Etihad: a gulf between ambition
and reality September 2017

Hunter strategies don’t work. Publicly-owned SAir Group (aka Swissair), following this plan in the 1990s, succumbed in the early noughties from an inability to repatriate (non-existent) cash from its associate investments in the wake of the Sept 11 atrocities — notwithstanding its poor choice of investments. Etihad, with a far wealthier shareholder, has struggled to convince that a series of minority investments in similarly dross airlines would be viable way to pursue its ambitions to be a major global airline. It viewed its strategy as a way to catch up with its close neighbours Emirates and Qatar in exploiting its similar geographical position in the Gulf to access sixth freedom flows.

The shareholder has obviously lost confidence: it has decided not to continue to fund Air Berlin and has walked away from attempts to recapitalise Alitalia. Both carriers have fallen into administration and are subject to sale in whole or in part. It apparently has sold its stake in Etihad Regional (formerly Darwin Airlines). It has also parted company with James Hogan and James Rigley, respectively CEO and CFO of Etihad, engineers of the growth of the company since 2006, and supposed architects of the strategy. Where does Etihad go now?

As a private company Etihad provides little reliable financial or operational information. In July Etihad Aviation Group announced an annual loss for 2016 of $1.86bn on $8.4bn of revenues.

The Group stated: "The core airline business achieved steady passenger revenues of $4.9 billion and 79% load factors while carrying a record 18.5 million passengers. Available seat kilometres (ASKs) increased by 9%. Yields fell 8% amid market capacity pressures and the tough global economic climate, but this was partially offset by an 11% reduction in unit costs."

It went on to say: "Total impairments of $1.9 billion included a US$1.06 billion charge on aircraft, reflecting lower market values and the early phase out of certain aircraft types. There was also a $808 million charge on certain assets and financial exposures to equity partners, mainly related to Alitalia and Air Berlin."

However, for some reason, it does file accounts (for the airline alone) in Singapore. The results for the year to Dec 2015 were filed in July this year. We present a chart of an analysis of these results below, and they do not make happy reading.

Nominally the airline appears to present a net profit of $103m for 2015 on revenues of $6.4bn. However this includes a recognition of book profits of $1.9bn on the sale of various subsidiaries (including its cargo operations and its own frequent flier programme Etihad Guest) to Etihad Aviation Group (the holding company). It also transferred its investment holding company (which included its investment in Alitalia) but as this transaction was not deemed to be of commercial value did not recognise a book gain through the P&L account. In the year it registered a $(442)m share of associates' net losses. Excluding asset sale gains underlying operating losses reached $(1.2)bn with $(1.75)bn at the net level — roughly $100 for each passenger carried.

Taking the comments from the group results statement for 2016 it is possible that the airline’s underlying operating losses could have been reduced from those in 2015; and increased associate losses from Alitalia and Air Berlin may even have been offset by profits from Jet Airways and Virgin Australia. However, it is likely that Abu Dhabi will have had yet again to inject another billion or two into the aviation group to keep it running.

A troubled region

Geopolitical risks — ever present in the region — have taken a toll in the past year. Not only has the relatively low oil price depressed income for the oil states, but has had a negative impact on point-to-point O&D demand.

The US earlier this year suddenly tried to impose a ban on travel from certain Muslim countries, and then prohibited the carriage of laptops in aircraft cabins from certain airports (since rescinded).

International air traffic demand through the Middle East has shown a sudden drop in growth rates. While capacity and traffic in the region had been increasing by around 12% during 2016, by July 2017 this growth rate had slumped to a mere 4% (see chart).

The problem is regional. Emirates — the progenitor of the superconnector strategy and the largest airline in the world ranked by international traffic — announced an 80% fall in profits for the year to end March 2017, its first decline in profitability for five years. Qatar has been broadsided by sanctions from its fellow Arab nations.

Etihad doesn’t publish monthly traffic statistics — but the Abu Dhabi Airport does. Etihad accounts for 75% of the total throughput at Abu Dhabi and has obviously been reining back on its growth. As shown in the chart, traffic growth through the airport has slumped dramatically. On a twelve-month rolling total basis, growth rates have gone from the high mid teens in early 2016 to 4% in July 2017.

Something has got to give. The airline has 122 aircraft in service and orders for 173 between 2017 and 2025 (see table). The company is due to retire its A340s this year, but if growth remains subdued the future orders must surely be in doubt.

Meanwhile should we anticipate that Etihad may now be looking to dispose of its investments in Virgin Australia and Jet Airways? Both last year returned a profit. But Virgin Australia is increasing ties with shareholder HNA at the expense of Etihad (boasting that a major reason for turning a profit in the year to June 2017 was closing a route to Abu Dhabi) while Jet is getting closer to Air France-KLM and Delta, developing joint routes through Heathrow with the SkyTeam joint venture, with Delta rumoured to be interested in a 25% stake.

Abu Dhabi has a further dilemma. Hailed as the deal of the year in 2015/16 Etihad raised $1.2bn debt in the capital markets through a complex special purpose vehicle EA Partners; with the proceeds used to enter into debt obligations with it and its airline investments: Etihad Airways, its subsidiary, Etihad Airport Services, Alitalia, Air Berlin, Jet Airways, Air Serbia and Air Seychelles. There was no cross-default provision and it appears that none of the partners are legally obliged to support each other in the event of one of them defaulting. The bonds seem to have been rated and priced on the assumption that there would be some sovereign support.

On the announcement of Alitalia’s fall into administration, Fitch lowered its rating on the bonds to virtual junk status, persuaded not to lower it further disclosing that Etihad had agreed to repay a portion of the bonds on behalf of Alitalia if the Italian airline ended up defaulting. Amusingly EA Partners was unaware of the agreement. With the failure of Air Berlin, the moral exposure has increased. 

Unravelling the Empire

What are the options? All seem fraught with difficulties.

• Merger with one of the other superconnectors. THY is not an option. Qatar does not seem a realistic option as the UAE is one of those that has ostracised its neighbour. That leaves exploring links with the far larger Emirates — where there may be some strategic rationale to create a dual-hub network à la Air France-KLM. As in that merger, however, there would be significant political issues, this time complicated by the relationships, rivalries and relative wealth of the ruling Al Maktoum and Al Nahyan cousins.
• Divest its stakes in Jet, Virgin Australia (and Air Serbia and Air Seychelles). These would no doubt be distressed sales.
• Cancel its aircraft orders. This would possibly destroy relationships with Airbus and Boeing — and undermine its attempts to counter the arguments of unfair subsidies by the American Open and Fair Skies campaign.
• Full Government bailout.  This too would create an aeropolitical nightmare.