Tourism in : Soft landing or a belly flop?

Arion Research October 2018 Table of contents

• Key findings (p. 3) • From zero to hero (p. 4) • Airlines operating environment and impact on tourist arrivals (p. 11) • The downside risk is significant (p. 21) • Are we getting ahead of ourselves in hotel construction? (p. 28) – How do Icelandic hotels fare in international comparison? (p. 38) – Airbnb showing signs of growing pains (p. 49) • How quickly the tide turns (p. 54) Key findings

• Increased capacity of the Icelandic airlines has played a large role in the sensational growth in tourist arrivals to Iceland.

• Although oil prices have surged since 2016, airfares have not followed. According to estimates, the Icelandic airlines will pay around one thousand ISK with each passenger in 2018, a development that is unsustainable in the long run. Airfares are simply too cheap and they need to increase. Analysis of tourist’s price elasticity of demand indicate that rising airfares could lead to decrease in number of tourists, especially if the ISK remains strong.

• We predict very little growth in in the coming years. In our base case tourist arrivals will increase by 1.4% next year and 2.4% in 2020. There is quite a lot of uncertainty, but we consider the downward risk to be greater. For example, if growth in VIA passengers continues at the same rate in 2019 as it has done in 2018, number of inbound tourists could slightly decrease. Global trade tension could also slow growth in passenger transport, a development which would affect Iceland.

• Last year, hotels accounted for less than half of all registered overnight stays in Iceland. In recent years, the vast majority of hotel nights have been in the capital area. However, countryside hotels have been attracting increased shareholding, mostly in Southern Iceland, Reykjanes Peninsula (South-West) and West Iceland.

• Increase in tourism beyond supply growth in hotels has created basis for Airbnb to gain market share. However, recent numbers indicate that Airbnb’s activities are shrinking, as Airbnb’s overnight stays reduced significantly over the summer.

• It appears that strong króna and high prices has not shortened tourist’s vacation time as much as previously thought because tourists have increasingly sought after cheaper accommodation, such as Airbnb. Tourist’s consumption in ISK has in turn contracted, but pretty much stayed unchanged in foreign currency. Developments differ from nationalities where some are more vulnerable than others.

• For the economy in general, consumer behavior is now more important than before, since the tourism industry can no longer rely on revenue growth through an increased number of tourists. From zero to hero

In a very short period of time, tourism has gone from a small industry to the largest export sector in the country. A Cinderella Story More and more foreign tourists, less and less seasonality

Tourist arrivals via KEF Total number of tourists Seasonality airport - millions 70% - millions 10.0 2.5 65% 9.0 60%

2.0 8.0 55% 7.0 50% 1.5 6.0 45% 5.0

40% 1.0 4.0

35% 3.0

30%

0.5 2.0

6 years 6 64 years 64 25%

1.0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 - 2018* - Percentage of tourists visiting in June-August

1949-2012 2013-2018

1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 1949 Percentage of tourists visiting in other months

Sources: Icelandic Tourist Board, Arion Research. * Based on Research‘s forecast. Tourism contribution to GDP has doubled For the past three years, tourism has accounted for roughly 23% of business investment

GDP and tourism* Business investment - bn. ISK at constant prices - bn. ISK at constant prices 2,700 14% 450 30%

400 12% 2,500 25% 350 10% 2,300 300 20%

8% 250 2,100 15% 200 6%

1,900 150 10% 4% 100 5% 1,700 2% 50

0 0% 1,500 0% 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Tourism contribution to business investment Tourism contribution to GDP GDP without tourism Business investment without tourism Share of tourism in GDP (r.axis) Share of tourism in business investment (r.axis) Sources: Statistics Iceland, Arion Research. * The weight of tourism in GDP is not in perfect accordance with Statistics Iceland's TSA, as air passenger transportation weighs more here than in the TSA. The recovery time would have been much longer… The economic upturn in Iceland has been in a class of its own, largely due to growth in tourism

Economic growth and effects of tourism 8% 7.4%

7%

6%

5.2% 5% 4.5% 4.1% 4.3% 4.0%4.1% 4% 3.4% 3.4% 3.2% 2.9% 3% 2.1% 1.9% 2% 1.4% 1.3% 1.4% 1.0% 1.1% 1.1% 1% 0.7%

0% -0.1%

-1% 2011 2012 2013 2014 2015 2016 2017

Economic growth withouth tourism contribution to GDP Economic growth withouth tourism contribution to GDP and business investment Actual GDP growth

Sources: Statistics Iceland, Arion Research … and the current account would only be a shadow of its current self The surplus of trade in services, which is primarily due to tourism, has carried the trade surplus. It should be noted that the analysis below is likely inaccurate, as the impact of tourism on imports has not been taken into account.

Export revenues of foreign travellers Scenario where export revenues of foreign - bn. ISK at constant exchange rate travellers increase by 5% annually 600 - bn. ISK at constant exchange rate 400

300 500

200

400 100

0 300 -100

200 -200

-300 100 -400 2010 2011 2012 2013 2014 2015 2016 2017 2018* Secondary income 0 Primary income 2010 2011 2012 2013 2014 2015 2016 2017 2018* Balance on services Balance on goods Travel Air transport Current account balance Current account balance with 5% growth

Sources: Statistics Iceland, Arion Research. * Research‘s forecast from August. For every 100 tourists, one new job has been created The increase in tourist related jobs has closely followed the increase in tourist arrivals. The figures for Q2 indicate that the slowdown in tourist arrivals has begun to affect the labor market. Increase in tourist arrivals* and the number of tourist related jobs - increase between years, quarterly data 5,000 200

4,000 150

3,000 100

2,000

50 1,000

0 0

-1,000 -50 2011 2012 2013 2014 2015 2016 2017 2018

Other activities linked to tourism Travel agency, tour operator and other reservation service and related activities Food and beverage service activities Accommodation Passenger air transport Increase in the number of tourists, thous. (r.axis)

Sources: Statistics Iceland, Icelandic Tourist Board, Arion Research. * Tourist arrivals via KEF airport. Handing over the growth reins According to our forecast from August, other export sectors will grow more than tourism in 2018

Share in total exports Exports revenues 100% - YoY growth, constant exchange rate 50% 90% 20% 18% 17% 18% 20% 19% 19% 18% 19% 23%

80% 40%

70% 23% 23% 23% 28% 30% 33% 30% 29% 35% 36% 60% 31% 20%

50% 20% 16% 17%

22% 10% 40% 26% 23% 27% 26% 26% 30% 25% 0%

42% 20% 39% 41% 29% 31% -10% 24% 26% 10% 20% 19% 20%

0% -20% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018* 2010 2011 2012 2013 2014 2015 2016 2017 2018*

Tourism Seafood Industrial goods Other Tourism Industrial goods Seafood Other

Sources: Statistics Iceland, Arion Research. * Research‘s forecast from August. Airlines operating environment and impact on tourist arrivals

For small islands, passenger transport is the key driver of tourism. With rising oil prices and fierce competition, Icelandic airlines are now facing considerable headwinds. How will that impact the amount of tourists coming to the country? Out of European countries, Iceland is the most dependent on home-based airlines Two other are on the list of top 15 European countries for home carriers

Home carriers - seat capacity

Iceland

Turkey

Ireland

Belarus

Russia

Norway

Moldova

Finland

Slovenia

Latvia

Netherlands

Luxembourg

UK

Germany

Austria

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

12 Sources: Anna aero, Arion Research Capacity has increased a lot The Icelandic airlines will carry around eight million passengers this year

Number of passengers - in millions 5

4.2 4.0 4 3.7 3.6

3.1 3 2.8 2.6

2.3 2.0 2 1.7

1 0.7 0.4 0.5 0.1 0 2012 2013 2014 2015 2016 2017 2018e

Icelandair WOW air

13 Sources: Group, WOW air, Arion Research Tourism has followed the Icelandic airlines capacity increase Proportionately higher growth in tourism 2014 and 2015 than increased airline capacity, can possibly be explained by increased flight offerings from foreign airlines Icelandair and WOW air capacity growth and tourist arrivals via KEF airport

45%

40%

35%

30%

25%

20%

15%

10%

5%

0% 2013 2014 2015 2016 2017 2018e 2019e

Icelandair and WOW air Tourists

14 Sources: , WOW air, Icelandic Tourist Board, Arion Research Broken up since 2016: Oil price and airfares When oil price started plummeting, airfares followed. However, that has not been the case since oil price started rising again.

Jet fuel (USD/Ton) and unit revenue (=100, 2014) 1,200 120

110 1,000

100 800

90

600

80

400 70

200 60

0 50 2014 2015 2016 2017 2018

Jet fuel (l.axis) European airlines (r.axis) Icelandair (r.axis) WOW air (r.axis)

Sources: Bloomberg, Icelandair Group, WOW air, Arion Research 15 Unit revenue = Revenues / Revenue passenger kilometers (RPK) Parallel with unfavorable development of external factors, earnings have gone south Icelandair Group and WOW air projections assume that operating loss (EBIT) for 2018 will be around thousand ISK per passenger

Earnings per passenger - USD 80

70

60

50

40

30

20

10

0

-10

-20 2014 2015 2016 2017 2018 T12m

Icelandair Group, EBITDA Icelandair Group, EBIT WOW air, EBITDA WOW air, EBIT

Sources: Icelandair Group, WOW air, Arion Research 16 Arion Research projections for 2018 Icelandair Group‘s EBIT based on company‘s EBITDA guidance Our base case projects very little growth in tourism in the coming years Based on expected flight capacity and continuing growth in share of VIA passengers

Tourist arrivals via KEF airport - millions annually, % increase 3.0

2.7% 2.5 2.4% 4.5% 1.4% 24.2%

2.0 40.1%

1.5

1.0

0.5

0.0 2016 2017 2018 2019 2020 2021

17 Sources: Icelandic Tourist Board, Arion Research With capacity blow, we could go roughly two years back in time Pessimistic scenario: Capacity of a major airline disappears

Pessimistic scenario - millions annually, % increase 3.0

2.7% 2.5 2.4% 4.5% 4.5% 1.4% 24.2% 5.5% 10.1%

2.0 -17.8% 40.1%

1.5

1.0

0.5

0.0 2016 2017 2018 2019 2020 2021

Base case Pessimistic scenario

18 Sources: Icelandic Tourist Board, Arion Research Less fluctuations are in our optimistic scenario than the pessimistic Optimistic scenario: Airline operations improve and they continue to grow

Optimistic scenario - millions annually, % increase 3.0 7.1% 6.5% 2.7% 2.5 4.5% 2.4% 4.5% 4.5% 1.4% 24.2%

2.0 40.1%

1.5

1.0

0.5

0.0 2016 2017 2018 2019 2020 2021

Base case Optimistic scenario

19 Sources: Icelandic Tourist Board, Arion Research The scenarios are three, but possible outcomes are more If airfares increase and the ISK stays strong, we could see results in the gray area between the base- and pessimistic scenarios

All scenarios - millions, annually 3

2.5

2

1.5

1

0.5

0 2016 2017 2018 2019 2020 2021

Base case Pessimistic scenario Optimistic scenario

20 Sources: Icelandic Tourist Board, Arion Research The downside risk is significant

What if airfares increase significantly? What if the world economy slows down? Sources: The Travel, Insider, Frugal Travel Guy Flying to and from Iceland has never been so cheap While the ISK has appreciated, flights to Iceland have become cheaper. Lower airfares have somewhat offset the rising cost of staying in the country.

Flight ticket to Iceland: Passenger air transport per tourist - in EUR and USD, YoY

500 6% -3% 450 -10% -2%

400 -9%

2% 1% 350 -3% -14% -5% -6% -9% 2% 300 -6% -10% -4% -12% 250 -10%

200

150

100

50

0 2010 2011 2012 2013 2014 2015 2016 2017 2018*

EUR USD

Sources: Statistics Iceland, Icelandic Tourist Board, CBI, Arion Research. * Estimation based on airfares in 1H 2018. What could it mean if airfares increase? First, we have to look at the price elasticity of demand. For tourism in Iceland, and North-America are the most important markets, although the Asia market is growing. According to studies, tourists from America are more sensitive to price changes than others. Europeans are fairly price sensitive as well.

Origins

Africa America Asia Oceana Europe

Africa -0.282 -3.081 -0.579 -2.190

America -0.704 -1.619 -1.310 -0.804 -1.136

Asia -1.767 -1.223 -1.818 -1.246 -1.436 Destination Oceana -0.675 -1.046 -0.917 -0.449

Europe -1.374 -0.750 -1.205

Sources: A Meta-Analysis of International Tourism Demand Elasticities. If airfares to Iceland rise, it could have significant impact Depends on the price elasticity of demand, whether airfares to Iceland would increase relatively more than to other destinations and whether other costs would decrease, for example through depreciation of the ISK. Effect of 10% increase in airfares on tourist arrivals - millions of tourists, based on different price elasticity of demand and Research's base case, all other things being equal 2.4

2.3

2.2

2.1

2.0

1.9

1.8

1.7 2016 2017 2018 2019

Base Case -0.4 -0.8 -1 -1.2 -1.6

Sources: Icelandic Travel Board, Arion Research Economic growth is the fundamental driver of demand for air travel Further escalation in global trade protectionism could have negative effect on air transport

Global air passengers Assumed income elasticity - billion, income elasticity = 1 4.7 1 1.3 1.8

GDP -0.1% -0.1% (-4)* -0.1% (-6) -0.2% (-8) 4.6

on Estimated -0.4% -0.4% (-18) -0.5% (-23) -0.7% (-32) 4.5 negative impactnegative -1.1% -1.1% (-48) -1.4% (-63) -2.0% (-87)

4.4 Selected passenger shocks in the past - global passenger numbers, YoY change 4.3 6% 2008-2017 5% Trade war? 4% 4.2 3% 2% Volcker 4.1 1% recession 9/11 0%

-1% Global 4 Second oil financial crisis -2% shock 2017 2018 2019 -3% Gulf War Base case Very small impact on GDP (-0.1%) 1991 1980 1981 2009 2001 2019 10-year average Larger impact on GDP (-1.1%)

Sources: IATA. * Numbers in brackets represent millions of tourists. What does the pessimistic scenario mean for the economy? All other things being equal, fewer tourists would mean a drop in tourism expenditure, which could lead to firings. The current account surplus could easily be reversed. The graphs below show what could be called the worst case scenario, as the ISK is kept stable and the effects of tourism on imports is ignored.

Inbound tourism expenditure New/lost jobs in tourist Current account in Iceland related activities - % of GDP 5,000 8% - bn. ISK, floating exchange rate 450

4,000 6% 400

350 3,000 4%

300 2,000 2% 250

0% 200 1,000

150 0 -2%

100 -1,000 -4% 50 2013 2014 2015 2016 2017 2018 2019

- -2,000 Current account - pessimistic scenario 2017 2018 2019 2014 2015 2016 2017 2018 2019

27 Sources: Statistics Iceland, CBI, Arion Research Are we getting ahead of ourselves in hotel construction?

Accommodation is on average the largest expense of traveling. Hotel construction has been trying to keep pace with booming demand from tourists. With tourist arrivals slowing down rapidly, the question is raised: Are we getting ahead of ourselves in hotel construction? Hotels shoulder the burden Every four in ten overnight stays by tourists were spent at hotels in 2017

Registered overnight stays by type of lodging 4,000,000

3,500,000

3,000,000

2,500,000

2,000,000

1,500,000

1,000,000

500,000

0 Hotel Unlisted Airbnb Guesthouses Other unlisted Apartments and Camping sites Youth hostels Other Private-home accommodation

2012 2013 2014 2015 2016 2017

29 Sources: Statistics Iceland, Arion Research Lion‘s share of overnight stays are spent in the capital area In relative terms, however, growth has been slowest in the capital area as occupancy rates have been very high. The number of tourists visiting the country has outpaced hotel construction, growing 378% since 2010 while the latter has grown by 79%.

Overnight stays in hotels by regions - stays (thous) and change from 2010 2,500 214%

2,000

1,500

1,000

427%

500 534% 266% 418% 477%

0 Capital area Southwest West and North East South

2010 2014 2017

30 Sources: Statistics Iceland, Arion Research Overnight hotel stays per thousand travelers has decreased Supply shortage, appreciation of the króna and competition with Airbnb seem to be the main causes

Overnight hotel stays per 1000 tourists, by Overnight hotel stays per 1000 tourists, region countryside 1,800 350

1,600 300

1,400 250 1,200

200 1,000

800 150

600 100

400 50 200

0 0 Southwest West and North East South Capital area Countryside Westfjords

2010 2014 2017 2010 2014 2017

31 Sources: Statistics Iceland, Arion Research Length of stay per each hotel guest has not decreased markedly, indicating supply shortage Tourists cut their stay in the capital area in 2014, but since then their average stay has hovered around 2.2 nights

Average length of stay by hotel guest - stays and YoY percentage change 3.0

5% 2.5 -2% -2% -9% 4% -4% -3%

2.0

1.5

1.0

0.5

0.0 2010 2011 2012 2013 2014 2015 2016 2017

32 Sources: Statistics Iceland, Arion Research In the beginning of the year, overnight stays decreased in all parts of the country except South Iceland and West Iceland This trend reversed in August with travelers lengthening their stay at hotels

Overnight stays - change between 2017 and 2018 45,000 15%

35,000 10%

25,000 5%

15,000

0%

5,000

-5% -5,000

-10% -15,000

-25,000 -15% Jan Feb Mar Apr May Jun Jul Aug

Capital area Southwest West and Westfjords North East East Total change Tourist arrivals (YoY - r.ax)

33 Sources: Statistics Iceland, Arion Research Which has coincided with lower occupancy rates Occupancy rates in the capital area are still robust and higher than outside the capital area

Hotel room occupancy rates Hotel room occupancy rates - - other regions 100% 100%

90% 90%

80% 80%

70% 70%

60% 60%

50% 50%

40% 40%

30% 30%

20% 20%

10% 10%

0% 0% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2010 2014 2016 2017 2018 2010 2014 2016 2017 2018

34 Sources: Statistics Iceland, Arion Research We forecast that the number of hotel rooms in the capital area will be around 7,000 by 2022 Should our forecast materialize hotel rooms will increase by 43%

Arion Research's hotel room forecast in the capital area

8000

7000

6000

5000

4000

3000

2000

1000

0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Year end 2022 Hotel rooms New rooms (forecast)

35 Sources: Statistics Iceland, City of Reykjavik, media, Arion Research We expect overnight stays at hotels to increase Increased supply, together with slower growth in tourist arrivals, lead to a decline in occupancy rates

Arion Research's forecast for overnight stays and occupancy in the capital area - thousands 3,000 90% Forecast

80% 2,500 70%

2,000 60%

50% 1,500 40%

1,000 30%

20% 500 10%

0 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Base scenario Room occupancy (r. ax) Average occupancy in Nordic capital areas (2010-2017)

36 Sources: Statistics Iceland, Arion Research Are we getting ahead of ourselves in hotel construction? Compared to the Nordic countries, it seems we are rather reaching a sustainable long-term equilibrium. The substitution effect over to other accommodation has been considerable since 2010 in the capital area. That development seems to have reversed over the last few months when supply has increased.

Occupancy forecast: optimistic scenario Occupancy forecast: pessimistic scenario - Only current construction finished, travelers increase - All projections in development realize, travelers their length of stay at hotels decrease their length of stay at hotels 100% 100% Forecast Forecast 90% 90%

80% 80%

70% 70%

60% 60%

50% 50%

40% 40%

30% 30%

20% 20%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Base scenario Base scenario Optimistic tourist arrivals scenario Optimistic tourist arrivals scenario Pessimistic tourist arrivals scenario Pessimistic tourist arrivals scenario Average occupancy in Nordic capital areas (2010-2017) Average occupancy in Nordic capital areas (2010-2017)

37 Sources: Statistics Iceland, Arion Research How do Icelandic hotels fare in international comparison?

What do sliding occupancy rates mean in the big picture?

38 Icelandic hotels rely on foreign travelers In other Nordic countries locals comprise the majority of overnight hotel stays

Foreign travelers' overnight hotel stays in 2017 as a percentage of total 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Sources: Eurostat, Arion Research. *2017 data for those available 39 The capital area reaching occupancy seen in the Nordic countries over the summertime The occupancy in Reykjavík is generally better during winter than in other capital areas

Occupancy rates in the Nordic countries - capital areas 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

01/2010 04/2010 07/2010 10/2010 01/2011 04/2011 07/2011 10/2011 01/2012 04/2012 07/2012 10/2012 01/2013 04/2013 07/2013 10/2013 01/2014 04/2014 07/2014 10/2014 01/2015 04/2015 07/2015 10/2015 01/2016 04/2016 07/2016 10/2016 01/2017 04/2017 07/2017 10/2017 01/2018 04/2018 07/2018

Reykjavík Helsinki

Sources: Statistics Iceland, local statistics agencies in Nordic countries, Arion Research 40 Occupancy of hotel rooms at a national level is very good in European comparison The seasonality is similar to that seen in the Nordic countries

Occupancy rates in Europe 100

90

80

70

60

50

40

30

20

10

0

01/2012 03/2012 05/2012 07/2012 09/2012 11/2012 01/2013 03/2013 05/2013 07/2013 09/2013 11/2013 01/2014 03/2014 05/2014 07/2014 09/2014 11/2014 01/2015 03/2015 05/2015 07/2015 09/2015 11/2015 01/2016 03/2016 05/2016 07/2016 09/2016 11/2016 01/2017 03/2017 05/2017 07/2017 09/2017 11/2017 01/2018 03/2018 05/2018 07/2018

Iceland Norway Finland Netherlands Switzerland

41 Sources: Eurostat, Arion Research Occupancy in Reykjavík will remain with the best in class

Occupancy rates in European cities 90%

85%

80%

75%

70%

65%

60%

55%

50% London Amsterdam Prague Reykjavík Lisbon Berlin Porto Paris Zurich Milan Geneva Rome Frankfurt

2015 2016 2017 2018 - forecast European average 2015-2017

Sources: Statistics Iceland, PwC, Benchmarking Alliance, Arion Research 42 Prices are, however, very high Accommodation prices have more than doubled over the last decade. Prices of hotels and restaurants in Iceland are among the highest in Europe.

Hotel and restaurants prices - price level indices, EU 28 = 100 210

190

170

150

130

110

90

70 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Iceland Denmark Sweden Norway Finland Germany Netherlands Switzerland

43 Sources: Statistics Iceland, Eurostat, Arion Research Considerable seasonality in ADR as well Rising ISK prices in parallel with the appreciation of the króna has led to hotel rooms in the capital becoming more expensive than in the Nordic countries

Hotel room ADR in Nordic capital areas - euros 250

200

150

100

50

0

01/2010 04/2010 07/2010 10/2010 01/2011 04/2011 07/2011 10/2011 01/2012 04/2012 07/2012 10/2012 01/2013 04/2013 07/2013 10/2013 01/2014 04/2014 07/2014 10/2014 01/2015 04/2015 07/2015 10/2015 01/2016 04/2016 07/2016 10/2016 01/2017 04/2017 07/2017 10/2017 01/2018 04/2018 07/2018

Oslo Stockholm Helsinki Reykjavík

Sources: Benchmarking Alliance, local statistics agencies in Nordic countries, Arion Research 44 ADR similar to that seen in London and Amsterdam It should be borne in mind that there are still no five-star hotels in Reykjavik that distorts comparison to some extent

Average daily rate (ADR) in European cities - euros

250

200

150

100

50

0 Geneva Paris Zurich Reykjavík London Amsterdam Rome Milano Frankfurt Lisbon Porto Berlin Prague

2015 2016 2017 2018 - forecast Average ADR 2015-2017

Sources: Statistics Iceland, PwC, Arion Research 45 RevPAR has been largely unchanged since 2016 Off season RevPAR decreased YoY in 2018*

Revenue per available room (RevPAR) in Reykjavík - ISK, thousands and change from previous year 25 9% 1% 0%

9% 13% 20 -4% 12%

27%

15 9% 17% -2%

16%

11% 10 17% 22% 22%

5

0 2010 2011 2012 2013 2014 2015 2016 2017 2018

High season Off season

Sources: Statistics Iceland, Benchmarking Alliance, Arion Research *Jan-May 46 RevPAR among the highest in Europe

RevPAR in European cities -EUR 200

180

160

140

120

100

80

60

40

20

0 Paris Geneva Zurich Reykjavík London Amsterdam Rome Milano Lisbon Frankfurt Porto Prague Berlin

2015 2016 2017 2018 - forecast Average RevPAR 2015-2017

47 Sources: Statistics Iceland, PwC, Arion Research Equity ratios have never been better

Equity ratios in tourism related industries

40%

30%

20%

10%

0%

-10%

-20%

-30%

-40%

-50% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Transport by air Accomodation Food and beverage service activities

48 Sources: Statistics Iceland, Arion Research Airbnb showing signs of growing pains

Airbnb has soaked up demand for overnight stays in the past three years, especially in the capital area. However, the development over this summer indicates the sharing economy for overnight stays is shrinking

49 Same old story: Airbnb has been growing The growth has been particularly powerful outside the capital area. However, it is difficult to quantify the actual number of overnight stays on Airbnb, as Airdna and Statistics Iceland tell a different story. Thus, the total share of Airbnb was 21% in 2017, based on data from Statistics Iceland, but 31% based on Airdna's data.

Overnight stays on Airbnb - stays and percentage change YoY 2,500,000

2,000,000 40%

1,500,000 181% 335% -6%*

15%* 1,000,000

500,000 1630%

0 2015 2016 2017 2018*

Capital area Countryside

50 Sources: Statistics Iceland, Airdna.com, Arion Research *Jan-Aug But growing pains are appearing Following growth spur over the last two years overnight stays in Airbnb have decreased YoY over the past five months in the capital area

Overnight stays on Airbnb - stays and percentage change YoY 250,000

200,000 -19% -20% -11% -4% -6%

10% 6% 150,000 11% 13% -2% 27% 58% -6% 22% 100,000 52% 65%

50,000

0

Capital area Countryside

Sources: Statistics Iceland, Airdna.com, Arion Research 51 Supply of Airbnb rentals has started to decrease A strong real exchange rate, tightening regulation and increased competition with hotels has potentially reduced the incentive to rent out assets through Airbnb. Rising real estate prices have also made selling more attractive.

Active Airbnb rentals Active Airbnb rentals - capital area - countryside 4500 4500

4000 4000

3500 3500

3000 3000

2500 2500

2000 2000

1500 1500

1000 1000

500 500

0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2017 2018 2017 2018

52 Sources: Statistics Iceland, Airdna.com, Arion Research *A working paper by the Central Bank of Iceland suggests that full time rentals on Airbnb in 2017 were around 752-1,898 in the capital area and 204-902 in the countryside. Less seasonality in Airbnb ADR On average there are more bed places per bedroom on Airbnb, compared to hotel rooms

Hotel and Airbnb ADR Hotel and Airbnb ADR - ADR in ISK per bed room - ADR in ISK per bed place 30,000 14,000

12,000 25,000

10,000 20,000

8,000

15,000 6,000

10,000 4,000

5,000 2,000

0 0

01/2015 03/2015 05/2015 07/2015 09/2015 11/2015 01/2016 03/2016 05/2016 07/2016 09/2016 11/2016 01/2017 03/2017 05/2017 07/2017 09/2017 11/2017 01/2018 03/2018 05/2018 07/2018 01/2015 03/2015 05/2015 07/2015 09/2015 11/2015 01/2016 03/2016 05/2016 07/2016 09/2016 11/2016 01/2017 03/2017 05/2017 07/2017 09/2017 11/2017 01/2018 03/2018 05/2018 07/2018

Airbnb - Entire home Airbnb - Private room Hotel room Airbnb - Entire home Airbnb - Private room Hotel room

Sources: Statistics Iceland, Airdna.com, Arion Research 53 How quickly the tide turns

In no time at all the tourist industry has gone from double digit growth to much more sustainable levels. What happened? The Icelandic airlines are not expanding as fast The main reason for slower growth in tourist arrivals is that the Icelandic airlines route network is not expanding as fast as before. The composition of nationalities visiting Iceland largely depends on where, and how often, the airlines fly.

Icelandair and WOW air capacity growth and Flight supply and tourists tourist arrivals via KEF airport - change between July 2017 and 2018 45% 40%

40% 30%

35% 20% 30%

25% 10%

20% 0%

15% -10% 10%

-20% 5%

0% -30% 2013 2014 2015 2016 2017 2018e 2019e Nordic countries Germany Icelandair and WOW air Tourists Change in available flights Change in the number of tourists

Sources: Icelandair Group, WOW air, Túristi.is, Icelandic Tourist Board, Arion Research More VIA passengers than ever before Other development that contributes to slower growth in tourist arrivals is the growing importance of VIA passengers. To some extent, this trend can be attributed to new destinations in the Icelandic airlines route network, but another important factor is how expansive the country has become. VIA passengers - % of total traffic through the airport

50%

45%

40%

35%

30%

25%

20%

15%

10% January February March April May June July August September October November December

2012 2013 2014 2015 2016 2017 2018

Sources: Isavia, Arion Research One of the most expensive destination in the world Few places are as expensive as Iceland for the typical tourist, both because of strong króna and high prices Europe 3-star travel index for 2018 - typical budget for normal daily expenses* 25,000

20,000

15,000

10,000

5,000

0

Split Kiev

Nice

Oslo Riga

Ibiza

Paris Sofia

Berlin

Rome

Zürich Český…

Dublin

Milano Tallinn Vilnius

Lisbon

Venice Madrid

Vienna Naples Athens

Bruges Zagreb

Munich

Bergen Prague

London Valletta Krakow

Helsinki

Istanbul

Warsaw

Moscow

Tenerife

Brussels

Florence

Salzburg Santorini Sarajevo

Ljubljana Belgrade

Hamburg

Budapest

Reykjavík

Interlaken Bratislava

Barcelona Dubrovnik Bucharest

Edinburgh

Stockholm

Amsterdam

Luxembourg

Copenhagen St.Petersburg

Sources: Priceoftravel.com, CBI, Arion Research. * Prices from May, in ISK. Exchange rate from September 18. What does this dubious title mean for the consumption pattern of foreign tourist?

Studies indicate that consumer behavior and the duration of stay is more vulnerable to price increases than arrivals. This is especially true for small islands. The income effect seems to be relatively small When the trip becomes more expensive, many tourists respond by shortening their stay. Looking at all overnight stays in the country, registered and unlisted, the effect seems to be small – so far.

Overnight stays per tourist and the real exchange rate 5.00 105

4.50 100

4.00 95

3.50 90

3.00 85 2.50 80 2.00

75 1.50

70 1.00

0.50 65

- 60 2010 2011 2012 2013 2014 2015 2016 2017 2018*

Overnight stays per tourist Real exchange rate (r.axis)

Sources: Statistics Iceland, Airdna, Arion Research. *Research‘s estimation for 2018. The substitution effect is clearer If all overnight stays are summarized, the duration of stay has changed only slightly, while registered overnight stays per tourist have dropped. This indicates that as prices of hotels and guesthouses increase, tourists look to cheaper options, i.e. Airbnb. Overnight stays per tourist 6.5

6

5.5

5

4.5

4

3.5

3

2.5

2 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018*

Winter* - all Summer - all Winter - registered Summer - registered

Sources: Statistics Iceland, Airdna, Arion Research. * Summer 2018 based on the latest figures. Winter period is from September to April. Winter stay stretches to the countryside While tourists seem to be increasingly moving out of the capital area for the winter months, there have been little changes over the summer. According to overnight stays in hotels, this trend has continued in 2018. Registered overnight stays in the capital area - % of all registered overnight stays 90%

79% 80% 78% 72% 70% 70% 68% 65% 60% 60%

50%

40% 39% 38% 36% 35% 35% 32% 34% 30%

20%

10%

0% 2011 2012 2013 2014 2015 2016 2017

Winter Summer

Sources: Statistics Iceland, Arion Research Tourists migrate South for winter During the winter months, tourists increasingly travel to the South and Southwest. This means that tourists are more concentrated than ever, contrary to the goal of better distribution.

Registered overnight stays in the countryside Registered overnight stays in the countryside in winter in summer - % of all registered overnight stays - % of all registered overnight stays 20% 30%

18% 25% 16%

14% 20%

12%

10% 15%

8% 10% 6%

4% 5% 2%

0% 0% 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017

South Southwest West Westfjords South Southwest West Westfjords Northwest Northeast East Northwest Northeast East

Sources: Statistics Iceland, Arion Research Each tourists spends fewer ISK than before The bright side is that each tourist has been spending more and more in his/her own currency. In fact, 2017 was the first year where this trend reversed. Total consumption per tourist Total consumption per overnight stay - in ISK and YoY - in ISK and YoY 250,000 50,000 0% -5% 45,000 -3% 0% 0% -4% 1% 200,000 -5% 40,000 11% -13%-3% 6% -12%-2% 1% 1% 0% 4% 35,000 1% 2% 150,000 30,000

25,000

100,000 20,000

15,000

50,000 10,000

5,000

0 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Floating exchange rate Constant exchange rate Floating exchange rate Constant exchange rate

Sources: Statistics Iceland, Airdna, CBI, Arion Research Weaker ISK = more spending in ISK Latest figures for 1H of 2018 show that each tourist is spending more in ISK than before, which isn‘t surprising as the ISK has depreciated in 2018. Spending in foreign currency has stood its ground. Consumption per tourist Foreign payment card turnover per visitor - YoY - excl. flights, YOY 15% 25%

20% 10% 15%

5% 10%

5% 0% 0%

-5% -5%

-10% -10%

-15%

-15% -20%

-20% -25% 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Constant exchange rate Floating exchange rate Floating exchange rate Constant exchange rate

Sources: Statistics Iceland, CBI, the Centre for Retail Studies, Arion Research Why does consumer behaviour matter? Because we can no longer rely on revenue growth through growth in tourist arrivals. In 2017 each tourist spent less than before, both in ISK and foreign currency. However, as tourist arrivals increased by 24%, export revenues continued to increase. Export revenues of foreign travellers, based on different developments of consumption - Research's base case for tourist arrivals, bn. ISK at constant prices 450

400

350

300

250

200

150 2015 2016 2017 2018 2019 2020 2021 Travels, unchanged consumption per tourist Travels, 3% growth in consumption per tourist Travels, 3% decline in consumption per tourist

Sources: Icelandic Tourist Board, Statistics Iceland, Arion Research Contacts

Elvar Ingi Möller Erna Björg Sverrisdóttir [email protected] [email protected]

Þorsteinn Andri Haraldsson Head of Research [email protected] Stefán Broddi Guðjónsson [email protected]

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