Icelandair Group hf ICEAIR IR
September 05, 2013 - 1:57pm EST by
2013 2014
Price: 14.90 EPS $1.57 $2.45
Shares Out. (in M): 5,000 P/E 0.0x 0.0x
Market Cap (in $M): 611 P/FCF 0.0x 0.0x
Net Debt (in $M): -85 EBIT 0 0
TEV ($): 526 TEV/EBIT 0.0x 0.0x

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  • Iceland
  • Airline
  • High ROIC


Who wants to buy an airline in a country that's got a population the size of Lexington Kentucky that recently defaulted and whose economy is based on fish? 

I'm fascinated by Iceland, it has to be the quirkiest place in the world. It has a population of just 320,000. The language is totally bizarre, "Vaðlaheiðarvegavinnuverkfærageymsluskúraútidyralyklakippuhringur" is an actual word. There are 14 public companies...Vodafone Iceland's annual report has a color head shots of its employees, not just executives, every employee of the company. 25% of the population believe in elves. They eat puffin, as in those cute little birds. The prime minister's phone number is in the phone book. They used a Facebook survey to create a new constitution. There is essentially no crime at all and mothers leave their baby carriages on sidewalks while they go inside to shop. Someone created an app to make sure residents dont hook up with relatives. You could tell me pretty much anything about Iceland and I'd probably believe it at this point. 

Leaving aside its oddities, the entire country is basically a natural wonder. It's the go-to place for eco-tourism...Iceland is like Disney World for environmental folk and more broadly anyone who wants to visit someplace different. The blue lagoonNorthern lightsGullfoss falls. Glaciers. Hiking. Volcanos. Scuba diving. Lots of seafood. There's almost no pollution at all, virtually all of their electricity is generated from geothermal and hydroelectric. It's an extraordinarily clean and friendly country and it's a short flight from New York, London, and Scandinavia. Feel free to check out reviews on TripAdvisor and such, and watch various videos on YouTube...much better to see it than read what I have to say. (Spoiler alert: people rave about it) And everyone speaks english. Here's a link to the most recent data on tourism stats for the country that provides a good statistical overview and some additional color on tourism. Visitors have doubled in 10 years and tourism has been even stronger since the financial crisis.

There's another important thing that earns Reykjavik a special distinction from other Nordic destinations and plays a surprisingly large role in driving tourism: Reykjavik's nightlife. Who would've guessed that Reykjavik of all places has a legendary bar/club scene. After a long day of hiking glaciers, people party. Tourists get the best of both worlds. Imagine Vegas but instead of gambling, it's hot springs. (Since it's relevant I'm just gonna throw this out there: Iceland is full of babes. Bachelor parties in Reykjavik are becoming a thing, and people in the age group of 26-34 are by far the largest cohort of visitors to the country. Iceland was formed around the 9th century by vikings, and supposedly they kidnapped the hottest women they could find when they settled. For the last 1,000 years they've had one of the purest gene pools in the world. If nothing else, now you have a legitimate explanation for your compliance officer why were googling "hot Iceland women". You're welcome.) My point is simply this. Iceland offers travelers a one-of-a-kind experience, yet it's still relatively undiscovered as a tourist destination. With an ever-growing segment of the world that cares deeply about the environment and wants to experience something naturally breathtaking, Iceland is the place to go. I expect tourism to the country to continue to grow 7-10% annually, although I wouldn't be surprised to see a higher growth rate in the next few years given the increased awareness and weaker currency (keep in mind that growth was still strong before the financial crisis).

As the name implies, Icelandair is the flagship carrier of Iceland. It has a fleet of 39 aircraft (24 owned) and its hub is Keflavík International Airport which is the largest and only major airport in Iceland. Most passengers come from the US, UK, and western and northern Europe. The company originally IPO'd in late 2006 and until the financial crisis it was run as a conglomerate. The collapse of the banking system in Iceland led to a rationalization of many of the non-core assets and a balance sheet restructuring. Today, Icelandair is focused on its core businesses and generating decent return from them, while things are improving every month.

It's probably fair to say that most investors instantly dismiss investments in airlines for obvious reasons. Chronically unprofitable, irrational competition, capital intensive, blah blah. 95 times out of 100 they're right, except in this case I believe Icelandair has a durable competitive advantage, something not based on its business model, capital structure, fuel hedging, etc. Icelandair's advantage is a matter of simple geography combined with the inherent bottleneck that is Iceland: 
  • Iceland is very small
  • Iceland is an island and 98% of travelers arrive by plane
  • Keflavík Airport is effectively the country's only airport for international travel (94% of all travelers pass through it)
  • Keflavík Airport is small and cannot support many other airlines
  • Iceland lies almost directly between the US and Scandanavia
No other airline can match Icelandair's route network to/from Iceland, as both a tourist destination and a layover for connecting traffic between North America and Northern Europe. Try flying from anywhere in the US to Iceland without flying Icelandair - it's almost impossible. (go to skyscanner and see for yourself) The other carriers that can fly you to Reykjavik will force you on a long layover somewhere, and it's more expensive anyway. Part of the problem is the configuration of Keflavík Airport, where 6 out of its 15 terminals cannot handle US flights due to different rules regarding passport controls and weapons searches. 40% of the only airport's capacity is off-limits to US carriers. There has been some discussion about expanding the airport, but these things tend to take very long times if they even happen at all.

Europe is more competitive but the same dynamics generally exist there as well. Furthermore, Iceland's location gives Icelandair a unique advantage as a connection point between the North America and Scandanavia (which is further bolstered by the fact that the US and Scandanavian countries of Sweden/Norway/Denmark/Finland are the largest sources of tourists). I estimate it's 35-40% cheaper to book on Icelandair and connect (briefly) through Reykjavik than fly direct on one of the large regional carriers such as SAS, mostly because the tourism keeps the flights fuller, thus giving them a cost advantage. The upshot is that competition is relatively benign and fares tend to go up. There's little point in engaging in a price war since Keflavík is so capacity constrained and there aren't enough slots and gates.

RASK (RASM in kilometers) growth is very strong, mostly from added capacity but also higher loads. RASK increased 20.4% and 18.2% in 2011 and 2012, respectively, and monthly stats appear remain encouraging. Yields have been steadily rising while costs (CASK ex fuel) have been falling. Everything has been moving in the right direction. Travel is highly seasonal with planes and hotels being nearly maxed out in summer, then half-used during winter. Encouragingly, travel during winter months has been very strong (up 16-22% annually) in recent years as tourists are lured by lower fares and room rates. 

The company also has a hospitality and services business that includes hotel operationtravel agencies, and airport ground services. They are the largest hotel operator in the country with 8 highly rated hotels under management. Surprisingly, the segment is a drag on the overall results. Despite generating almost $80m in revenue (9% of overall revenue) the services business only managed to eke out $4m in ebitda in 2012. The hotels average 71% utilization for the full year which is considered excellent (for some frame of reference, the Miami hotel market averages 71% utilization and it has the 3rd highest utilization rate in the US after Hawaii and DC). The balance sheet is underlevered with $222m in cash (Q2 is the seasonal Q4 it should be ~$160m) and $137m in debt. There is an additional $269m in capital leases but they are also lessors for $211m of planes and hotels mostly during the winter. This is one of the least levered balance sheets in the airline world since they undertook a restructuring stemming from the economic collapse. 

Like most airlines, Icelandair is cheap. It has one of the lowest multiples in the group despite operating in a defensible niche where it will generate 20-25% ROE/ROIC going forward. Given all of its virtues, I would expect it to trade at a premium. I would also consider the stock one of the best ways to invest in Iceland. There are only 14 publicly traded Icelandic companies so the choices are limited, especially post-default. If tourism and the economy continue to do well, I dont see why Icelandair couldn't trade at a higher multiple as the story becomes more well known, partly as a way to invest in Iceland's recovering economy and its booming tourism industry. At 5.5x 2013 ev/ebitda (the same multiple as JBLU) the stock is worth 18kr today. But Icelandair should grow ebitda 25-30% next year, so looking out a little farther it's worth 22-23kr. I estimate that in 2015, Icelandair could reasonably be generating 2.80kr in EPS which would still be a merely average profit margin. A 12x multiple on that gets 34kr price target in a couple years. None of this seems crazy to me. 
Might as well mention Iceland's economic situation really quickly. Iceland's banks defaulted after a comical failure, and the government took some IMF loans to avoid a sovereign default. The government told the bank creditors to piss off, then they moved on with their lives, albeit with a currency that was worth half of what it used to be. But today the economy is growing respectably, the currency is stable, unemployment is down from 8% to almost 5%, and GDP per capita remains one of the highest in the world. I have no view on the direction of the Icelandic Krona (USDISK is 122) but I believe the currency should remain relatively stable. A strengthening krona will have a positive effect on Icelandair's profits (and owning the stock in krona) but could result in reduced tourism.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


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It's an airline
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