Why airlines must transform business models

dubai - Higher oil prices and a strong US dollar are impacting profit margins

The UAE's aviation industry witnessed challenges in 2018, with increased oil prices and a strong US dollar impacting profit margins. In response to this, local airlines have refined their strategies to remain in a strong position.

From the outset, the UAE's government has recognised the importance of aviation to the country's economy. Since 1985, when Emirates airline was founded, investments in airlines and airports have supported growth in the aviation sector and contributed to the national economy.

Dubai International Airport leads globally in terms of international travellers and saw nearly 90 million people through its halls in the last year. Abu Dhabi International Airport is one of the fastest-growing airports globally in terms of international travellers. Emirates airline recorded a total cargo and passenger capacity of 61.4 billion available tonne kilometres in the 2017-2018 financial year.

Nevertheless, the UAE's aviation sector success story has not been without challenges.

In the past year, fluctuating oil prices and a strong US dollar affected fuel prices and profitability. Emirates Airline Group, for example, reported a 53 per cent decrease in profitability in the second half of 2018, due to the 37 per cent increase in fuel prices and unfavourable exchange rates.

The price of crude oil has recently fallen below $65 per barrel. This may be attributed to recent equity market turmoil, Iran sanctions excluding some crude oil exports, and concerns regarding potential global trade wars. However, it seems the elevated fuel prices of the last 15 months will persist, which could impact global aviation earnings by as much as $50 billion in 2018.

Many airline costs - such as aircraft, fuel and maintenance - tend to be traded in US dollars. Consequently, a strong US dollar has a direct impact on operating costs for airlines that earn revenues in currencies that are not pegged to the US dollar. Certain costs for passengers, such as airline tickets, are also likely to have increased given the strength of the currency throughout 2018. As a result, it may have become necessary for airlines to reduce their ticket prices to attract such passengers from Europe and the sub-continent, further impacting profitability.

After two relatively buoyant years for some of the UAE's airlines, 2018 was a test of resilience in an environment of stubbornly flat yields and rising costs. Global load factors have ranged from 80 per cent to 85 per cent in the past year, however, yields have not grown much. Combined with high fuel prices, airlines have reported volatile profits over the last year.

As a result, local airlines have focused on streamlining operations in this higher-cost environment, squeezing out controllable costs and driving yield where possible. Airlines with more agile operations and a strong history of developing new ancillary revenue streams to protect margins should fare better than those with longer-term structural cost inefficiencies. These trends may lead to increased consolidation, whether in the form of M&A or strategic alliances.

While demand remains robust in key Middle East markets, profitability is much softer due to pressures on both ticket prices and costs. The UAE continues to experience consistent airline traffic, with locally-based airports acting as hubs between the East and West.

The new year is expected to be challenging, as economic growth, oil prices and currency fluctuations will likely continue.

As we enter 2019, geopolitics will likely continue to be a concern as we see how bilateral arrangements between the UK and the US, as well as the rest of Europe, pan out following Brexit. The outcome of the trade dispute between the US and China may also impact airlines' freighter businesses. Upcoming challenges will test the resilience of the UAE's airlines. Although they have benefited from considerable success in the past, growth within the region and economic and geopolitical challenges may require them to revisit their strategies and transform their business models in order to continue to succeed.

The writer is partner and head of transport and logistics at KPMG Lower Gulf. Views expressed are his own and do not reflect the newspaper's policy.