Jazeera Airways:
Small can be beautiful; Sep/Oct 2019

Jazeera Airways, the Kuwait-based LCC, is remarkable in that it has achieved consistent and very decent margins, and a stock market quotation, while operating a very small fleet of A320s, challenging the assumption that scale is a necessity for operational and financial success.

Jazeera was founded in 2004 by local investors led by the Boodai Group, Kuwait’s leading private conglomerate, with interests in construction, engineering, shipping, logistical services, energy, consumer durables and media (although it is not connected to the Qatar-based Jazeera television service — Jazeera means peninsula, as in Arabian). The Boodai Group currently owns 26% of the airline, 24% by other Kuwaiti companies, with the remaining 50% traded on the Boursa Kuwait. As at the end of September the airline was valued on the stockmarket at KWD194m (US $640m).

The chairman of Jazeera is Marwan Boodai who also leads the Boodai Group. The CEO for the past three years has been Rohit Ramachandran who was formerly at Singapore Airlines and Air Arabia.

As the graph shows, Jazeera has produced net profits in most years since 2011 and achieved an average profit margin of 17% during 2014-18. In 2018 the margin dipped to 8% in 2018 partly as the result of one-off costs associated with the opening of its new terminal. (For Jazeera net profit is very close to the standard definition of operating profit as the airline has no interest costs, nor does it pay any significant taxes; Jazeera’s definition of operating profit excludes administrative and overhead costs.)

The first six months of this year saw a surge in revenue to KWD47.3 (US $156m) compared to KWD30.5m for the same period of 2018. Net profit at KWD6.2m represented a 13% margin and a quadrupling of the 2018 result.

At the beginning of this year Jazeera’s fleet comprised nine aircraft, eight A320 ceos and one neo, with four more neos on order. The contrast with other Middle East LCCs is stark: Flydubai and Air Arabia (see Aviation Strategy, June 2019) operate fleets of 59 A320s and 55 737s respectively, and by the end of this year will have a firm order commitment of about 340 narrowbodies.

Flyadeal, Saudia’s LCC subsidiary, only started operations at the end of 2017 but has already a fleet of 11 A320s and has recently announced a fleet plan that involves 30 to 50 new neos, part of an order placed by the parent airline. At least the Kuwait-based start-up, Wataniya Airlines, which had announced an order for 25 A320 neos in late 2017 appears to have gone out of business, having had its AOC suspended last year.

Jazeera itself once had similarly expansionist plans, but in 2011 cancelled its order for 25 A320s, citing the global recession, overcapacity in local markets and specifically the establishment of FlyDubai which put paid to Jazeera’s strategy of developing a second base at Dubai.

Jazeera is now moving into a phase of rapid growth by its own standards — by the end of this year the fleet will have grown to 13 A320s of which four will be neos, and by the end of 2020., Jazeera will comprise 16 A320s, of which eight will be neos. However, the “mature” fleet size, according to Ramachandran, will only be around 23 units.

Kuwait is a very rich petro-economy, and GDP per capita fluctuates with the oil price; the latest estimate is US $66,000 for 2018, although it touched nearly $100,000 in 2007. Despite, or because of, this wealth there is substantial demand for low cost air travel.

The population of Kuwait is 4.3m but less than a quarter are Kuwaitis, the rest mostly foreign workers. There are more people from the Indian sub-continent in the country, 1.4m, than there are Kuwaitis, 1.1m. Egyptians account for 0.6m, Syrians and Lebanese, 0.2m, and Filipinos also 0.2m. Jazeera’s geographical passenger distribution (see chart) certainly reflects the importance of Egypt but also the under-representation of India.

The Indian market is key for all Middle East LCCs, and the problem for Jazeera is the 2007 bilateral between Indian and Kuwait which allocated a meagre number of seats (12,000 weekly) to Kuwaiti carriers. Moreover, Jazeera, Kuwait Airways and various Indian airlines together carry less than 45% of the total traffic between the two countries, the other 55% connects at Doha, Dubai, Muscat, etc. Negotiations between Kuwaiti and Indian aviation authorities are currently being held and a liberalisation of the bilateral is expected before the end of 2019.

This is critical for the deployment of Jazeera’s new aircraft, although it also opens up the market to more competition from the Indian LCCs. If the bilateral isn’t changed Jazeera management claims to have a Plan B which involves opening more routes to Eastern Europe.

Jazeera’s traffic grew by an average of 13.6% pa between 2014 and 2018, but from a low base, 1.2m, and most of the growth occurred in 2018. Its 2m passengers represented just 13% of Kuwait Airport’s total traffic in 2018. The 2019 passenger total should be about 2.5m.

The network comprises 28 destinations all served from Kuwait Airport. The strategy is not so much to serve secondary airports, which would be very difficult in this region of the world, but to avoid the main gateway airports. This year it has started service to Bodrum and Istanbul Sabiha, and plans to fly to Kathmandu, Dhaka. Karachi and London in 2019.

It is the Kuwait to London Gatwick route that has naturally attracted attention — it will be the longest A320 neo flight to date (4,600km; 6½ to 7 hours). The first flight is scheduled for October 27^th with three classes on offer — Business, Premium Economy and Economy.

There are two marketing issues. First, the package of slots Jazeera has obtained at Gatwick does not allow a regular schedule: daily departure time varies from 12.30 and 16.40, with the later flights arriving at 02.00 in Kuwait. Second, Kuwait is a dry state so there will be no alcohol on board.

Nevertheless, there is a good opportunity to challenge the tight BA/Kuwait Airways duopoly in both the Economy and Business segments. Economy fares are being priced at around £300 return, a 25% discount on the lowest direct fares offered by the established competitors. Business Class is around £900 which contrasts with BA’s £4,000-plus premium fares (although corporate discounts can be up to 50%) in a cabin which always seems to have a near 100% load factor. Unfortunately, passengers in both Jazeera’s and BA’s Business Classes have to pay the same passenger duty at £172.

Jazeera management intends to modify and refine the offering over the coming year. Then there is the question of the next destination if London works; Paris? If London doesn’t work, one of Jazeera’s strengths has been its willingness to terminate unprofitable activities.

Operating model

Jazeera’s operating model places much more emphasis on maximising yield than European or Asian LCCs. It highlighted that in the first half of the year average fares were up 10% to KWD42.1 (US $139),which is roughly half way between Air Arabia and FlyDubai, but it is not clear how much of this increase was due to network changes.

Ramachandran in the half-year analysts’ call talked about not relying on price-sensitive traffic; managing yields with “a bit more sophisticated algorithms”; going after corporate business; and having effective commercial teams, not just travel agents, in all of Jazeera’s destinations, but particularly in India and Egypt.

A unique aspect of Jazeera’s offering is its own dedicated terminal T5, at Kuwait Airport. The terminal was opened in May 2018, financed solely by Jazeera and managed solely by Jazeera. It is a profit centre in its own right, generating revenue from aeronautical charges (currently a matter of negotiation with the government) and commercial revenues from its own lounge and F&B and duty-free concessions. Capacity is currently 3.5m passengers with expansion planned for 5m. As well as internalising airport/handing costs, 14% of its total in 2018, the idea is to ensure rapid aircraft turn-rounds and a better customer experience.

Seating configuration is classic LCC standard for A320s — 165 seats — but with a Business Class which is created by cancelling six middle sears to provide 12 Business seats, plus 147 Economy. On the London route further seats will be blocked off to create a Premium Economy product.

Jazeera’s load factors have been low by leading LCC standards, just 69% in 2016 but have been pushed up to over 75% this year, and the minimum target for 2020 is 76%, which compares to Air Arabia’s 81%. Similarly, average aircraft utilisation was only 10.9 hours per day in 2017 but the target for 2020 is 14-plus hours a day, the level Air Arabia achieves. With a 24-hour operation at Kuwait Airport and an increase in longer-haul flying this target looks feasible.

Jazeera’s fleet policy is to be asset-light: all its aircraft are on operating leases (from ALAFCO, Avolon GECAS, Goshawk and Park Aerospace). Consequently, rentals in 2018 accounted for 23% of its costs but the airline was debt-free. Interestingly, the management contends that operating leasing is for it the least expensive form of aircraft supply. Jazeera itself was originally a combined lessor/airline, until 2011 when as part of its restructuring, Sahaab, the leasing operation, was sold off to Chinese interests.

It applies leasing expertise to its fleet acquisition, specifically targeting distressed sales at Airbus — ie aircraft due for delivery but whose orderers, for whatever reason, cannot take the equipment. By using this strategy Jazeera claims to be able to purchase, then sell and leaseback, aircraft at prices and rates comparable to or better than larger airlines placing bulk orders. Slightly contradicting this approach, Jazeera has indicated that is also talking to the two OEMs about an order for 25 units; it may just be keeping all its options open.

IFRS 16, the new accounting standard adopted by Jazeera and most other airlines around the world, has managed to obscure the asset-light policy. This accountancy change means that aircraft under operating lease, and owned by lessors, have to be put on the airline’s balance sheet as assets, technically “right to use assets” and future lease payments have to be capitalised as liabilities. Hopefully this explains why Jazeera’s balance sheet (see left) changed so much between December 2018 and June 2019. (Also, the cost break-down in the P&L is affected by this accountancy change: what simply used to be a big rentals item disappears while a small depreciation cost item increases greatly as does the finance cost line. In short, Jazeera’s aircraft ownership costs, adding these three elements together went from KWD 5.7m in the first half of 2018 to KWD 7.5m in the first half to 2019.)

Average aircraft age is 8.2 years, which will come down as the neos enter the fleet. Much of the maintenance is outsourced to Lufthansa Technik though there are plans to bring more operation in-house.

Fuel accounts for 27% of Jazeera’s costs — Jet A is consistently more expensive in the Middle East than Europe. Fuel unit costs should be substantially reduced with the introduction of more Neos to the fleet, with their claimed 16% fuel consumption advantage. Up to now Jazeera has not hedged its fuel — as the Kuwaiti petro-economy provides a kind of natural hedge — but limited hedging is planned for next year.

Kuwait Airways

The reality for Jazeera is that it has to live with a state-subsidised Legacy carrier, Kuwait Airways, and part of its legacy was the destruction of much of its fleet when Saddam Hussein’s army invaded Kuwait in 1990.

Fully state-owned, Kuwait Airways has produced no financials in recent years though it has placed significant orders for A330neos and A320neo, bringing its orderbook up to 27 units, with an operating fleet also totalling 27 aircraft. Its 2019 plan is for 4.7m passengers. Worrying for Jazeera is the national carrier’s intention of introducing six A320neos this year, the equivalent of over half of Jazeera’s total capacity. And Kuwait Airways’ network overlaps much of Jazeera’s — see maps above

Ramachandran’s response is phlegmatic: Jazeera is so much lower cost and nimble, used to outmanoeuvring the flag-carrier. He’s probably right as long as the government assures some form of fair competition, and the Boodai Group has its own political clout.