Icelandair Group Annual Report 2019

Icelandair Group has for the past decade been at the forefront of transforming Iceland into a year-round destination and our focus on steadily expanding our route network over the years has been key to enhancing Iceland’s position as an international connecting hub. During this time, we have also strengthened our cargo business, our leasing and consulting services, our regional flight operation, as well as built up high-quality hospitality services across the country through Icelandair Hotels.

The incredible growth of the tourism industry in Iceland has created significant value for the Icelandic economy and now accounts for 39% of total export, 14% of the entire workforce in Iceland and contributes 8,6% to economic growth (GDP). The travel industry contributes around ISK 65 billion to the economy in the form of tax revenue, about three times more than it did ten years ago. A decade ago, the number of tourists visiting Iceland was around 500 thousand, but in 2019 we received 2 million tourists and the total number of passengers that travelled through Keflavik airport were 7 million.

We can be proud of what we have achieved as a country over the past decade. However, in the long run, such rapid growth is neither realistic nor sustainable. The value and quality of the tourism industry will not be measured solely by the number of tourists. We should be focusing on profitability and value creation, and at the same time ensure sustainability and respect for the environment. For a number of years, this has been the focus of Icelandair Group and continues to be the core of the Company’s new strategy that is currently being implemented. It is therefore pleasant to see that the new policy framework presented by the Icelandic Minister of Tourism in 2019 is also in line with this strategy. I believe Iceland is well equipped to become a leader in high-value and sustainable tourism and Icelandair Group will continue its contribution to this development.

Although there was a slight decline in the total number of tourists in Iceland in 2019, Icelandair transported 25% more passengers to Iceland than in 2018. Interestingly, we are already seeing a positive trend with the expenditure of foreign tourists increasing in 2019 and that many of them stayed longer than in the previous year, according to numbers from Statistics Iceland. In other words, the Icelandic tourist market is showing important signs towards a more sustainable future.

At our Annual General Meeting in 2019, we introduced our new vision and strategy for the future. We will always be closely connected with the tourism industry in Iceland, but after a decade of direct involvement and significant investments, we decided to shift our focus back to our roots, aviation. In line with this, we are currently divesting our hotel operations and introduced a new Company structure in 2019 to support this new strategy.

As mentioned before, aviation is one of the main foundations for progress and quality of life in Iceland. Now that tourism has established itself as a stable and growing industry in Iceland, Icelandair Group will focus on operating an international airline, with a strong customer focus, efficient operations and working towards sustainable, profitable growth. Furthermore, we are committed to maintaining a passionate and performance-driven culture and becoming an industry leader in responsibility.

Icelandair Group benefits from having the backing of a broad shareholder base, with 3,171 shareholders at the end of 2019. A new shareholder, PAR Capital, joined Icelandair Group's shareholders’ group in 2019 and is now the largest shareholder. We welcome PAR Capital and value the experience and industry knowledge that PAR brings to the Company.

No dividends were paid out to shareholders for 2018 and Icelandair Group’s Board of Directors proposes that no dividends will be paid out to shareholders for the year 2019.

We have experienced various challenges during the course of our over 80 years of operation. We understand the forces of nature, have gone through economic downturns, epidemics and other challenges that have affected our operations and the airline industry.

Today we are also facing several short-term challenges. The suspension of the MAX aircraft has been ongoing since March 2019 and we are experiencing considerable uncertainty on how the COVID-19 virus will affect travels and airline operations in the near future.

The operating environment will remain challenging in 2020. However, one of the key strengths of Icelandair Group is the flexibility of our route network that allows us to capitalise upon opportunities that arise and adjust unprofitable capacity if needed. The Company stands on solid foundations, its financial position is sound, and we benefit from the vast experience, expertise and spirit of our employees.

Despite short-term challenges, it is important to never lose focus on the future. Our key goal is to build a solid Company and achieve sustainable profitable growth for the future. However, it is equally important for Icelandic authorities to ensure the competitiveness of Iceland as a modern tourist destination with good infrastructure and ensuring a business environment that allows travel and tourism companies to flourish.

Airline's operations are structured in such a way that they can cope with temporary setbacks or difficulties. I believe we are well equipped to deal with any short-term challenges that we are facing. At the same time we have a focused strategy for the future which is in the capable hands of our strong management team that is ready to deliver a sustainable and profitable long-term business.

The MAX aircraft that were suspended in March 2019 were intended to cover almost 30% of Icelandair’s passenger capacity in 2019. A number of mitigating measures were taken during the year to minimise the impact of the suspension on the Company, its passengers and the Icelandic tourism industry, such as by leasing several aircraft during the high season. However, the negative impact was extensive in 2019. The estimated effect on Icelandair Group’s results quantified to date was around USD 100 million in 2019 at EBIT level, net of the partial compensation agreements that were reached with Boeing during the year. Discussions with Boeing are ongoing regarding further compensation for the financial loss resulting from the suspension.

In 2019 we achieved operational improvements in many areas of the business by focusing on the rationalization of our route network, improved revenue management and better utilization of our crew. In addition, we managed to reduce disruption costs considerably with several actions taken to improve our on-time performance.

Our route network serves three independent and distinct passenger markets – to, from and via Iceland. The via market has been the main growth driver of our route network over the last decade and the proportion of via passengers has grown steadily during that time. Due to changes in the competitive environment, we, however, shifted the focus in our route network and our sales and marketing activities to the markets to and from Iceland during the year. This resulted in a changed composition of our passengers with the markets to Iceland accounting for 42% of our passengers, the markets from Iceland accounting for 15% and the via market 43%. The strength and flexibility of our route network allowed us to realign our network to adapt quickly to changes in the competitive environment and respond to the situation caused by the MAX suspension, and at the same time benefit the Icelandic tourist market by ensuring seat capacity to and from Iceland.

Our air freight and logistics operations performed well in 2019, leveraging our passenger route network in addition to scheduled air cargo flights to and from North America and Europe. Carried freight measured in freight tonne kilometres (FTK) amounted to 134 million FTKs, a 6% increase from 2018.

In 2019, several measures were taken to improve the operations of our regional operator, Air Iceland Connect. These measures considerably improved performance between years and the outlook is positive going forward. Air Iceland Connect transported 280 thousand passengers on 7,300 flights in 2019.

Loftleidir Icelandic, our aircraft leasing and consulting company, performed well in 2019. Loftleidir Icelandic has continued to operate VIP charters on behalf of some of the largest VIP travel agencies in the world on a year-round basis. At the beginning of March 2019, Loftleidir Cabo Verde, a subsidiary of Loftleidir Icelandic, became a shareholder in Cabo Verde Airlines. The year has been challenging for Cabo Verde Airlines and the company is now in a refinancing process to secure its foundations for the future.

Iceland Travel achieved some operational improvements between years despite declining demand in sales of package tours. VITA travel agency performed well in 2019 with turnover increasing between years and returning profit despite increased competition.

In July, Icelandair Group signed a share purchase agreement with Berjaya Property on the sale of a 75% stake in Icelandair Hotels and related real estate. The transaction is expected to be completed before the end of May 2020, but Icelandair Group will hold a 25% equity stake for a minimum of three years. During the year of 2019, Icelandair Hotels sold 349 thousand hotel nights, which is an increase of 5% from the previous year. The operating environment of hospitality businesses in Iceland was challenging during the year as recent contractual wage increases in the labour market significantly increased salary costs and therefore impacted performance. Nevertheless, Icelandair Hotels managed to maintain reasonable occupancy rates and average prices over the year.

We further strengthened the liquidity of the Company and improved the capital structure of the company during the year. We refinanced a full redemption of unsecured bonds successfully with bilateral loan agreements with international and domestic credit institutions. Additional equity was issued when a new shareholder, Par Capital, joined the shareholders’ group, becoming the single largest shareholder of the Company. It is pleasant to have international investors and financial institutions sharing our belief in the prospects of the Company.

Sustainability is an integral part of the new Company strategy that is currently being implemented with focus on profitability, sustainable growth and to become an industry leader in responsibility. A comprehensive strategy in corporate social responsibility was developed in 2019. We decided to base our focus areas on the United Nations’ Sustainable Development Goals as they have become a universal language of governments and businesses to work towards a more sustainable future. We have chosen four goals to focus on: Gender equality, Decent work and economic growth, Responsible consumption and production and Climate action. We are committed to do what it takes to succeed in this area and have developed clear goals and action plans that are further detailed in the responsibility section of this report.

The key focus in 2020 will be on the profitability of Icelandair’s route network and on mitigating the operating risk of a potential further suspension of the MAX aircraft. There is also significant uncertainty around the impact of the Covid-19 virus on world travel. This situation has led to increased uncertainty for the Company’s financial outcome of 2020. Therefore, in the beginning of March 2020, Icelandair Group announced that the guidance earlier provided to the market, no longer applies and that it is not possible to give an accurate guidance at this stage.

Icelandair Group’s competitive environment has changed significantly. Airlines that used to focus primarily on growth and market share have either disappeared from the market or significantly changed their focus to an emphasis on profitability rather than growth. In 2020, we will continue to focus on the tourism market to Iceland. Although our flight schedule for the year assumes reduction in the number of flights by about 3% and available seat kilometres by 8%, we expect to transport at least as many passengers to Iceland this year as in 2019.

The number of Icelandair’s passengers in 2020 is projected around 4.2 million to 24 European and 19 North American destinations. As has been announced, the MAX aircraft will not be a part of the Company's fleet during the high season, but we expect the aircraft to return to service in the autumn.

Our priorities for 2020 are clear – to return to profitability and build a sustainable platform for sustainable growth. Unprofitable capacity within the route network has already been reduced, and the balance in the passenger capacity between Europe and North America improved with the aim of increasing unit revenues. We will continue to build up the new connection bank that was introduced during the high season in 2019 with the objective of improving the utilisation of our fleet and enable continued growth at our connection hub at Keflavik Airport. We will also continue to focus on further streamlining of our operations in line with the Company’s new strategy, which emphasises operational efficiency. In addition, we expect on-time performance to continue to improve in 2020, locking in the significant gains made in 2019 and at the same time introducing further improvement measures. Success in this area contributes to improved customer satisfaction and reduces disruption costs. Various other initiatives have been undertaken to further explore and implement streamlining measures. This work will continue throughout 2020 and beyond with the objective of continually improving customer service and ensuring the future competitiveness of the Company.

The year 2019 was an eventful year where we were faced with a series of challenges. I want to thank our employees for their excellent work, strong commitment and endurance during the year. I would also like to thank the members of our Board of Directors for their valuable contribution.

With a clear strategy, flexible route network, strong financial position and our outstanding employees, we are well positioned to tackle the challenges we are currently facing and achieve our key goal of returning to profitability in 2020 and building a platform for sustainable, profitable growth for the future.