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competition bites December 2016 Download PDF

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2016 has proven to be a period of deep discomfort for the super-connectors — the three Gulf airlines of Emirates, Qatar and Etihad plus THY. Emirates (the world’s largest carrier ranked by international RPKs) recently announced a first half profit for the six months to September down by 64% year on year, while THY revealed a net operating loss of $260m for the nine months to end September down from a $732m profit in the prior year period. Does this throw doubt on the strategies of these new airlines?

Emirates stated that in the first half of the fiscal year ending March 2017 group revenues had risen by a mere 1% to AED46.5bn ($12.7bn) and profits had declined by 64% to AED1.3bn ($364m). The Emirates airline itself saw revenues fall by 1% despite a 9% increase in the number of passengers. It cited the double impact of a strong US dollar and a “challenging” operating environment.

Capacity in ASK terms grew by 12% in the period while passenger demand in RPK increased by only 8% resulting in a 3 point reduction in load factor to 75.3%. Cargo traffic in tonnage was at a similar level to the prior year period. Fuel costs fell by 10% in the period and total unit costs seem to have declined by 4% year on year with total costs up by 5% and capacity in ATK terms 9% higher than in the prior year period.

The group figures include the results of Dnata (ground handling, inflight catering etc), which seems to be doing reasonably well, with revenues up by 14% but profits down by 1% to AED549m because of the effect of the strong US Dollar on the translation of its international operations.  Emirates Airline profits apparently fell by 75% to AED786m ($214m).

Turkish woes

THY meanwhile published results showing a 10% year-on-year decline in revenues for the third quarter to $2.9bn and a 6% fall for the nine months to September to $7.6bn. Net operating profits in the quarter fell by two thirds to $226m making a total operating loss for the nine months of $(260)m compared with a profit of $732m for the same period last year.

This was on the back of a 14% increase in capacity in ASK terms over the nine month period and an 8% growth in traffic in RPKs — the load factor fell by 4 points to 74.5% — while yields collapsed by 12% on a like-for-like basis excluding currency movements. Unit revenues equally fell by 15%. Unit costs meanwhile fell by 8% in the quarter and 6.5% over the nine months; total fuel costs falling by 6.5% and 11% respectively.

THY particularly highlighted overcapacity on some of its major markets — notably in Europe and on the North Atlantic — while the terrorist attacks in Europe earlier in the year and on Istanbul’s Atatürk airport in June continue to have a dampening effect on local demand in Turkey and inbound tourist traffic. In October it announced that it had rescheduled the delivery of some 90 A320s and 10 737s originally planned for 2018-2022.

In the company’s Q3 results’ presentation, it showed the market development by region which makes some disturbing reading (see chart). Its biggest growth areas in the third quarter were into the Americas and Africa with respective capacity growth of 32% and 25%. Unit revenues on these route areas fell by 23% and 12%. This you might expect, but at least total revenue on these areas seems to have grown. However, on routes to Europe, the Far East, Middle East and domestically unit revenue declines exceeded the increase in capacity.

Some of THY’s data may represent its own unique problems, but it probably reflects the general trend on the super-connector routes through the Middle East. In their recent results’ statements IAG highlighted an 11% decline, and Air France-KLM and Lufthansa an 8% fall in unit revenues to Asia, while the Asian majors have also commented on weak yield and unit revenue progression without necessarily putting down such fine detail.

Meanwhile in the chart we show the results of the performance of all Middle East based carriers during 2016. Traffic in RPK terms has been growing at around 8% a year while capacity in ASKs has been increasing at around 10%. Load factors have dipped by an average 2 percentage points. In this environment one would expect weak yields and unit revenues beyond that to be expected from the fall in fuel prices. This probably helps to explain Emirates’ comments on first half results. This will no doubt be exacerbated by the fact that the Dinar (as indeed the Qatari Riyal) is pegged to the US dollar.

The other two major Gulf carriers, Qatar and Etihad, do not publish reliable results or consistent data. However, as a result presumably of the public action by the US majors accusing the Gulf carriers of “unfair” competition and the disgrace of state “subsidies”, these two are now trying to present a more open attitude towards financial and operational disclosure, even though there is no statutory requirement to do so.

Qatar’s first annual report

Qatar published its “very first” annual report in July along with audited financial statements covering the year to March 2016. In that year it achieved an operating profit of QR3bn ($837m)  (treble the amount achieved in the previous financial year) on revenues of QR35.6bn (up by 4%) representing an operating margin of 8.6% — probably the best operating margin in its 20 year history. This followed a 20% increase in seat capacity and a 19% growth in passenger numbers to 26.6m and benefited from a near 30% decline in fuel costs — passenger unit revenues appear to have fallen by 15% in the period.

The company doesn’t say much about the operating environment in the current year, save that it will be opening 17 new destinations after the 13 introduced in 2015/16 and, with reference to a falling fuel price, that “cost offsets to date are not greater than the lost revenue opportunities”. Like Emirates and Etihad, Qatar does not publish monthly traffic statistics; but we understand that it has continued to grow in 2016/17 at the same 20% rate of the previous financial year. Half the size of Emirates in the number of seats offered, it still has some way to go to catch up.

Etihad and its partners

Etihad didn’t publish an “annual report” per se for its financial year ended 2015 but it did put out a press release with a few numbers. In that year it increased seat kilometre capacity by 21%, matched by a similar growth in passenger kilometres, while the number of passengers grew by 19% to 17.6m and load factors were little changed at 79%. Total revenues also supposedly increased by 19% while operating profits were similar to the prior year at $259m — a 3% margin.

This operating profit figure may include non-operating exceptional items at the operating level as it has in the past (see chart). We assume that it also excludes any recognition of the gains or losses at the Etihad Equity Partners — airBerlin, Alitalia, Jet, Virgin Australia, Air Serbia, Air Seychelles and Darwin. 

CEO James Hogan stated that "the airline’s return on its equity investments into the seven airlines was many times more than the money it had spent. For an investment smaller than the cost of three new aircraft, we have been able to build our global network, attract five million new customers and $1.4 billion of revenues, and share massive cost synergies. That’s smart business."

Whether or not we agree with him, Etihad has had to keep pushing cash into airBerlin to keep it afloat — and the latest restructuring plan involves adding another €300m into a new airline to be created out the “bad” airBerlin and TUI (see Aviation Strategy, October 2016). There are rumours meanwhile that Alitalia also is running out of cash again — it is reputed to be losing €1.5m a day. The Italian flag-carrier, in which Etihad has a 49% equity stake,  is proposing some further 2,000 job cuts (a sixth of its workforce) and grounding twenty aircraft with an anticipated return to break-even by 2020.

For the current year Etihad has said little. In a factsheet published in October the company indicated that the number of passengers had grown by (a modest) 7% in the nine months to September (well down on the 19% growth in 2015) and that it had cut the number of destinations served. In December however there was a news report that Etihad has issued a statement suggesting it was cutting jobs “as part of a restructuring”, adding that it was “operating in an increasingly competitive landscape, against a backdrop of weakened global economic conditions”. So they are hurting too.

Reputable reports from Abu Dhabi suggest that Etihad, as well as cost cutting, is reviewing its airline investment strategy and management structure, which may mean a series of (challenging) divestments and the departure of CEO James Hogan.

Competitive overlap

The four carriers have not just been providing thorny competition to the established legacy network carriers (primarily driven by their advantage of location); they also compete heavily against each other. In the table we show a matrix that highlights the distinct overlap between the respective hub networks. Based on the number of seats scheduled to depart from respective “spoke” cities in 2016, it is only THY with its extensive short haul network that serves a significant number of destinations that are not in competition with the other three — covering some 40% of its total planned seats.

For the Gulf carriers both Emirates and Qatar have just 6% of their network seats, and Etihad a minuscule 1%, on destinations not served by the other three. As a corollary, for example, Etihad has 95% of its spoke seat capacity competing directly against Emirates and this accounts for 26% of the joint capacity offered on these destinations, while Emirates sees 76% of its seats in direct competition with Etihad and has a 74% share.

Meanwhile, all four carriers continue to take significant numbers of new aircraft into their fleets. This year Emirates alone has taken delivery of 16 A380s and 13 777s (while disposing of 14 older A330s and 777s). All have huge orders with the manufacturers (see chart). Qatar in October announced an order for another 30 787s and ten 777s, and a LoI for 60 737MAX 8s. It is only THY so far that has publicly announced aircraft delivery deferrals.

So where now?

  • The competition is intense between the four, and is unlikely to abate.
  • In this subdued growth environment there is the prospect of a period of significant over-capacity: clearly demand, for whatever reason, is not being stimulated by the introduction of routes bypassing the traditional network hubs in Europe, Asia and North America in the same way it had in the past decade. Something will have to give.
  • The risks to this group may be increasing. Trump’s election in the US may be signalling a move towards protectionist policies that might favour the top 3 US carriers' complaints of “unfair” subsidies and bolster the campaign of the Partnership for Open and Fair Skies. The EU, following the UK referendum vote to leave the bloc, is likely to be increasingly taking the more protectionist attitudes of France and Germany without the influence of the British liberalising input.
  • THY’s problems in the current year emphasise the dangers of the political tensions that lie so close to the surface in the region.
in competition with
Emirates Etihad Qatar THY Not competing "Spoke" seats 2016 (m)
pct share pct share pct share pct share
Sched Seats Emirates -- -- 76% 74% 81% 66% 22% 59% 6% 42.3
Etihad 95% 26% -- -- 92% 42% 22% 34% 1% 11.8
Qatar 79% 34% 69% 58% -- -- 80% 37% 6% 22.0
THY 34% 41% 34% 66% 54% 63% -- -- 41% 55.2
gnuplot Produced by GNUPLOT 5.0 patchlevel 5 -40% -30% -20% -10% 0% 10% 20% 30% 40% America Europe Asia Africa Middle East Domestic Year on year % change ASK RASK Revenue Capacity (ASK) Unit revenues Revenues

Source: Company Reports, Aviation Strategy

gnuplot Produced by GNUPLOT 5.0 patchlevel 5 -5% 0% 5% 10% 15% 20% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 60% 65% 70% 75% 80% 85% Year on year % change LF ASK RPK LFCH Load Factors RPK ASK Load factor change

Source: IATA

gnuplot Produced by GNUPLOT 5.0 patchlevel 5 0.0 0.5 1.0 1.5 2010 2011 2012 2013 2014 2015 2015 9Mos 2015 9Mos 5 7.5 10 12.5 Operating Profit Pre-tax Profit Revenues Op prof pretax revenues Operating Profit Pre-tax Profit Revenues
gnuplot Produced by GNUPLOT 5.0 patchlevel 5 0 50 100 150 200 250 300 Fleet Orders Fleet Orders Fleet Orders Fleet Orders NB in service WB in service A380 in service NB Order WB Order A380 Order Narrowbody Widebody A380s Emirates Qatar Etihad THY

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