Emirates: Entering
a new era November 2017

Having suffered a shock in 2016/17 when its profits slumped, Emirates, partly out of necessity, reined in capacity expansion this year. As a result, profits have recovered, though its margins are still modest in comparison to double digit rates it has achieved in the past.

Overall capacity, passenger and cargo, during the first six months (April-September 2017) of the current financial year to end March 2018 increased by just 2%. Emirates launched only two new routes, to Zagreb (Croatia) and Phnom Penh (Cambodia).  ASK growth was limited to 3%, while RPKs were up 5%, which meant that the passenger load factor improved to 77.2%, compared with last year’s 75.3%. This, however, is still some way off the near 80% load factors that Emirates used to achieve.

On the other hand, we estimate that overall unit revenues rose by 6.4% during the first half, which, if reflected in the full year results, will reverse a long-term trend for Emirates. Unit costs appear to have edged up by about 2% during this period, largely due to an 11% increase in the price of fuel.

Emirates’ revenue (the airline, not the group) including other operating income totalled AED44.5bn ($12.1bn), up 6% compared with AED41.9bn ($11.4bn) for the same period last year. Net profit was reported as AED1.7bn ($452m), over twice the result last year. The profit margin was 3.7%, compared to a low of 1.7% last year, but nowhere near the 10%-plus margins Emirates has reported in the past.

Emirates is operating in increasingly challenging economic and political environment. Dubai is part of regional embargo against its neighbour Qatar; there is the possibility of instability, or much needed reform, in Saudi Arabia; and oil production is only now edging up again. The UAE’s GDP growth in 2017 is going to be a very modest 1.3%, though forecasts from the World Bank and IMF suggest a rebound to 3%-plus in 2018.

The airline has suffered from the US Administration’s new policies on carrying onboard electronic equipment (now rescinded) and its proposed restrictions on travel from certain Muslim countries. The initial impact was a 15% fall in demand on US routes, and a consequent reduction in services. Emirates still has not restored its 2016 frequency levels to Seattle, Boston and Los Angeles.

Now the US government is contemplating imposing corporation taxes on airlines that fly from countries to which US passenger airlines serve two or less times a week. It must have taken a high degree of creativity to come up with this rule which neatly captures the three Middle East super-connectors, without naming them explicitly (which would be discriminatory).

Also, the EU is becoming more protectionist and gaining new routes in France and Germany is going to be difficult.

Sir Tim Clark, Emirates CEO, remains, as normal, upbeat about the near future, and, interestingly, identifies the development of long-haul LCCs as being the big issue for 2018. In July, the airline announced a “partnership" with flydubai, the LCC which like Emirates is owned by the government’s Investment Corporation of Dubai. It is unclear as to how this will work in practice — the press release talked about “leveraging both airlines’ complementary networks to open new city-pair routings for customers”.

Although the airline’s official line is that its growth potential remains huge, faced with this uncertainty — Sir Tim Clark has stated that he expects “traumas” on a monthly rather than an annual basis — it seems very likely that Emirates’ era of super-growth is over. This is not necessarily a negative — like Ryanair it has completed a “land grab” and now can focus on placing capacity where it earns maximum returns. Indeed, looking at the chart, there does appear to be a tentative inverse relationship between Emirates’ annual capacity growth and profitability.

From this perspective, Emirates’ last-minute refusal to agree a new contract with Airbus at the November Dubai airshow is less surprising. Emirates had been expected to place an order for 36 A380s valued at around $7bn (our estimate rather than the widely quoted $15bn, which was based as usual on artificial list prices).

Reportedly, Emirates demanded a guarantee that Airbus would maintain A380 production for 10 to 15 years after it received the last of its current orders; in turn Airbus demanded that Emirates accelerate deliveries to fill the empty slots after 2019, but Emirates’ priority is to retain flexibility, and commit to taking on new aircraft only after the opening of the Al Maktoum super-airport in 2023. Pricing was probably also a major issue behind the break-down.

Emirates inflicted further pain on Airbus by selecting the 787-10 over the A350 at the airshow, placing an order for 40 units, worth by our estimates around $6bn, for delivery from 2022 on.

How important is the A380 to Emirates?

The chart encapsulates an analysis of the size and structure of long-haul operations (defined strictly as sectors of over 5,000km), which gives the following insights into the fleet strategies of the 22 leading airlines:

• Emirates is by some margin the number one global network airline in terms of long-haul seat capacity; the three European Majors, (Air France Group, IAG and Lufthansa Group), each combining several individual airlines, are 25-35% smaller.
• Emirates is clearly the number one A380 operator, with A380s accounting for 55% of its long- haul capacity; Qantas, with 36% of its long-haul capacity, and SIA, with 28%, are the closest.
• Emirates has a clearly defined dual fleet strategy; the other 45% of its capacity is provided exclusively by 777s, which will be complemented by 787s after 2022.
• The other two Middle East super-connectors — Qatar and Etihad — have not committed to the A380 to anything like the same degree as Emirates, utilising A380s for 14% and 24% or their long-haul capacity
• The three US Majors — American, Delta and United — have not touched the A380. (Hence, there is no Form 41 data available on operating performance and no publicly available information on actual A380 economic performance.)
• Each of the US Majors deploy, on average, about half of Emirates’ long-haul capacity.
• The global long-haul capacity split by aircraft type is:
• A380s, 14%
• Standard A330/777s, 55%
• New A350s/787s, 12%
• Once dominant 747s, 8%
• Others (A340, 767, 757, Narrowbodies, etc), 12%

In short, Emirates is an outlier in the global long-haul market, both in terms of its size and its A380 operation. It may be the only airline that is able to utilise the A380 (“hugely profitably”, according to Sir Tim Clark)  as its main asset in its mainstream operations, as opposed to a niche role on limited routes. The conditions for Emirates’ success — being the first mover, building a huge intercontinental network at its Dubai hub, unencumbered by capacity or curfew constraints (wave patterns throughout the 24-hour period), and fully supported by an integrated national but commercial aviation corporation, which in turn is wholly owned and controlled by the national power, the Emirate of Dubai — are probably unique.

However, business models evolve, and Emirates may be moving towards a more mainstream long-haul fleet structure, with proportionately more capacity being provided by 777/787s than by A380s.

How important is Emirates’ A380 fleet to Airbus?

The short answer is, totally. The tables A380 FIRM ORDERSsummarise the A380 fleet in service and those, allegedly, on order.

• Emirates accounts for just under half of the global A380 fleet of 217 units as of November 2017.
• SIA is the only other major operator to have the A380 as an important component of its fleet.
• The three Euro-Majors together account for 16% of the global fleet, but one suspects that Lufthansa and Air France were sort of obliged to buy.
• MAS has put its six A380s into a Hajj charter subsidiary.
• The first A380, returned by SIA to a German investment fund, has been parked; more returns are imminent from SIA and Emirates to leasing companies, notably to Amedeo.
• Deliveries have tailed off badly in recent years and there is a gaping hole for delivery slots post-2019 which Airbus was hoping Emirates would fill.
• In theory, Emirates accounts for 42% of the orderbook; in reality, this is about 70% after stripping out dubious commitments — Amedeo, Virgin under Delta control, Air Accord (who?).

One of the most important purchasers of the A380 has been lessor Amedeo; it has 13 leased out to Emirates, five to SIA, and 20 on order from Airbus. The company is considering some innovative ideas for using A380s as they come off lease. The concept seems to be to operate the A380s themselves, selling seat blocks to other airlines or to travel companies. CEO Peter Lapidus thinks that Airbnb might be a prime customer.

The unit cost argument is tempting, but the practicalities are daunting. For a 700-seat A380, targeting one daily return flight, a 90% load factor, and a 30% market share, which would be highly disruptive, the aircraft would have to be deployed on city-pairs with about 1.5m pax/year. There are very few long-haul routes with that volume of traffic, and those that meet this criterion tend to be very defensible.

The alternative might be an Allegiant-type long-haul operation, and organised around seasonal demand. But this implies low average aircraft utilisation which is incompatible with the capital costs of second-hand A380s.

What is the value of a ten-year old A380? AVAC, the most transparent and realistic of the appraisal companies (see page 18) indicates $100m, but with no second-market this figure cannot be validated. In any case, there are no apparent buyers at this price. And if the price is lowered it might quickly hit a floor where it is more economic to part-out the airframe and four Trent 900 engines.