One Simple Reason Not To Believe Etihad’s Claim Of Profitability

James Hogan, the chief executive of Etihad Airways, has reaffirmed his claim that the Gulf carrier is a “commercial organization” that benefits from “no subsidies or state support”.

In a speech to The Wings Club in New York last week, the boss of Abu Dhabi’s flag-carrier talked up the consumer benefits and the economic growth that have accompanied the rise of the Persian Gulf carriers. Responding to accusations of unfair competition by US lobbyists, he said that Etihad’s opponents are promulgating “myths about our business” – specifically that its shareholder does not expect “a clear return on its investment”.

It is true that both sides of the Gulf-US aviation dispute are spinning a narrative to suit their own biased agendas.

On the American side, claims of unfair advantages seem hypocritical given the decades of government support that US carriers enjoyed before deregulation in the 1970s. On the Gulf side, counter-claims of protectionism gloss over the fact that subsidies distort the competitive landscape, in turn harming consumer choice by pushing out competitors. Both groups have legitimate grievances, and I make no attempt to resolve their dispute in this article.

However, there is one aspect of the Gulf argument which deserves particular scrutiny. Though he avoided discussing profitability last week, Hogan routinely claims that the company has been in the black for several years. “We set a timetable to break even within a decade and we beat that target,” he said during another speech in Washington in 2015.

 That claim is important because genuine commercial profitability would nullify US allegations of state dependency. But it lacks credibility. Here’s why.

Unclear costs from equity alliance

In a May 2015 statement announcing its “fourth consecutive year of net profit”, Etihad claimed a positive result of $73 million for 2014 with total revenues of $7.6 billion. The latter figure included $1.1 billion of “partnership revenues” – a reference to bookings throughout codeshares, interlines and other commercial arrangements with its equity partners.

Etihad holds sizable stakes in seven foreign airlines – Air Berlin, Air Serbia, Air Seychelles, Alitalia, Darwin Airline, Jet Airways and Virgin Australia – each of which feeds traffic into its Gulf network.

However, while Etihad includes partnership revenues in its top line, the extent to which associated alliance costs bear down on its bottom line is not disclosed. Let’s be clear: the revenues that Etihad enjoys from its partners do not come for free. Its 49% stake in Alitalia came with a price-tag of €560 million ($750 million), for example. The funds for this acquisition came directly from Abu Dhabi’s government, according to The Wall Street Journal, which alleged overall capital injections of $2.5 billion by the state in 2014.

Such investments are not one-off expenses. Since Etihad upped its stake in Air Berlin in 2012, the German carrier has posted net losses of $916 million. It is logical to suppose that Etihad, as a significant shareholder, shoulders some of the pain. Indeed, the same WSJ report alleged that Etihad purchased perpetual bonds in Air Berlin to the tune of $399 million two years ago.

By talking up the positive returns from the alliance without acknowledging associated costs, Etihad is reaping the rewards of its government’s spending spree in a vacuum – ignoring all concomitant liabilities. That doesn’t sound like a commercial operation to me.

How Etihad can defend its claims

If Etihad is serious about demonstrating its claim to profitability as a commercial entity, the path forward is clear: it should release its financial statements in their entirety.

The airline makes much of the fact that its annual reports are audited by KPMG. Beyond serving as an impressive sound-bite, however, this assertion means very little. KPMG’s involvement will be limited to ensuring compliance with International Financial Reporting Standards (IFRS), and validating the claims made by management on behalf of the government shareholder and any lenders. KPMG has no higher responsibility to the media or general public vis-à-vis disproving subsidies and affirming self-sufficient profitability.

It is very likely that Etihad will become a profitable company in the future, given its proven operating strengths and ubiquitous brand. It may already be one today. But as long as the company refuses to publish financial reports, a cloud of suspicion will rightly hang over its claim to success.

Hogan would be better off defending Gulf subsidies as a legitimate response to historic US advantages, rather than making bold assertions bereft of any supporting evidence.

Originally Published on Forbes.