The continued growth of the Gulf's national airlines - which are expanding their fleets and route networks - does not bode well for regional carriers such as Air Arabia, according to Nomura Holdings.
A Nomura analyst downgraded the Sharjah carrier to neutral from buy yesterday.
"Smaller, domestically focused regional carriers have less operational and financial strength to compete with national carriers," said Scott Darling, the analyst. National carriers were becoming increasingly comfortable in operating Boeing 777 and Airbus A380 aircraft on short-haul routes "to maintain fleet load factors and access specific premium cabin traffic", he said.
Most passenger traffic in the Middle East is moving to or from points outside the region, presenting an inherent problem for regional carriers.
"With regional carriers' growth being partly determined on developing regional hubs, increasingly these will encroach on national carrier routes Ö which may limit the potential upside to margins for smaller carriers," Mr Darling said.
Moreover, the rising cost of jet fuel, which represents 40 per cent of an airline's operating costs, is likely to restrict earnings.
Air Arabia has made forward purchases of only 15 per cent of jet fuel requirements so far this year.
"With global jet fuel demand up 1.2 per cent year-on-year so far, and inventories at the [Organisation for Economic Co-operation and Development] where they are, we expect [higher] jet fuel prices and hence further cost pressures for these operators for 2011 and beyond," Mr Darling said.
He also lowered his forecast on Air Arabia's passenger growth in the next five years to 7 per cent from 10 per cent. He lowered his price target for the shares to 90 fils, down from Dh1.10.
Shares of Air Arabia lost 0.5 per cent to 70 fils yesterday.