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Aircraft Leases

In: Business and Management

Submitted By sunseeker8
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EasyJet, Vueling and RyanAir Lease Strategies
Classifying leases as operational or financial is a key accounting issue in the airline industry because of the high value of the leased assets. When classifying leases the IFRS principle “substance over form” should be the prime criteria to identify the type of lease.
In 2012 EasyJet operated 214 aircrafts. 148 of them were owned, 55 were acquired under operating leases contracts and 11 under a finance leases. In its annual report EasyJet states that it targets a ratio of 70:30 of owned vs. leased aircrafts but the ratio is expected to fluctuate with the introduction of the next generation aircraft. EasyJet is the only company of the 3 selected that openly acknowledges asset valuation issues arising from operating leases and thus provides ROCE ratios with and without the operating leases included. Operating leases are capitalized at rate 7 times the annual lease rental. It is evident that inclusion of operating leases considerably lowers the ROCE (return on employed capital) ratio. Without the lease adjustments the ROCE ratio is 14.5% and with operating leases included , the ratio lowers to 11.3%. EasyJet’s lease strategy is more conservative that of its competitors and the management demonstrates grater prudence when employing leases. EasyJet is also determined on owning the majority of its aircrafts.
On the other hand, Vueling relies totally on operating leases to support its aircraft fleet. In 2012 its lease expense amounted to Euro 121M while the PPE figure listed on the balance sheet was negligible (Euro 2.68M). There are several reasons why Vueling has chosen this strategy. Low-cost companies rely mainly on new and more fuel efficient aircrafts to reduce the fuel expenses and be less susceptible to oil price fluctuations. However the prime reason for choosing this strategy is to conceal the liabilities arising from capital leases of new and expensive aircrafts. Vueling also operates some many seasonal routes. In summer the company needs additional aircrafts and the operating lease is the most flexible option. In summer 2012 the company operated 59 aircrafts or six more than the year’s average in order to cover the additional passenger demand.
In 2011 Ryanair had more than 77 million scheduled passengers or 14 million more than the combined figure for AirFrance and British Airways. It is the largest company in the world in terms of passengers and operates a total of 294 aircrafts – owned and acquired under finance or operating leases. The average age of the fleet is below 4 years and all of the aircrafts are Boeing 737-800. The company uses only one type of aircraft in order to reduce costs relating to training to personnel and to be able to acquire spare parts at more favorable conditions. In 2012 the company had 59 operating lease aircraft in the fleet. Aircrafts operated under finance leases are capitalized on the balance sheet and are depreciated over their estimated useful lives. Operating leases are not capitalized and therefore these aircraft are not present on the balance sheet.
The examples above illustrate the limitations and difficulties finance analysts face when comparing companies with different asset structure. Leases are a particularly sensitive issue in the aircraft industry and significantly distort the profitability ratios.…...

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