows AerCap to offer Delta a lower per-period cost than if Delta were to purchase the aircraft outright without a financing partner.
While Delta is a well-established airline, its credit profile can be impacted by industry volatility and economic downturns, which can affect passenger demand and fuel prices. In contrast, AerCap's business model, which involves leasing to a broad range of airlines, provides more stability and resilience against sector-specific risks. This enables AerCap to maintain higher credit ratings, translating to lower financing costs that are passed on to Delta in the form of competitive lease terms. This dynamic demonstrates how strategic partnerships with leasing companies can enhance financial efficiency for airlines seeking to modernize their fleets.
One other advantage of the finance lease arrangement is the potential for ownership. At the end of the lease term, Delta has the option to purchase the aircraft, allowing the airline to acquire the asset if it proves beneficial for its operations. This purchase option offers Delta flexibility, enabling the company to evaluate the aircraft's performance and suitability within its network before committing to ownership.
If the aircraft meets Delta's operational needs, exercising the purchase option can be a cost-effective way to add the aircraft to its fleet permanently. This option provides Delta with the ability to hedge against market fluctuations in aircraft prices and financing rates, securing favorable terms based on the initial lease agreement. Furthermore, owning the aircraft can offer long-term financial benefits by eliminating ongoing lease payments and enhancing the airline's asset base. A strong asset base gives the airline liquidity and further financial flexibility, in the event of an economic downturn.
Finally, the finance lease arrangement has significant implications for Delta's financial statements under the accounting standard ASC 842. According to this standard, Delta records the leased aircraft as right-of-use assets and corresponding lease liabilities on its balance sheet. This treatment accurately reflects Delta's control over the aircraft during the lease term, similar to ownership, despite the aircraft being legally owned by the lessor, AerCap.
From a profitability and cash flow perspective, Delta's lease payments are considered operating expenses. This classification impacts the airline's profitability metrics, as lease payments reduce reported earnings. However, this approach provides Delta with several strategic advantages. By treating lease payments as operating expenses, Delta can better manage its cash flow, allowing for predictable budgeting and financial planning. The structure of these payments enables Delta to allocate resources more effectively across its operations, maintaining financial stability while pursuing its fleet modernization goals.
The finance lease structure provides airlines like Delta with a strategic advantage, allowing them to acquire the latest aircraft without significant upfront capital costs. By partnering with AerCap, Delta benefits from favorable financing terms, accelerated fleet modernization and enhanced operational efficiency. This aligns financial strategies with operational goals while supporting transparent financial reporting and cash flow management.
Let's explore this week's noteworthy events that are shaping the future of air travel.
In the news
The latest and most impactful stories shaping the world of commercial aviation this week.
August 9th, 2024
August 8th, 2024
Why British Airways Is Cutting Its London Heathrow To Beijing Route
Cathay is investing over HK$100 billion to strengthen Hong Kong’s international aviation hub status
LATAM Group Posts $145 Million Profit Amid Rising International Demand
August 7th, 2024
August 6th, 2024
Turkish Airlines Grew Its Passenger Capacity By Over 7% During Q2 2024
Air Astana Adds 6 Airbus A320 Family Jets And Boosts First Half Revenue By 13%
Denver International Airport Marks June As Busiest Month Ever
LATAM Cargo to add Europe capacity following rivals’ transatlantic cutbacks
Sun Country Cites Industry Overcapacity As 2Q Pax Revenue Shrinks 21%
August 5th, 2024
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Thank you for reading. Flightlines looks forward to bringing you more insights and updates in the world of commercial aviation next week.
Until then, safe travels and happy flying!
International Air Transport Association (IATA), "Airline Profit Per Passenger: Not Enough to Buy a Big Mac in Switzerland," IATA Economic Report, accessed August 10, 2024.
Delta Air Lines, "Delta Continues Fleet Renewal with 30 Additional Airbus A321neos," Delta Professional, accessed August 10, 2024.
ResearchAndMarkets.com, "Global Commercial Aircraft Market Analysis/Growth Opportunities Report 2022: Airbus, Boeing, and Embraer are the 3 Leading Manufacturers that Account for 97.8% of the Total Market," Business Wire, accessed August 10, 2024.
Curious as to why there are only 2 major airline manufacturers for this vast industry??