Bloomberg News

Emirates Meets Oil Pinch With Fare Cuts, Turning Screw on BA

July 01, 2011

(Updates with CEOs’ comments on alliances, share sales starting in 26th paragraph.)

July 1 (Bloomberg) -- Emirates, the biggest international airline, said it will combat a profit squeeze from higher fuel costs by slashing fares to fill its 500-seat Airbus A380s, heightening competition for Air France-KLM and British Airways.

Emirates will resist the urge to cut routes and flights as oil prices threaten the profitability of some destinations and instead aims to stir up demand with cheaper tickets, Tim Clark, the Dubai-based carrier’s president, said in an interview.

“I can understand how irritated some airlines become, because 43 percent of our daily costs are for fuel, and it’s out of our control,” Clark said last week in Paris. “But the last thing you should contemplate is capacity reduction. It’s easy to do, but it has sounded the death knell for so many carriers.”

Industry practice has generally been to halt growth when times are hard and costs high, focusing on the most profitable routes that can sustain higher fares. That strategy is risky because it hurts sales and destroys confidence among passengers, airports, holiday companies and businesses in destination cities, so that traffic often never returns, Clark said on June 20 after a visit to the Paris Air Show.

Qatar Airways Ltd. Chief Executive Officer Akbar al Baker said that the second-biggest Middle-Eastern carrier may operate 190 planes by 2020, 60 more than envisaged, as it follows Emirates in building a long-haul transfer hub to rival London, Paris and Frankfurt. Abu Dhabi’s Etihad Airways, the regional No. 3, is also committed to adding new jets and routes, CEO James Hogan said in an interview in London.

45,000 Seats

Clark cited U.S.-based Trans World Airlines Inc. and Pan American World Airways as major carriers that have gone bust during his career after fatally paring back their networks.

Emirates will stick with a rapid-growth model based on building Dubai into a high-volume, inter-continental travel hub using a wide-body fleet featuring 90 A380 superjumbos with 45,000 seats, Clark said.

While cutting fares to sell tickets on the 517-berth planes will push up the occupancy level needed to break even, the impact of government spending cuts in many overseas markets means that strategy is more likely to succeed than one based on curbing capacity and raising fares, he said.

Emirates had an 80 percent occupancy level in the year to March 31, when it boosted passengers 14 percent to 31.4 million and lifted net income 43 percent to 5.93 billion dirhams ($1.6 billion) on sales that rose 26 percent to 57.4 billion dirhams.

‘Bare Cupboard’

“There is a wave of austerity in Europe from France and the U.K. to Ireland and Greece, and people are concerned about that,” Clark said. “But what has changed in the last 20 years is that whereas travel used to be way down the list of priorities, people now rate it as the No. 1 thing they want to do. So we need to stimulate demand and get back to pricing levels that are affordable for the customers while still giving us a margin.”

Deutsche Lufthansa AG and British Airways have already slashed costs after oil surged to more than $145 a barrel in 2008, sending jet fuel to a record $4.36 a gallon, and have little room left for maneuver, Clark said. Airlines will probably achieve a collective profit of $4 billion this year, 54 percent less than previously forecast, the International Air Transport Association said June 6, citing the impact of higher oil prices, Arab unrest and the Japanese earthquake and tsunami.

“When oil reached $145 that caused a huge reworking of the way things were done, and airlines got themselves back on an even keel and began making money again, only to get another kick in the solar plexus when it went back to $120,” Clark said. “Now everyone says let’s contract, ground planes and lay off crew. But this time the cupboard is bare.”

Dominos

Brent crude reached $127 a barrel on April 11 and was priced at about $112 yesterday. Clark said oil needs to sell for between $60 to $80 a barrel for airlines to operate in comfort.

Emirates is also conscious of the impact that reining in jet orders would have on manufacturers, Clark said, with contract cancellations or modifications likely to prompt an “horrendous domino effect” among smaller carriers that could compromise Airbus SAS, Boeing Co. and their supplier base.

“You start to bring down the global duopoly when it’s in our interests to maintain it,” he said. “In a leaner industry your costs go up because you don’t have the plethora of choice.”

Clark said he’s in any case confident the plane orders are necessary as Dubai’s location between Asia and Australasia and Europe, North America and Latin America allows Emirates to tap demand spurred by globalization and growth in emerging markets.

‘Right Place’

Founded in 1985, the carrier developed an inter-continental network from 1996, when long-range Boeing 777s and Airbus A340s allowed it to reach new cities and meet the global aspirations of Dubai’s rulers, Clark said. The model has proved scale-able as the world economy enters “a new paradigm,” he said.

“We’re in the right place at the right time,” the executive said. “We would have done it anyway but on a smaller scale. Our business model was always structured around maximizing the benefits of our location.”

Etihad, which ranks third in the Middle East and has added seven more planes this year, will announce three more routes next week that will commence in the next 12 months, Hogan said in an interview in London on June 22.

“We’ve no intention of cutting back our growth,” he said. “But that doesn’t stop us from redeploying assets if we think we can get a better return on a certain route.”

Doha Hub

At Qatar Air, CEO al Baker said in an interview at the Paris show that he’s not only sticking with a plan to grow the fleet to between 120 and 130 airplanes, but aims to extend it.

“The way I see the opportunities today we’ll end up anywhere in the region of 175 to 190 aircraft by 2020,” he said on June 20. Doha-based Qatar had a 178-plane order backlog worth $35 billion at list prices even before a show where it added six more Boeing 777s and said it’s mulling a contract for Airbus’s re-engined A320neo single-aisle model.

“I’m very ambitious,” al Baker said. “I want to make sure that Qatar will be a major hub between East and West. I am never intimidated by anybody’s size. I like it as a matter of fact. It keeps our eyes on the ball.”

Emirates didn’t buy planes in Paris but may announce orders at the Dubai Air Show in November, Chairman Sheikh Ahmed bin Saeed al-Maktoum said May 10th. The carrier currently has about 150 Airbus and Boeing jets, including 15 A380s, with a 200- strong order book worth in excess of $68 billion before options.

Alliance-Friendly

Etihad has less expansive growth plans and Hogan has been open to cooperation with other companies, operating more than 30 code-shares that allow it to attach its code to services flown by other carriers.

“We’re still going to be a mid-sized airline,” he said. “My brief is to create an airline that is the right size and shape. And we’ve got two competitors on our doorstep, were mindful of that, so we see how we can compete working with other airlines.”

Hogan, linked earlier this year with a bid for Richard Branson’s Virgin Atlantic Airways Ltd., which is seeking a partner, said that Etihad is open to opportunities, though “there’s nothing compelling on the table today.”

Al Baker said he sees no need for Qatar Air to join an alliance for the next five years at least, and that remaining independent gives him “a freehand to expand and to design the product the way I want.” The CEO said he’s receptive to a stock- exchange listing, if only because a share sale would curtail a debate over how much the airline benefits from state ownership.

“In a way it is good for us to do an IPO so that the people who keep making noise about us being government subsidized, government supported, will have to shut their mouth and not talk about it again,” al Baker said.

Clark at Emirates said he’s “not an alliance person” and that the pursuit of takeovers by airlines usually distracts management. Becoming a traded stock with shareholders and independent directors would also be “hell on earth,” he said.

--With assistance from Tamara Walid in Dubai. Editor: Chris Jasper, Heather Harris.

To contact the reporter on this story: Andrea Rothman in Paris at aerothman@bloomberg.net; Steve Rothwell in London at srothwell@bloomberg.net

To contact the editors responsible for this story: Benedikt Kammel at bkammel@bloomberg.net; Chad Thomas at cthomas16@bloomberg.net


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