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Is there a struggle ahead for Emirates?

Airline will battle with operating margins, states Frost & Sullivan.
COMMENT, Business Trends, Aviation

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Written by Diogenis Papiomytis, principal consultant at Frost & Sullivan’s aerospace and defence practice

The latest financial results from Emirates Group have highlighted a record-breaking year for the Dubai-based powerhouse in 2010, with US$1.6 billion in net profit. While impressive, especially in the face of higher oil prices and the Middle East political crisis, these figures are basically inline with our expectations at Frost & Sullivan and support a return to profitability for most major carriers around the world. However, the current financial year will be challenging for the airline industry as a whole, including Emirates. Last year’s record results were, more than anything, a return to normality after two years of heavy losses during the global economic recession.

But airlines are still susceptible to global economic and political events and operate in a heavily regulated market that is characterised by overcapacity. Those with primarily international route networks, like Emirates, are more affected by global events. In addition, further capacity growth and the introduction of untested routes will impact their profitability. As such, Frost & Sullivan does not expect the carrier to repeat last year’s performance during the current financial year. Its market share and dominance in routes connecting Asia with North America and Europe will definitely grow, but operating margins will struggle to remain at the same level.

Emirates’ decision to remove fuel surcharges came as a surprise, as the fuel surcharge was only introduced across its network a few weeks back. We believe that in the medium-to-long term, oil prices will keep rising, forcing many airlines to reintroduce or increase fuel surcharges. Nonetheless, this move by Emirates will bring in additional traffic over the summer period, boosting its load factors further and can also be interpreted as a response to a prolonged political crisis in the wider region. Even if oil prices return to higher levels, Emirates has a strong cash position to absorb costs, rather than pass these on to the consumers.

One of the hindrances to the airline’s growth this year is volatility in oil prices. The aviation industry is also characterised by overcapacity and strict regulations, forbidding foreign investments and uncontrolled growth in international markets. For example, a restrictive bilateral agreement between the UAE and Canada is an obstacle for Emirates’ growth plans in that country. Additional hindrances are the political unrest in the Middle East, which everyone predicted as a short-term issue just three months ago, uncertainty over the future of Western economies and overall industry consolidation. Emirates is now having to compete against large airline groups, such as the Lufthansa Group, Air France-KLM, BA-Iberia, United-Continental and Delta-Northwest, which have completed big mergers adding economies of scale in their operations.

The codesharing agreements that Emirates signed with JetBlue in New York and Virgin America in San Francisco are a sign of things to come, as Emirates partners with more airlines to counter competitor actions. A future merger or acquisition is not out of the cards for the airline either.

Emirates has traditionally been well-served by its fuel hedging strategy, with the single exception of 2009 when it bet that oil prices were going to continue growing and signed large contracts. As opposed to other airlines, it does not have a strict hedging policy, instead adopting a “wait-and-see” approach. This is, perhaps, the best approach at this point in time.

With regards to launching an IPO, we do not see this as an ideal move in the next couple of years, at least until investors feel more confident over the future outlook of the airline industry. Political instability in the Middle East, doubts over economic growth in Europe/North America and fluctuating oil prices are all causes of concern. Its strong financial results and cash pile to fund medium-term growth are not adding pressure for an IPO soon.

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