Too Early To Write Off Gulf Superconnectors

These are troubled times for the three big Middle East “superconnectors.” The UAE’s Emirates and Etihad have seen profits nosedive in their last fiscal years, and a wave of overcapacity in the market has triggered uncertainty about whether they’ll delay or postpone orders. Qatar has since June suffered through a blockade by a quartet of former allies over ties to extremist groups [see separate story], and the closure of Saudi airspace to Qatar Airways’ flights has made air transit on certain routes quite inconvenient.

Low oil prices have stubbornly refused to budge above $50 per barrel and are holding back regional economies, causing cost-cutting within the two Emirati carriers’ core markets.

It has reached the stage where Abu Dhabi National Oil Company, which controls approximately 85 percent of the UAE’s oil reserves and produces 3 million barrels per day, now plans to sell peripheral downstream assets through IPOs, the method that Saudi Aramco could also employ to entice international investment.

One might even argue that the sheer scale of Emirates’ 2013 orders was unrealistic, setting it up for a fall. At that Dubai Airshow, it executed its largest set of aircraft orders yet: for 115 Boeing 777-9Xs and thirty-five 777-8Xs, along with 50 Airbus A380s, together worth $99 billion at list prices. It now operates 150 Boeing 777s, 135 of them -300ERs.

While revenues remained flat for its fiscal year ending March 31, at $23.2 billion, Emirates’ profits dove 82.5 percent, to $340 million. Rumors of staff cuts swirled and a freeze on cabin crew hiring coupled with questions about international staff morale beset the organization.

Emirates president Tim Clark expressed fears that the "low-cost long-haul" model might eat into market share. Today, Norwegian Air Shuttle and Singapore Airlines low-cost subsidiary Scoot pose a long-term threat to Emirates’ "one stop to the world" business case.

“At the back end of ’90s I did a paper on long-haul low-cost,” Clark told Bloomberg's Berlin Forum in March. “Everyone laughed at me, but what I predicted then has finally started to happen. We have players in all arenas: Europe, America, Asia. It’s a gathering storm.”

One response could involve Emirates establishing ties with Dhabi's Etihad. Last month Clark expressed interest in some sort of collaboration, although he cautioned it likely couldn't involve a merger. In any case, the respective airlines' owners would have to decide on whether cooperation would be in their best interests, he told Reuters. 

“Frankly, as they are currently configured, they are going to need some restructuring, a different emphasis, perhaps on the A350, B787 or even 777-9X,” Teal Group analyst Richard Aboulafia said of Emirates. “The current model may be unsustainable, and they will have to focus on the right traffic. With the bigger planes, 140 of them [A380s], and their second biggest aircraft at 150 [777s], where will you be able to improve?”

Etihad also continues to struggle as it carries many more aircraft types than the two-workhorse model at Emirates and several core elements of its “equity alliance” strategy in Europe unravel. Former CEO James Hogan paid the price in July for the debacle, as a number of equity stakes turned virtually worthless.

In 2016, Etihad lost $1.8 billion. Total impairments of $1.9 billion saw a $1.06 billion charge on aircraft, reflecting lower market values and the early retirement of certain aircraft types. The airline also took a $808 million charge on certain assets and financial exposures to equity partners, mainly related to Alitalia and Air Berlin.

Etihad's losses on European equity stakes could ultimately total as high as $2.5 billion.

Etihad announced in September that Briton Tony Douglas would serve as Hogan’s replacement beginning in January. Its shareholders appointed the airline industry newcomer because he delivered a new port terminal in Abu Dhabi on schedule in 2012 and was well on the way to completing Abu Dhabi Airport’s new midfield terminal when the UK’s Ministry of Defence poached him in 2015.

Despite mounting problems, it seems premature to write off the Gulf carriers. On a single day-March 26—Emirates launched new A380 routes serving Narita, Japan; Casablanca, Morocco; and São Paolo, Brazil, marking the first-ever deployment of an A380 to South America. The world’s largest A380 customer, Emirates flies to 48 destinations with 100 of the superjumbos, leaving a further 42 on order.

Mindful of the benefits of airplanes that are easier to fill, Emirates announced October 2 that it would expand its network with a code share with Flydubai covering 29 destinations on three continents. Hogan might have also insulated Etihad better for the future by ordering 40 Airbus A350 XWBs and taking delivery of 17 of 71 Boeing 787s on order. Emirates has yet to commit to either type.

“It makes a lot of sense, getting a smaller plane with a long range,” said Aboulafia. “It is the logical path. Do they need the capacity? The A380 is effectively a proxy of this problem, where you have a volume and growth approach to the business rather than profitability. This has been the case since the company was created.”

Expecting some 25 million tourists for Expo 2020, Dubai’s focus as a hub for travel and tourism means that restructuring and belt-tightening should have the desired effect and keep profitability intact.