How Significant Is The Gulf’s Slowing Capacity Growth?

Expansion by the big Gulf carriers has been a dominant theme in the airline industry over the past decade. Few airlines have not had to respond – whether by embracing or by battling – to these new rivals as their reach spread into every continent.

Dubai-based Emirates, Qatar Airways, and latterly Abu Dhabi’s Etihad Airways, with their mandates to develop transport and tourism in their key hubs, have placed huge aircraft orders and expanded at breakneck speed.

A decade ago, Emirates was still outside the 10 biggest airlines by traffic, as measured in revenue passenger-kilometres. Qatar was the 41st biggest and Etihad was just emerging among the 100 biggest airlines. Between them, the three carriers transported almost 28 million passengers in 2006. The same trio handled getting on for 100 million passengers by 2015, and all three now rank among the top 20 biggest airlines by traffic – with Emirates now the fourth biggest in the world.

Further growth in 2016 sees that now top 100 million.

But a combination of the competitive environment, market climate and impact of a strong US dollar is threatening to take the momentum out of this growth. Given the capacity they have brought into the market – and will bring in over the next few years – this could have a significant impact on the wider market if it turns out to be a more prolonged slowing in Gulf carrier growth. Factoring in the separate challenges in Istanbul that Turkish Airlines faces, that could mean that the region’s key emerging transit hubs face the prospect of slowing growth.

Warning Signs

Signs of a more challenging environment – both in cost and revenue terms – in the region have been emerging over the past six months.

Emirates was the first to signal a change in fortunes when it disclosed in November that the airline’s profit had fallen 75%, to Dh786 million ($214 million), in the six months ended 30 September. It linked the result to “the double impact of a strong US dollar and challenging operating environment”.

Emirates Group chief executive Sheikh Ahmed bin Saeed Al Maktoum cited increased competition as well as sustained economic and political uncertainty in many parts of the world as hitting yields and dampening travel demand. “The bleak global economic outlook appears to be the new norm, with no immediate resolution in sight,” he added.

At the end of 2016 it emerged that Emirates was to defer delivery of 12 Airbus A380s that had been due to arrive over the next two years. While Emirates had previously disclosed temporary technical gripes centred on wear in the Rolls-Royce Trent 900 engine, to which it had newly switched, the deferral came at a point when the Gulf region was having to cope with reduced demand and a consequent need to rein-in capacity.

Much of the focus on Etihad’s challenges have been with the performance of its European equity partners. But carrier has also announced likely job cuts of its own and conceded that 2017 will be “another challenging year”.

Group chief executive James Hogan said on 1 February that despite 2016 having been “tough” for Etihad, the airline’s financial results for the year would be “positive”.  But he acknowledged that in 2017 the airline would need to “navigate the challenges of competition, capacity – that means we have to tackle our cost base”.

In December Etihad confirmed it was planning to make redundancies as part of “managed, controlled restructuring” in light of what it calls the “increasingly competitive landscape” and “weakened global economic conditions”.

Wider Region Challenges

Nor are the challenging conditions restricted to the big Gulf carriers’ long-haul operations. Since the turn of the year, the more challenging outlook has been evident in reports from short-haul carriers in the region – including Emirates’ sister carrier Flydubai, which disclosed a sharp fall in full-year profits to Dh31.6 million and, citing downward pressure on yields, is planning to keep capacity flat this year.

Operating profit was down a third at Kuwaiti budget carrier Jazeera Airways last year. It says it has experienced yield pressure from a “slowing” macroeconomic environment and overcapacity on its network.

Air Arabia’s net profit for 2016 came in at Dh509 million, a 4% slip on the previous year’s figure. The carrier similarly highlighted “challenging” market conditions and the “economic and political uncertainty” affecting the industry.

Emirates Reaction

Emirates Airline is undertaking what its president Tim Clark terms a “major exercise” to adjust its business amid changing customer demand.

Speaking at a media briefing during the ITB travel fair in Berlin on 9 March, Clark conceded that the full-year results would be below those of 2014. He said adverse currency effects had been a significant factor. An appreciation of the dollar has itself created pressure for the Dubai-based carrier, and also triggered secondary effects as weak currencies in other markets declined versus the US currency.

Clark notes that markets in Emirates’ home region – such as Iraq, Libya and Syria – have disappeared as a result of conflicts. “The Middle East is a different place now to when we started to fly in 1985,” he says.

However, he argues that wider geopolitical, socioeconomic and industrial developments have made the business environment less certain. Following the UK’s decision to exit the European Union, Emirates took an “18% whack in the summer” in that country, which Clark describes as a “high-production market”.

When US President Donald Trump signed an executive order in January temporarily banning citizens of seven majority-Muslim countries from entering the USA, Emirates’ rate of ticket sales growth fell by more than a third versus previous years, Clark says.

He adds that efforts by European airlines to establish low-cost long-haul subsidiaries are also having an effect on the industry and on Emirates’ business.

“Airline communities are reacting to, basically, much lower yield,” is how Clark sums up the overall development. “We are trying to… understand better what has been going on [and] why it has been going on.

“I honestly believe that the nature of demand… in regional, domestic and long-haul is going to change over time, and therefore we have to adapt and adjust our business model accordingly.”

Etihad And Qatar

Etihad boss Hogan says the group will “expand prudently and efficiently, reflecting the nature of the economic environment”. He adds: “We remain optimistic and have every belief that our robust business model will succeed and, most importantly, stand the test of time.”

The group though is continuing its major strategic review and further adding to the uncertain environment is a change in leadership at the Abu Dhabi carrier. Hogan and chief financial officer James Rigney leave later this year after a decade leading the group’s expansion drive.

Of the three big Gulf carriers, Qatar Airways appears the most bullish. The airline has not disclosed its financial or traffic performance for 2016, but Qatar’s hub of Doha Hamad International airport bucked the regional trend, reporting 37.3 million passengers in 2016 compared with 31 million in 2015 – even faster growth than seen in the previous year.

By contrast Abu Dhabi International airport reported a 5% rise in passenger numbers for 2016, following double-digit growth previously. Dubai International airport’s passenger numbers grew 7% in 2016, a slight drop from almost 11% growth in 2015.

But delays to the Airbus A350 and A320neo programmes have held back Qatar Airways’ plans to expand its network says chief executive Akbar Al Baker.

Also speaking at ITB, Al Baker said the delays meant his airline was “nearly 10” aircraft behind in its fleet expansion programme and had consequently been unable to open “nearly eight” planned new routes, adding: “We hope that this will be resolved this year.”

The airline nonetheless continues to increase capacity at “double-digit” rates, says Al Baker. But he insists: “Qatar Airways has been very prudent in the way we grow capacity. We don’t grow capacity that the market does not digest.”

Qatar Airways is scheduled to receive four or five Boeing 777s and 10 A350s this year, says Al Baker. “Unfortunately, we will not receive any narrowbodies due to the still-ongoing issues.” The carrier has 46 A320neo-family jets on order, with options for 30 more.

What Is At Stake

A 2015 report by Kristian Coates Ulrichsen for the Baker Institute of Public Policy warned that capacity growth was vital for the region’s big three carriers.

“Questions nevertheless remain over whether three such aggressive and expansionary airlines can co-exist in such a concentrated region, no matter how global their activity,” his report says. “So long as Emirates, Etihad and Qatar Airways are taking market share from international rivals, they are likely to continue to grow.

“However, should the aviation market ever reach saturation point or the host emirates begin to experience long-term fiscal challenges, this will put to the test the Gulf carriers’ ability to turn a profit and operate as genuine standalone entities independent of any state support.”

While it remains too early to judge whether the Gulf market is reaching its saturation point, it is clear that capacity growth for 2017, at least, has been checked.

In February, Lufthansa Group’s chief executive, Carsten Spohr, speaking at an event to mark a tie-up between Lufthansa and Etihad, said that the region’s airlines might need to trim their capacity plans. He suggested limited growth would be the issue that would “play a bigger role in the next 12 months than in the last 10 years” in the region.

FlightGlobal schedules data for 2017 illustrates the loss of pace. Data for the second quarter shows all three carriers increasing capacity at their slowest rate for five or more years – albeit off larger base figures.

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Emirates is lifting its second-quarter capacity by just over 7% – compared with an 11% increase in the same period last year.

Qatar Airways is increasing capacity by 9.5% in the second quarter – the fastest rate of the three carriers, though from a smaller base than Emirates. This still represents slower growth than the double-digit levels seen in the previous four years.

Etihad is meanwhile making the sharpest changes to capacity. The airline’s second-quarter capacity growth has been running at 15% or above in each of the previous four years. But for the second quarter of 2017, Etihad is increasing capacity by only 1%.

Similar trends in the growth rates also apply to capacity data for the full year 2017.

At ITB, Emirates’ Clark acknowledged that there was a “degree of flatlining” by Middle Eastern airlines in terms of capacity, but noted that it is still being increased and sees no danger of overcapacity in the long term.

He reflects that airlines in the past had to respond to one or two critical events per year, such as economic slowdowns in individual markets or flying bans due to volcanic ash clouds. “[Now] the pace of change is accelerating and is quite destabilising,” he says. “The world is in a high degree of volatility for all sorts of reasons. And the way people travel, their decision to be travelling, the amount of money they are prepared to pay, new entrants coming to the market… this is all changing.”

Fleeting Impact?

Potentially compounding weakening capacity growth for each airline are fleet strategies geared towards aggressive expansion in the near future. Emirates and Etihad are set to take 42 and 32 aircraft in 2017-18, respectively, Flight Fleets Analyzer shows – or roughly a fifth of each airline’s respective total orders.

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All of these aircraft are widebodies, meaning that Emirates and Etihad are essentially relying on sustained capacity growth to make their fleet strategy work.

Qatar is taking 74 aircraft over the next two years, roughly a third of its total order. However, the carrier is not pursuing the widebody-only strategy of Emirates and Etihad; Airbus A320neos will complement the Oneworld carrier’s planned A350 intake.

Source: www.flightglobal.com, 15 March 2017

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