Though dulled by drink, the American business class passenger was able to stab a finger towards the aircraft window as it taxied into Frankfurt airport. 'Emirates. That's a good little airline,' he slurred, pointing at a parked Airbus 310. Therein lies the Dubai flag carrier's problem. Despite its well-deserved reputation for quality of service one would expect of an airline whose chairman is a member of the Royal family and the owner of numerous thoroughbred racing horses, it remains marginalised as 'just' a Middle East carrier.

Amid the global game of alliance-building and partner chasing, Emirates has remained relatively aloof. It has a handful of codeshares - most notably with United Airlines, Qantas, Thai International and South African Airways. But it turned down an offer to join the Star alliance and plans to develop its own global network with an order for up to 12 ultra long-haul aircraft. A decision between the A340-500 and Boeing 777-200X, for six firm orders and six options, is due in September.

Maurice Flanagan, Emirates Group managing director, says the new longhaul equipment will be used to launch direct services to New York and Sydney in 2003, with Los Angeles, Brisbane and Perth also under consideration. The carrier also plans to order an extra A330-200 and another two 777-300s (in addition to four options already exercised), taking its outstanding orders to 17 A330s and six 777s. The aircraft are due for delivery in 1999-2003 and will add capacity to existing routes, particularly Pakistan with which a new open skies deal has been signed.

Flanagan says the carrier was approached by Lufthansa about joining the eight-member Star grouping but that Emirates is opting for a go-it-alone strategy plus a series of bilateral alliances. The airline's rejection of the overtures from Lufthansa was in part decided by its dislike of frequent flyer programmes. 'We're giving so much away to our customers that they are still loyal to us,' says Sheikh Ahmed bin Saeed Al-Maktoum, chairman of Emirates group. He adds that an Emirates FFP - currently being studied - would eat up 5 per cent of revenues.

Joining Star or either of the other two global formations would preclude some of the existing deals, says Flanagan. 'The bilateral deals work very well for us,' he says. 'It is time for the regulators to step in and look at alliances. They do not work in the public interest and the unit costs of smaller partners tend to be pushed up to the level of the larger airlines.'

For all Flanagan's confidence, the danger is that Emirates could miss the opportunity to secure the best possible terms for joining one of the global groupings. It would fit well into all of them and, given its high service reputation, has been actively courted by them. But then again, so was Cathay Pacific before the slump in Asia's economies destroyed its profitability and left it to knock on other airline doors rather than receive visitors. If a major oil shock were to harm the Dubai and Gulf economies - not just the oil business itself - Emirates could become rather less attractive.

As it stands, Emirates is very alluring, having weathered the storms of the Asian crisis and nearly doubled group profits to Dh371.2 million (US$101 million) in the year to 31 March 1998. Group revenues, which include the handling, catering and duty free business at Dubai airport, climbed 23.7 per cent to Dh4.436 billion.

Net profits at the airline rose 135 per cent to Dh262 million while operating profits climbed 72 per cent to Dh402 million. Passenger numbers rose 23 per cent to 3.7 million and, though capacity increased by 26 per cent, the overall load factor rose to 70 per cent.

Flanagan accepts that Emirates still has far to go before breaking into the global market. 'We are perceived where we are known as a high-quality carrier. Where we are not known we still have a problem,' he says.

Emirates has expanded rapidly over the past two years, taking delivery of seven 777-200s and boosting overall capacity by 56 per cent. Three new destinations - Baku, Dar es Salaam and Valetta - have been added over the past 12 months, taking the total to 44. The airline has increased capacity on routes to Europe and Asia and hopes to switch its three weekly Melbourne services to daily later this year. The new Dar es Salaam service increased capacity to Africa by 78 per cent over the past year and Flanagan says its performance has been driven by the growth of point-to-point rather than low-yield transfer traffic. Yields on the new Malta route are healthy as Valetta is a useful gateway for North Africa, notably sanctions-struck Libya.

Problem areas include the US, where Emirates is pinning its hopes of introducing direct ultra long-haul services with the new 777s or A340s. Flanagan says he could launch a Dubai-New York flight next week if he had the aircraft. Emirates already feeds 100 passengers a day on US-bound services through its codeshare with United at London/Heathrow, and he expects the market to have grown by 60 per cent by 2002 or 2003 when its own flights could feasibly start.

The problem for Emirates, backed by Dubai's open-skies regime, is securing traffic rights. Its memorandum of understanding with the US leaves serious capacity problems unresolved. But Flanagan identifies India and France as the worst offenders in trying to block additional Emirates capacity despite consistently high load factors. Flights to Madras and Trivandrum in particular are running at 90 per cent plus, but the new Indian government's desire to protect Indian Airlines on its Gulf sectors remains as strong as its predecessor's, says Flanagan. Saudi Arabia is also refusing to increase frequencies despite 90 per cent plus year round load factors.

India's stance forms a strong contrast to the open skies deal brokered with Pakistan. Emirates' services to Lahore and Karachi are under review, though a capacity shortage means they are unlikely to be launched until the extra A330s arrive at the end of 1999.

Though it performed ahead of plan in the first three quarters, Emirates suffered a slowdown in its Asian traffic at the start of the year. It is sanguine, however, about the outlook for the region and the benefits of lower fuel prices helped compensate. Unit costs fell 4.9 per cent, a function of the efficiency of the new 777s introduced last year as well as the fall in fuel prices. This offset a 2.3 per cent drop in yields which, says Flanagan, had been hardening until the Asian crisis undermined business from the turn of the year.

Emirates must also learn to handle a changing relationship with the government which, while it provided only seed capital, has provided tacit support by placing the carrier at the centre of its economic development programme. 'We have the moral support of the government but, professionally, there is no privilege. We go hand-in-hand,' claims Sheikh Ahmed.

While Dubai has always been the least oil-reliant of the states in the region, the ruling family has been trying to diversify the economy further. Emirates has already benefited from the priority given to tourism and the next stage is the creation of an industrial base to complement the existing free trade zone. This will be supported by a cheap energy programme.

The reliance on oil exports can still hit hard, however. Since its inception Emirates has prospered on the back of rapid economic growth in Dubai, marred only by the Gulf war. But the collapse of the oil price will, according to economists at Standard Chartered Bank in Dubai, cut GDP growth from 10 per cent last year to just 1.5 per cent in 1998.

Sheikh Ahmed is clear that there is still room for improvement. Despite its reputation as being innovative and the Gulf's British Airways, there is tacit acknowledgement that rapid expansion has stretched resources and allowed costs to creep up. 'We had to do a lot of things without realising how expensive they would be,' says Sheikh Ahmed.

The expansion has sucked in management resources at a time when it also has to cope with the relaunch of Air Lanka in which it acquired a 40 per cent stake and a management contract in March. Tim Clark, Emirates' general director, is doubling as Air Lanka's acting chief operating officer, and a new management team is expected to be in place by September.

The 10-year management plan envisages the replacement of Air Lanka's four owned Lockheed L1011s and two A320s with a new order for six A330s. The focus will be on developing the leisure market, with extra flights to Europe and Africa and a repetition of the two holiday destination formula which Emirates has employed with Dubai and the Comoro Islands.

Flanagan rejects claims that the Air Lanka investment could collapse after the Sri Lankan presidential elections which could be called as early as November. The main opposition party has said it will refuse to ratify the deal if it comes to power, but Flanagan claims the contract is legally watertight.

The fleet expansion and the acquisition of Air Lanka has bitten deeply into Emirates' cash flow and depressed financial ratios. The first tranche of the Air Lanka stake cost $45 million with another $25 million due after two years. Downpayments on the A330s totalled $400 million in the last financial year. Dermot Mannion, the group finance the group financial director, says the debt:equity ratio stood at 1.8:1 at the end of the financial year and should climb to 2:1 over the next two years when the A330s start arriving, a figure he describes as 'manageable'.

With two 777s due to arrive in October and November and the first of the A330s due for delivery at the start of 1999, Mannion is gearing up for a major financing exercise which is likely to involve a mix of finance and operating lease purchases for the first batch of 777s.

Emirates remains the most settled carrier in the region as Gulf Air climbs back slowly from the abyss of its near-bankruptcy and Saudi Arabian Airlines talks a better expansion story than it delivers. Other possible threats, notably Qatar Airways with its new flag carrier status, offer only a small challenge to the transfer traffic which accounts for 30 per cent of Emirates' business.

However, while Flanagan has been a tireless champion of liberalisation and open skies in the past, it is unlikely the Dubai carrier can resist invitations like the one from Lufthansa for much longer.

Source: Airline Business