Unprofitable Oman Air faces uphill task to break-even by 2017

Oman Air made pre-tax losses of $209.18 million in 2015, adding to total accumulated losses of $1.7 billion, and although the airline has had some success in limiting its losses last year, its financial performance remains unsustainable.

The strategy is to break even by YE2017 and prepare the ground for a possible privatisation, but on current trends the Ishka view is that more needs to be done to make this happen.

A loss-making enterprise

Oman Air was confident of a good year in 2015, but its gains were overwhelmingly the result of lower fuel prices.  Cheaper fuel prices and higher revenues on the back of increased passenger numbers helped reduce losses by 21.2%.

But expenditure rose by 5% due to capacity and fleet expansion. This, combined with stiff regional competition from Emirates, Etihad and Qatar airlines (the ME3), pulled yields down by 14%.  

The airline’s cost cutting programme ‘Shape and Size’ has helped to trim expenditure by $259.7 million and has allowed the airline to reduce its dependence on government cash injections.  The carrier has maintained a recruitment freeze in place from the beginning of 2016 and has also temporarily stopped operating from the recently developed Sohar Airport, citing poor results.

Unit costs fell from around $8.62 in 2014 to $6.70 in 2015.  CEO Paul Gregorowitsch is determined that Oman Air will stand on its own feet as a business. But the carrier faces an uphill struggle to break even.

An end to government subsidies

The collapse in world oil prices has put pressure on the Omani government which now runs the largest budget deficit in the Middle East at around 55% of GDP.  As part of its response to IMF pressure to retrench, the government plans to end subsidies to the airline by the end of 2018.

Direct equity injections by the government have already been reduced from $194.8 million in 2014, to $140.2 million in 2015. Subsidies began following the financial crisis in 2008, when the government increased its shareholding stake from around 85% to its current level of 99.9%, and expanded the size of the subsidy every year to 2013.

Will the government have the discipline to keep the purse strings tight?  As the national flag carrier, the airline would certainly not be allowed to fail, but the government clearly has a good incentive to let the airline stand on its own feet.

On current projections, the IMF estimates that the government requires an oil price of $110 per barrel in order to clear its deficit.  With prices hovering around $50 p/b at the time of writing, this is very unlikely in the short term at least.

Moreover, it is a stated aim of the airline to break-even by YE2017. If that is achieved and maintained through 2018 then Oman Air will be ready for full privatisation says Gregorowitsch, which could in turn prove lucrative for the Omani treasury.

Currently the government is only divesting from nationalised companies that make a profit. So Oman Air will have to start behaving less like a state-owned-enterprise and more like a commercial concern.

However, if the airline is incapable of increasing its revenues and cutting costs, then a complete withdrawal of government support would prompt a liquidity crisis. Oman Air has dwindling cash reserves. Last year cash as a percentage of total reserves fell 2.5% to 2.3%.

The Ishka view is that government cash will continue to prop up the carrier for some time.

Oman Air pushes for increased bilateral traffic rights in India

India is the world’s fastest growing economy and Indians account for 20% of the Omani population, so it is unsurprising that the carrier has identified the country as a key market and a way of competing directly with the ME3 carriers. Oman Air has increased capacity there by 30% and has an average seat occupancy of 80%.

With the recent liberalisation of foreign-ownership rules in India, the airline has also indicated that it is open to taking equity stakes in Indian airlines. 

Oman Air operates 126 flights a week to 11 destinations in India. The ambition is to add a further 50 routes.  However, this is constrained by the current bilateral traffic rights of 21,147 seats a week which leaves it unable to operate wide body aircraft to India, says Gregorowitsch. Greater traffic rights that could support wide body aircraft [it has 8 B787s on order] would allow the carrier to increase revenues and its market share. In late 2015, Oman negotiated an increase of 5,131 seats a week but Gregorowitsch believes 29,000 seats a week are needed by 2018. 

The airline is pushing for more seats, better infrastructure, and even an open-skies agreement as a condition of any investment it makes in an Indian carrier. It hopes to follow the success of Etihad. Three years ago Etihad had its flying rights increased from 13,000 per week to 50,000, only hours after taking a 24% stake in India’s Jet Airways.

Iranian opportunities

Unlike many of its neighbours, Oman has good relations with Iran.  The airline plans to exploit the opportunities presented by the weakening of US sanctions and fleet renewal programmes by Iranian carriers by training Iranian pilots at its facilities in Muscat. 

Oman Air has also doubled flights to Tehran and has also begun a new B737-operated route to Iran’s second city, Mashhad. Since there are no incumbents on the route, and some firect flights from Saudi Arabia and Bahrain have been cancelled, the airline wants to cater to demand for some of the 20 million pilgrims who visit the Islamic shrines in Mashhad each year. The carrier expects 85,000 passengers on the route in 2017.

Fleet expansion plans

In tandem with its network expansion plans, Oman Air has 27 B737 MAX-8s on order, 20 direct from Boeing and seven from lessors, together with four B787-8s, four B787-9s and three B737-800s.  Oman Air currently has a 57-aircraft fleet and it is expected to grow to 70 by 2020. 

At the end of 2015 the airline leased 64% of its fleet and owned 36%.  As subsidies dwindle and the financial position of the airline becomes more challenging, it is possible that past commercial lenders such as Citibank and Standard Chartered may be less willing to increase their exposure and finance the incoming orders.  One banking source that Ishka spoke to said that the cost of financing for all the ME carriers is set to increase due to government fiscal pressure in a low oil price environment.  On the other hand, local lenders, many of which have the Omani state as its largest shareholder, may be in higher demand.  In early 2015, Oman Air’s second B787 order was financed by Meethaq Bank in Oman’s first Sharia-based Islamic financing.

Scenarios

What if the airline fails to achieve break-even?   As the nation’s flag carrier, the government is very unlikely to allow the airline to fail. However, this implicit support may be the reason why lenders and lessors continue to have confidence in the carrier.  If Oman Air is unsuccessful in returning to a profit, then the state will most probably maintain its current level of ownership for the foreseeable future. But even if subsidies are maintained, then aircraft deferrals could be expected as the airline changes strategy and battles a shortage of ready cash.

 

The Ishka View

Oman Air is currently an unprofitable airline that is expanding quickly in a bid to become profitable. While the Indian and Iranian markets are worthwhile ventures, the carrier should also continue to focus on aggressively reducing costs.  The government may well consider reducing its equity stake regardless of whether the company breaks-even.  This could assist in attracting private capital, relieving the burden on the treasury and gaining the confidence of commercial lenders.

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