Hard Landing: GCC carriers tighten belts in turbulent times

On a bright Monday morning in June in 2015, the world’s airline executives gathered in Miami to celebrate 70 years of the International Air Transport Association’s lobbying efforts, bullish and beaming at the prospect of a strong year in the black.

“For the first time in our history, the airline industry as a whole will earn its cost of capital,” IATA’s then director general Tony Tyler told reporters at the event.

Most of that profitability–the fastest growth rate since the post-recession spike in 2010–would come from North America, where carriers would generate nearly $25 in profit per passenger flown. The Middle East generated a more humble $7.71 per passenger in comparison, the world’s lowest margin according to IATA’s annual report. However, this figure included carriers such as Gulf Air, Oman Air and Kuwait Airways, which were all in the middle of announcing fleet modernisation and strategic revival strategies.

The GCC was a different story. In a year when global industry net profits totalled $35.3 billion, Dubai’s Emirates, the world’s biggest international airline, announced figures of $1.24 billion (AED 4.5 billion), a 40 percent increase from the year earlier. Emirates announces its annual results in May, and in 2015-2016 net profit would surge another 56.4 percent to nearly $2 billion. To put that into even deeper perspective, Emirates’ profit margins in 2015-2016 at above 8 percent matched the global average and were four times that of the combined Middle East’s figure.

The GCC’s other carriers recorded strong numbers as well. Qatar Airways net profit until March 2016 quadrupled to $445 million. And in what would become the holy grail of luxury, typical of the ‘world’s five star airline’, Etihad introduced its first class Residence Suites, round trip to New York on which would set a traveller back $32,000. The same year, the UAE’s national carrier’s announced 2015 profits of $103 million, it’s strongest to date.

In 2016, the bull run braked hard.

In September, Emirates reported first half net profit had fallen 64 percent, prompting chairman, Sheikh Ahmed bin Saeed al Maktoum to say the future held, “no signs of improvement.” Both Emirates and Abu Dhabi-based national carrier Etihad have announced job cuts. In what Etihad is referring to as a ‘transition process’ that began last summer, its CEO and CFO will be leaving by the summer.


 "One of the main reasons for UAE airlines falling profits is excess capacity.”


Two of the UAE’s four airlines, both low cost carriers have released 2016 statements reporting reduced profits for the year. The most startling results came from Flydubai. Dubai’s low cost airline carried a record 10.4 million passengers in 2016, but its net profit plummeted 69 percent from 2015 to AED 31.6 million. In two years, the carrier’s net profit has sunk 87.4 percent. Its last high came in 2014 when it posted figures of AED 250 million.

Only Flydubai and Emirates rerponded to a request for comment on future business prospects from Aviation Business, but analysts aren’t expecting record profit figures from 2016. IATA forecasts Middle East carrier profits will fall 67 percent to a combined $300 million in 2017 compared to the $900m forecast for 2016. And analysts suggest overcapacity, complicated by low oil prices and a strengthening dollar, and the ongoing threat of terrorism, mean the turbulence felt in 2016 will continue in 2017, particularly in the UAE.

“One of the main reasons for UAE airlines reporting falling profits is the excess capacity on the market, across the entire airline industry. The traffic demand is not growing at the same level as the number of seats airlines offer,” says Miguel A Lopez Avila, principal consultant at PA Consulting.

Qatar Airways isn’t immune either says Avila, but, “the airline offers prices that are extremely competitive against its regional and global competitors. Its traffic is also much more dependent on transferring passengers than OD traffic, meaning that a weaker demand of origin/destination passengers impacts less on Qatar Airways than UAE carriers.”

Data from CAPA Centre for Aviation and OAG show the GCC’s airlines have been on a capacity binge, adding non-stop flights to the US, Europe, Australia and New Zealand, Asia and Africa.

In February 2017, airlines have grown capacity between the UAE and India, and Doha and India, by 7.8 percent and 5.5 percent respectively versus year-ago levels. There has also been a 9.4 percent increase in capacity between the UAE and Africa in the same period. Overall, IATA saw demand for seats across the Middle East grow by 11.8 percent in 2016, falling short of capacity which grew by 13.7 percent. In 2017, capacity is forecast to grow at 10.1 percent while demand grows by of nine percent.

Increase in capacity resulting from lower-priced seats on Indian carriers such as Air India and Jet Airways is affecting demand for GCC carrier seats, according to Henry Harteveldt, president and analyst at Atmosphere Research Group.

“Softer profits [from India] are a function of increased capacity, especially by low-fare airlines [Indian carriers], which tend to beat the price leaders. There is also softer demand, in particular from business travellers, who tend to pay higher economy fares or fly in business- or first-class. Meanwhile Gulf, European, and Asian carriers have also been conducting ‘fare wars’ in business- and first-class. A business traveller may generate upwards of five times the profit of a leisure traveller. A decline in business passengers, even in economy, will have an outsized negative impact on an airline’s revenues and bottom-line profits. It’s also my understanding that there has been softer demand between the Gulf and certain markets in Africa,” says Harteveldt.

East to West traffic has also cut back, on account of the heightened security situation in Europe. The GCC 3 had been on a capacity spree to the continent until the third quarter of 2015, according to data tracked by Bloomberg. Seats have surged six-fold from 2004, but capacity to Europe is being reined in, receding to the slowest growth rate in a decade in the first quarter of 2017.


"There is only so much US demand for Gulf, India, Africa, Southeast Asia travel. At some point airlines are cannibalising themselves.”


“They travel en masse, 100, 200, 300,” Emirates CEO Tim Clark said in an interview, about travellers from China and the Far East. “When Ankara happened, when Paris happened, when Nice happened, they stopped. Not into a trickle–they stopped entirely.”

Part of the reason behind a softer demand for seats is also the product of a stronger dollar. “A stronger dollar, especially in countries where the local currency has weakened significantly, reduces demand for traveling,” says AbdulRahman Bakir at PA Consulting. In October last year, Emirates announced it would be cutting routes to a number of African cities, citing currency devaluations leading to a shortage of hard currency. “We’re seeing that development affect business conditions across industries in in the Middle East and wider region,” he says.
GCC carriers had tried to offset that lack demand by increasing capacity on to flights to and from the US. These routes bring higher yielding passengers–over a third from India and Pakistan, according to CAPA–despite the higher costs of running airplanes with bigger and more numerous engines such as A380s.

But that strategy has been complicated two-fold: signs of an increasingly protectionist administration in the US, and a limit to demand from the country.

“We can’t ignore the expansion of flights from the Gulf region to the US,” says Harteveldt. “Emirates, for example, has added nonstop flights from Dubai to Orlando and Fort Lauderdale, Florida. Qatar launched new flights between Doha and Atlanta. There is only so much demand in the US for travel to the Gulf, India, Africa, and Southeast Asia. At some point, airlines end up cannibalising themselves.”

Neither can geopolitical impacts, aka Trump, be ignored, he says. In conversation with Aviation Business, the Middle East’s major carriers said they had faced an ‘insignificant’ impact due to President Trump’s first attempt at a travel ban. But it is unlikely that a new attempt at a ban, as the US President has hinted, will not affect GCC airline operations, says Harteveldt.

“President Trump’s recent travel ban led to a global 6.5 percent decline in airline bookings to the US, and caused some US companies to scale back some of their business travel,” he says. “There is concern that when the Trump administration introduces its new version of the travel ban that it, too, may suppress demand to the US from abroad and international travel originating in the US. It’s possible this may disproportionately affect the Gulf airlines, given the markets they serve.”


"A stronger dollar, especially in countries where the local currency has weakened significantly, reduces demand for traveling,”


GCC carriers have tried to keep demand up by decreasing airfare. Each of the GCC’s major airlines has been offering some kind of discount, sometimes by up to half to keep demand up. In January, flights for two from Doha to Paris were selling for QAR 3,200 on Qatar Airways’ website. 

It isn’t an uncommon strategy: IATA estimates half of global passenger demand in 2016 was in response to a decrease in airline fares.

But while that has caused passenger numbers on aircraft to grow–all the UAE’s carriers report growth in passengers carried–the decrease in profits per passenger have led to lower overall revenues, and consequently, the shutting down of routes and a rethink in the kind of fleet to be deployed. In an interview with CNN earlier this year, Emirates CEO Tim Clark confirmed that the carrier would in the next 18 months decide about adding more narrow-bodied aircraft suited to thinner routes. When the time is right we will decide,” he said. “But so far, we are just biding our time to see which way it all pans out.”

At ITB Berlin in 2016, Clark had outlined the problem facing the carrier: “On the one hand you save on the operating costs [by downgrading from the A380], but your yield starts to fall because your corporate business is disappearing, so it’s a double-edged sword.”
Meanwhile, Etihad is opting to cut average seat kilometres by 4.2 percent in 2017 in all regions except Western Europe and Australia, according to CAPA, the first time any of the Gulf 3 super-connectors will contract in annual capacity. It is also possible that the UAE’s national carrier could delay or cancel some of its 787s on order, according to analysis by CAPA, something that would have been unthinkable in 2015.

Earlier in the year, sworn enemies became friends when Etihad and Lufthansa announced a codeshare agreement, which is being seen as the precursor to even more cooperation in the future. The $100 million dollar codeshare agreement was announced to show most of its impact would be felt on the catering operations of Etihad in Germany. But over the course of the year, Etihad has offloaded its cargo handling at Munich and Frankfurt to LUG, embarked on exploring maintenance cooperation with the German carrier’s MRO division, and most importantly, agreed to wet-lease 38 airlines to Lufthansa from struggling Airberlin which it has a 29% stake in.

The Airberlin agreement is most indicative of the new reality. With capacity outpacing demand in Europe, the agreement with Lufthansa allows Airberlin to offload some of that capacity, and spin off the rest in a merger with TUI Fly to cater to higher yielding markets in Dusseldorf and Berlin. Etihad’s board approved the merger in December.

At the joint press conference with Etihad’s outgoing CEO James Hogan last month, Lufthansa CEO, Carsten Spohr, made mention of protectionism, an emerging development that could derail aviation’s growth around the world were it to materialise. How long the golden age of growth for the Gulf’s carriers would continue was in question, he said, reiterating his stance against being propped up by state subsidies, an accusation the region’s carriers have denied, but also signalling that the agreement with Etihad, “marks the beginning of more partnerships.”

“We’re the good guys of globalisation,” said Spohr, referring to the aviation industry.

For Gulf carriers, long used to connecting the world from Buenos Aires to Auckland, the globalised world they helped create might be bringing home less than they bargained for.

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