Three airlines face disruption to their role as ‘superconnectors’ as the state-owned groups fight to justify a business model built around hubs in a volatile region
by: Tanya Powley and Simeon Kerr
They have been the great aviation disrupters of the 21st century. Over the past decade, Dubai’s Emirates, Etihad Airways of Abu Dhabi and Qatar Airways have quadrupled the number of passengers they fly each year.
They have tempted travellers with competitive pricing, superior service and luxurious premium cabins and turned the Gulf into the stopover destination in global air travel. In the process they even earned themselves a nickname: the “superconnectors”. But after years of what seemed like unstoppable growth, the three Middle Eastern airline upstarts are experiencing their own period of disruption.
In a short time, the state-owned Gulf carriers have been assailed by a mixture of economic, political and business crises. The economic slowdown triggered by the oil price collapse two years ago has sharply cut travel demand in the region.
Terrorist attacks across Europe and political tension over migrants and security in the US have hit their business hard. As if that were not enough, the United Arab Emirates is one of four Arab countries to impose an embargo on Qatar over accusations of sponsoring terrorism.
With competitors challenging some of their most prized routes, the airlines have to justify a business model that is built around hubs located in a volatile region. “The three superconnectors have hit some serious turbulence for the first time,” says Andrew Charlton, a Geneva-based aviation analyst.
“They’ve managed to go for 10-15 years on a perfect run, withstanding a bunch of issues, but now they are suffering.” The impact of this instability is directly affecting earnings. Profits for all airlines in the Middle East are forecast to more than halve, from $1.1bn in 2016 to $400m this year, according to Iata, the global airline trade association.
The region’s carriers will make an average $1.78 per passenger in 2017, compared with a global average of $7.69.
Each of the three carriers is suffering from the shift in fortunes. Emirates, the oldest and largest of the Middle Eastern airlines, is assessing its strategy after the carrier posted its first full-year profit decline for five years in May, as earnings plummeted 82 per cent. Etihad’s grand plan to catch up with its regional rivals by buying stakes in airlines around the world is unravelling and, in doing so, has had a big impact on the European aviation market.
Over the summer, two of Europe’s biggest airlines, Alitalia and Air Berlin, filed for bankruptcy after Etihad pulled the plug on further funding following a review of its acquisition strategy. Meanwhile, Qatar Airways, the Gulf’s fastest-growing supercarrier, faces its own problems following the unprecedented blockade.
Qatar’s airline saw a collapse in bookings after Saudi Arabia, the UAE, Bahrain and Egypt implemented an air and sea embargo against the gas-rich state in June. After a decade of untrammelled expansion, the fall in capacity growth for the three carriers now projected for calendar year 2017 is dramatic.
For Emirates, annual growth in scheduled seats departing from Dubai has averaged 11 per cent between 2012 and 2016, while at Etihad and Qatar, from Abu Dhabi and Doha respectively, they increased 14.6 per cent a year and 16.2 per cent a year over the same period. According to current schedules for 2017, the average annual increase in seats for the UAE carriers will now be 2 per cent and 3 per cent respectively over 2016, and Qatar Airways will drop 1 per cent, figures from Flight Ascend Consultancy show. Peter Morris, its chief economist, says political problems and US visa issues have had a big impact on the capacity deployed in different countries.
“Qatar Airways has been particularly hit on markets to Saudi, Egypt, Bahrain, UAE and Emirates on routes to the US,” he says. Sir Tim Clark, Emirates’ president and founding member of the carrier, is a well-known optimist but the past year has taken its toll on the airline veteran. In May, he told the Financial Times that the airline has “just got to tough it out”.
While Emirates is no stranger to turbulent conditions during its 32-year history, Sir Tim says that, while it previously may have had two major “traumas” a year, it now seems to have one a month, pointing to the growing number of terrorist attacks in European cities.
Its US business has been a particular problem since the beginning of the year. New restrictions on immigration procedures into the US and cabin bans on some electronic devices hit demand for travel to the US. In April, a month after the laptop ban was introduced, Emirates announced it was cutting flights to five of its 12 US destinations in response to the fall in demand.
Since the ban was lifted in July, Sir Tim says business has improved but adds that it is still too “early to say” whether it would reinstate its flights to the US. Etihad has spent the majority of this calendar year grappling with problems related to its investments in struggling airlines. In July, the Abu Dhabi carrier posted a $1.9bn loss for 2016, which included an $808m impairment associated to its equity stakes.
The airline has poured hundreds of millions of dollars into investing in Air Serbia, Air Seychelles, Air Berlin, Alitalia, Etihad Regional, Jet Airways and Virgin Australia over the past decade. A review of its strategy last year prompted the departure of James Hogan, its chief executive and principal architect of its business plan, as well as Alitalia and Air Berlin being put into administration after the Abu Dhabi-based airline pulled its funding support. Bonds worth $1.2bn linked to Etihad special purpose vehicles have slumped in value as investors fret over whether the government will offer support.
“It’s like Dubai’s [sovereign debt scare] in 2009 all over again. Investors bought on the assumption that the government will step in, even if there is no explicit guarantee,” says one Abu Dhabi-based banker. “Let’s see what happens.”
Etihad’s new chief executive, who is expected to be announced by the end of this year, will face a tough challenge. They must decide how to move on from the airline’s messy equity stake strategy in an era of austerity while reviving growth in increasingly competitive markets, according to analysts.
“This is a big, public, toxic mess to sort out,” says one Abu Dhabi-based investor. Qatar had been the star performer among the Gulf airlines. In contrast to its rivals, it announced net profit growth of 22 per cent to QR1.97bn ($541m) and an increase in revenues of 10 per cent to QR39.4bn in the financial year ending in March.
Its blend of wide and narrow-bodied aircraft provided the flexibility to navigate weaker demand in a region hit by falls in the oil price. But the blockade by its neighbours in June affected the carrier, instantly closing off 18 destinations and about a fifth of its seating capacity. While Qatar has refused to outline the impact of the move, it is likely to be incurring huge costs on rerouting aircraft and changes to crew rostering.
The airline has threatened legal action to recoup its losses. All three Gulf carriers have been forced to discount fares in an effort to retain market share. John Grant of OAG, an aviation data consultancy, says connecting traffic, which is central to their business models, is “always vulnerable to price”.
Mr Grant adds: “Such low local market demand, particularly for Qatar and Etihad, does highlight a real risk in their traffic and business structure.” The Gulf airlines are facing competition from low-cost long-haul airlines, such as Norwegian Air Shuttle and Singapore-based Scoot, which are luring customers with cheap fares on some of the same routes between Europe and the US and Asia.
In the face of tougher conditions, the Gulf carriers are adapting their businesses. Emirates has agreed a tie-up with its low-cost sister airline Flydubai, which will see the two airlines align systems and operations at their Dubai hub.
The partnership has added weight to rumours of a potential Emirates merger with Etihad, which analysts say could help relieve the latter’s losses and pare back excess capacity in the region. Both emirates have embarked on airport expansion plans at Dubai World Central and Abu Dhabi’s midfield terminal, concentrating on the need to operate more efficiently to sustain growth. Insiders say a merger has often been raised internally, but is a decision for the sheikhs running both emirates.
As well as cutting operational costs across their businesses, Emirates and Etihad have realised the importance of boosting revenue by charging more for services, particularly in economy class. This follows a trend of full-service airlines aping the practices of their low-cost peers.
Emirates now charges for seat assignment in economy while offering a pay-per-access service to its lounges, and aims to introduce other charges in the coming months. In June, Etihad revealed plans to charge for chauffeur services, which were previously included for business and first class customers.
“Passengers who didn’t previously have the option of using the lounge can now do so, and that revenue is almost pure profit,” says Mr Horton. “Gulf airlines stood out by offering chauffeur services. Perhaps it was inevitable there would be sensibility [on charges].”
For Emirates, Sir Tim says the second half of this year “should be much better”. Some of its changes have already helped its performance this year. “Last year was certainly a challenging one for Emirates, but we’ve made some changes in order to accelerate growth,” says Sir Tim.
“Across the network, load factors are strong. Yields are still under pressure, but business is definitely better than in the first half.” One thing that has been clear is that Gulf airlines can expect little sympathy from their peers.
Rivals in Europe have complained vociferously about their tactics in the European market, claiming that they exploit a state subsidised model to steal long-haul market share, while US airlines have run a concerted campaign against allegedly unfair competition because of subsidies, asking their government to tear up its aviation agreements with Qatar and the UAE.
Delta Air Lines, one of the US’s big three carriers, released a 15-minute video highlighting the danger the Gulf airlines pose to the US industry. The Gulf airlines, which deny receiving subsidies, argue that their order books sustain the US aeronautics industry. Aviation analysts say those hoping for the decline of the Gulf airlines will be disappointed, despite the turbulence they are experiencing.
They enjoy more efficient cost bases than their competitors, now enhanced by cuts and restructuring. The Gulf governments, while smarting from lower oil prices, are committed to transportation and tourism as sources of diversification away from oil.
The UAE, for example, is introducing a sales tax in 2018 to boost non-oil revenues, but has exempted aviation from the 5 per cent levy. “They will continue to be a strong force in the aviation market, there’s no doubt about it,” says Mr Charlton.
Hub theory: Geography and fleets offer the ‘perfect combination’
Emirates, Etihad Airways and Qatar Airways have shaken up the aviation world over the past 30 years by using their prime geographic location to connect any two places on earth with one stopover in the Gulf.
Emirates came up with the model, fuelled by Dubai’s position between east and west — with two-thirds of the world’s population living within eight hours of the city state. City and airline developed a symbiotic dynamic to generate growth: Emirates’ global connectivity feeds off Dubai’s role as a global tourism and commercial hub, and vice versa.
While all three may compete for passengers travelling mostly between the same pairs of city, each has developed a distinct strategy for growing market share. The airlines have wooed travellers from longer established airlines based in Asia, Europe and the US. In 2006, the three Gulf carriers carried 26.5m flyers between them. Ten years later, this has risen to 104.5m.
“The fact is their geography, where they’ve got their hubs, combined with the long-range capability of their modern fleets, is the perfect combination,” says John Strickland, an aviation analyst. The Middle Eastern airlines have also been helped by their vast airports designed for the seamless transfer of millions of passengers.
Connecting traffic outnumbers the number of travellers destined for the Gulf. Part of their rapid growth comes down to timing. Newer aircraft enabled them to link “secondary” cities such as Manchester in the UK and Stuttgart in Germany to major destinations, rather than passengers having to fly via their own country’s hub.
Around the same time, low-cost carriers ate into the short-haul market share of legacy carriers by taking passengers directly to more destinations. “The low-cost carriers were stealing the legacy airlines’ lunch. Then suddenly the Gulf carriers came and ate their dinner,” says Andrew Charlton, an aviation analyst.
culled from Financial Times of London