A hard landing for the Gulf's high fliers

The three carriers 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

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 United States have hit their business hard. As if those were not enough, the United Arab Emirates (UAE) is one of four Arab countries to impose an embargo on Qatar over accusations of sponsoring terrorism.


Profits for Middle Eastern airlines, including Emirates (above), are forecast to more than halve, from US$1.1 billion (S$1.5 billion) last year to US$400 million this year, according to Iata, the global airline trade association. The region's carriers will make an average US$1.78 per passenger this year, against a global average of US$7.69. PHOTO: REUTERS

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 Mr 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 US$1.1 billion (S$1.5 billion) last year to US$400 million this year, according to Iata, the global airline trade association. The region's carriers will make an average US$1.78 per passenger this year, against a global average of US$7.69.

DRAMATIC FALL

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 it 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.

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. Also, the Gulf governments, while smarting from lower oil prices, are committed to transportation and tourism as sources of diversification away from oil.

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 leaving Dubai has averaged 11 per cent between 2012 and last year, 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 rise 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. Mr 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.

Mr 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, Mr Clark 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.

TOXIC MESS

Its US business has been a particular problem since the beginning of the year. New restrictions on immigration procedures 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, Mr Clark 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 most of this calendar year grappling with problems related to its investments in struggling airlines. In July, the carrier posted a US$1.9 billion loss for 2016, which included an US$808 million 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 Mr 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 US$1.2 billion 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. It 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 a 22 per cent growth in net profit to 1.97 billion Qatari riyals (S$720 million and an increase in revenues of 10 per cent to 39.4 billion Qatari riyals in the financial year ended 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.

NEW SENSIBILITY

All three Gulf carriers have been forced to discount fares in an effort to retain market share. Mr John Grant of OAG, an aviation data consultancy, says connecting traffic, which is central to their business models, is "always vulnerable to price". He 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's 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."

For Emirates, Mr Clark 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," he says. "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 American 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' big three carriers, released a 15-minute video highlighting the danger the Gulf airlines pose to the American 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. Also, 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 next year 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.

FINANCIAL TIMES

A version of this article appeared in the print edition of The Straits Times on September 09, 2017, with the headline 'A hard landing for the Gulf's high fliers'. Print Edition | Subscribe