Airlines face a decreasing marginal return to leasing on their profit margin

New study from Toulouse Business School focuses on the impact of aircraft-leasing on the profitability of airlines.

The leasing business has seen remarkable growth over the last 20 years and has fundamentally changed the business of air transport. It was long thought that the performance of an airline company was proportional to the lease level of its fleet. But a new study of Toulouse Business School proves that there is an optimal level of leasing beyond which profitability is reduced.

Sylvain Bourjade, Professor of Corporate Finance and Catherine Muller-Vibes, Professor of Industrial Organization, both researchers at Toulouse Business School, along with Régis Huc, an air transport specialist, examine the impact of aircraft leasing choices on airlines’ financial performance in their paper “Leasing and profitability: Empirical evidence from the airline industry”, published in the top-tier academic international journal Transportation Research Part A in March 2017. They prove the existence of an optimal level of leasing and analyse how an airline’s experience affects the relationship between leasing and profitability proposing a new insight for aeronautical professionals.

Key takeaways from the study

• The article analyses financial data for 73 international airlines between 1996 and 2011.
• Airlines should purchase a high enough proportion of their fleet. BUT this proportion should not be too high as leasing provides a valuable flexibility for operating the riskiest routes.
• Difference between LCC (low cost carrier) and FCC (full cost carrier): FCC are less sensitive to changes in the level of leasing. Strategic stakes of leasing decisions are higher for LCC (financial performance).
• Flexibility benefits of leasing are lower for long-established airlines (as they typically have a larger and diverse fleet). Younger airlines may need to rely on leasing to quickly respond to demands.
• Thus, leasing is more profitable for LCC and younger airlines.
• Airlines should find the balance between the flexibility provided by leasing some of their capacity and the lower cost of owning this capacity.

Determining the optimal level of leasing – an original finding for the airline industry

The researchers analysed publicly available data collected since 1996 for 73 airlines operating worldwide. They show that the impact of leasing on operating margins is concave, forming an inverted U. This indicates that airlines face a decreasing marginal return to leasing on their profit margin. It also allows them to characterize the airlines’ optimal leasing level.

“Intuitively, when airlines have the ability to get the necessary funds, they should purchase their fleet to operate the safest part of their business instead of leasing the aircraft. However, leasing becomes relatively more profitable for the riskiest, more uncertain markets. The impact of leasing is therefore positive at first, when airlines have a low proportion of leased aircraft, but becomes negative when this percentage exceeds some threshold”, said Sylvain Bourjade and Catherine Muller-Vibes, Professors at TBS and authors of the study.

Business model, airlines’ experience and the impact of leasing on profitability

The study also analyses different factors affecting the impact of leasing on its profitability. “The optimum level varies according to the types of airlines, their business model, their experience, their location and the composition of their fleets. For example, EasyJet has a fleet composed of 35% leased aircraft and achieved a profit level of around 15%; Ryanair, with 12% leased aircraft has a profitability rate of 32% and Vueling’s profitability is estimated at 6% and owns only 1% of its fleet,” said Sylvain Bourjade and Catherine Muller-Vibes.

Examining how an airline’s business model affects the impact of leasing, the authors’ estimations point out that the benefits of leasing are more important for Low Cost Carriers than for Full Cost Carriers. They also compute how airlines ‘observed leasing strategies differ from the estimated optimal level in the industry, during the period under consideration.

Analysing how airlines’ experience affects their results, they show that leasing is less profitable for establishes airlines.
“Even if we estimate the impact of leasing on airlines’ profitability through a reduced form model, our rich sample over 16 years enables us to draw interesting policy conclusions that do not appear to be artefacts of the model’s simplifications. In particular, our results suggest that 50% of the companies in our sample would have enhanced their profit margin in 2011 by choosing the optimal leasing level predicted by our model. Moreover, the optimal leasing level that emerges from our estimations is significantly higher than the proportion of leased aircraft in the worldwide global fleets. The increasing trend in the use of leasing may therefore continue for years and it may benefit both airlines and lessors”, said Sylvain Bourjade and Catherine Muller-Vibes.

Other factors such as competition mechanisms, shareholder base and governance may also affect financial performance, but this is left for further research.