Middle Eastern aviation, a turning point?

This article was written by Robert Boyle in Partnership with Venari Partners.


A profile of Middle Eastern aviation

Boutique executive search firm Venari Partners has asked me to profile the aviation industry of some of the regions that get less coverage than Europe, North America and Asia. I’ve already taken a look at Africa, so this time it is the turn of the Middle East. This region is home to some of the biggest and fastest growing airlines in the world. The region’s airlines tend to win the top awards for customer service and have been some of the biggest investors in product and brand development. Owned and backed by governments, their strategies have been heavily driven by national development considerations. Making money has been a secondary consideration for their shareholders, who need to diversify their economies away from a reliance on oil and gas. A big part of their mission is to develop their home cities as global hubs for commerce and tourism, and to build the national brand.

It is perhaps ironic that Emirates, the pioneer that the others have sought to emulate, is based in Dubai, which does not have much oil wealth. Although by some margin the largest of the players before the crisis, it built that position over a much longer period and has been more moderate in its growth in recent years, with a stronger focus on profitability. Before looking at how the region’s airlines have coped with the crisis, I will start by reviewing the state of the industry in 2019.

Before the crisis

Measured by capacity touching the Middle East, four airlines dominated the market in 2019. After Emirates, Qatar, Etihad and Saudia, things drop off very quickly. I’ve used the OAG definition of the Middle East here, so Israel is included and Turkey is not. By this definition, Turkish Airlines is the only non Middle Eastern airline to feature in the top 10. They make the list even though most of their capacity is excluded according to this definition.

Source: OAG, GridPoint analysis

Where are all these flights going? Asia is the biggest destination region, followed by Europe. That reflects the fact that the primary role of the big Middle Eastern airlines is to connect the two regions, taking advantage of their geographic position between two of the world’s biggest aviation markets.

Source: OAG, GridPoint analysis

Asia Pacific

Middle Eastern airlines dominate the capacity to the Asia Pacific region. India is the biggest market, but Indian carriers are minnows compared to the capacity deployed by the big Middle Eastern operators.

Source: OAG, GridPoint analysis

Europe

The European operators are slightly more significant competitors on routes to Europe, but the position is not very different. The largest non-Middle Eastern operator to Europe is Turkish Airlines, a carrier that follows a similar strategy, using its geographical position at the cross-roads of Europe and Asia to link the two continents. IAG is the largest of the “big three” European network carriers, just ahead of Lufthansa group. That is driven by the importance of London as a destination for wealthy Arabs and the strong business and financial links between the UK and the Middle East.


Source: OAG, GridPoint analysis

North America

There is much less capacity operated from the Middle East direct to North America, but again most of it is operated by Middle Eastern airlines. United Airlines is the biggest North American operator to the region. However, much of the traffic is routed over the the big European hubs, which are generally on the great circle route from the Middle East to North America. The development of non-stop services to North America in recent years has eroded traffic carried on the transatlantic services of US airlines and their European alliance partners. That is one of the reasons why US airlines have sharply stepped up their lobbying efforts against the Middle Eastern carriers, accusing them of benefiting from big government subsidies, something that the Middle Eastern carriers deny.

Source: OAG, GridPoint analysis

Financial performance

We have reasonable data on the financial performance of the two biggest carriers, Emirates and Qatar. The third biggest, Saudia, publishes essentially nothing, although reports suggest that it was loss-making and required state aid even before the crisis. We have limited data for the number four player, Etihad. They don’t publish full results but have announced some key figures for 2019. Whilst I can’t include Saudia in my comparisons due to lack of data, I have decided to include Turkish Airlines. As I mentioned before, its business strategy and geographical position makes it a key competitor to the Middle Eastern carriers for flow traffic to Europe. In terms of overall revenue, Emirates is unsurprisingly the clear number one, with Qatar and Turkish quite similar in size. Qatar is much closer in size to Emirates when it comes to Cargo revenue. In the year ending March 2020, Emirates was only 12% bigger in cargo revenue terms. That was driven by the much larger fleet of dedicated freighters that Qatar operates. Its fleet of 28 freighters is over 2.5 times the size of its larger neighbour’s. That will have stood it in good stead during the pandemic. A worldwide shortage of cargo capacity caused by the huge reductions in wide-body passenger services has caused cargo yields to spike.


Source: company and press reports. Emirates and Qatar are year ending March 2020, Turkish and Etihad are year ending December 2019.

Profitability

Emirates and Turkish lead the way in terms of operating profit margins. Significant interest costs at Emirates mean that pre-tax profit margins are much lower, but still positive. Debt levels including leases are high at all these carriers, but Emirates seems to pay much higher interest rates, around double those at Qatar and Turkish. I guess that is one of the areas where it gets hit by not having such a rich shareholder willing to facilitate access to cheap financing. Qatar’s results for 2019/20 were pretty bad. On a technical note, I’ve included some costs in my definition of operating profit that the airline puts “below the line”. Examples include $1.6 billion of “General and administrative expenses”. I’ve no idea what justification they have for excluding them, other than a desire to make the figures look better. I’m sure their profitability was still suffering from the operational challenges caused by the blockade of Qatar imposed by its neighbours in June 2017. That has caused them to need to fly longer routings on many of their flights. Etihad profitability is even worse, whatever the definition of “profit” is for the figure they published (they don’t make it clear).


I haven’t included comparisons for unit costs, but Emirates, Qatar and Etihad all look quite similar to me. The difference in profitability seems mainly driven by revenue. Qatar’s load factor of 65.5% is extremely poor by any standards. In what is otherwise a fairly full set of accounts and other information, it is amazing that they don’t publish load factor figures. I’ve had to work them out using OAG data for seats, taken together with the passenger number figures that they do publish. I guess they are embarrassed about how low they are.

Source: company reports, GridPoint analysis

Compared to Emirates, Qatar also does badly on yield. Etihad is even worse. The average stage length of Emirates, Qatar and Etihad are very similar, so the yield figures are directly comparable. That’s not true of Turkish, whose stage length is less than half the others, so the yield figures are not very comparable. If you stage length adjust their yield, it would be about 20% lower even than Etihad. The fact that they manage to make a profit with those lower yields will be largely driven by their much heavier use of cheaper narrow body aircraft. 70% of their fleet is narrow-bodies, compared to 30% at Etihad and 17% at Qatar. Emirates operates only wide-bodies.

Source: company reports, GridPoint analysis

Capacity strategy since the crisis

There are big differences in how the carriers have approached capacity during the pandemic. Emirates and Etihad are operating between 25-30% of their pre-pandemic capacity. Qatar and Turkish have been much more aggressive, operating more like 45%. That means that both Qatar and Turkish have actually overtaken Emirates in terms of capacity at the moment. I’d hazard a guess that the same is not true of passenger numbers or revenue and even when it comes to capacity, I’m pretty sure that Emirates will be back on top next year.

Government support

As the biggest airline going into the crisis, Emirates will need the most cash to see it through. Fortunately, it started with the strongest cash balance, with $7 billion at the end of December. That compares to only $2 billion at Qatar. It has received $2 billion in fresh equity from Dubai, almost the same amount as Qatar has received. With over double the liquidity and a cost base only 50% bigger, it should be in better shape to weather the storm without going back to its shareholder for more money. However, Qatar’s profits from its much bigger freighter fleet will certainly help offset that.

Etihad has not revealed how much financial assistance they have received from Abu Dhabi, but even before the crisis its government paymasters were growing weary at the endless cash being consumed by the carrier, much of which was thrown away in ill-conceived overseas investments. The situation at Turkish is a bit unclear. Losses for the nine months to September 2020 came in at $0.9 billion, with cash balances halving to $1.3 billion. That is a very low balance for an airline the size of Turkish. There has been discussion of a $2.5 billion government loan package for Turkey’s airlines, most of which would go to Turkish Airlines. The company’s share price has held up quite well though, so the market obviously has confidence that it will be supported by the government. I’m sure that will be the case.

A turning point?

Many have wondered whether the pandemic will mark a turning point in the fortunes of the Middle East “super connectors”. Some have forecast that the days of the connecting hub are over and that in the future, passengers will avoid making connections at major hubs due to health concerns. I can’t see that happening. Most of the people making connections in the Middle East are making journeys where there are no non-stop options available. The only question for travellers is where to change planes. Middle Eastern airlines will remain highly competitive on both quality and price. As vaccines are rolled out across the world in 2021, the health effects of the pandemic will recede, although it will take years for demand to fully recover. Key to the timing will be the pace of vaccination programmes and how quickly borders can be reopened in key markets such as India and Australia.

The Middle Eastern carriers have such a big market share today that I can’t see them escaping the need to adjust their capacity and costs, as other airlines are being forced to do. That will be a relatively new experience for airlines which have only ever known growth and it will be even harder for airlines like Etihad who already lacked scale and were losing lots of money even before the crisis.

The possibility of a merger between Etihad and Emirates has long been a point of speculation. Their hubs are only 130 km apart and a massive new airport is being build on the Abu Dhabi side of Dubai. There is plenty of industrial logic, but UAE politics have always seemed to make it impossible. Will the scale of this crisis have changed that? Especially in an environment where oil prices are low and government finances are under pressure? Only time will tell.