Emirates airlines' notes have risen in the past month, regaining an advantage they enjoyed over Dubai's sovereign bonds as the world's biggest international carrier benefits from rising tourism and falling oil prices.

The extra yield investors demand to hold Dubai government's 6.7 percent bond due 2015 over the Emirates' note widened to 16 basis points yesterday from a discount of 22 basis points on Aug. 4, according to data compiled by Bloomberg. The yield on the Dubai-owned airline's 5.125 percent bond due 2016 fell 21 basis points, or 0.21 of a percentage point, to 5.28 percent yesterday since reaching a record 5.49 percent on Aug. 11.

"The fundamental drivers for Emirates have improved," Ahmad Alanani, the Dubai-based head of fixed-income sales for the Middle East at investment bank Exotix Ltd., said in an interview. "The number of travelers going through Dubai Airport have hit a record high" and oil prices have dropped, he said.

Emirates' earnings in the year to March surged 43 percent to a record 5.93 billion dirhams (US$1.6 billion) as it attracted more passengers using a growing fleet of Airbus SAS A380s. The Arab world's biggest carrier is building the largest superjumbo fleet as it seeks to establish Dubai as an intercontinental travel hub and win passengers from Air France-KLM Group, British Airways and Deutsche Lufthansa AG. It also competes with regional rivals Qatar Airways and Abu Dhabi's Etihad.

Destination Dubai

Dubai International Airport, home to Emirates airline, handled a record number of passengers in July. The number of travelers rose to 4.7 million from 4.3 million a year ago. The number of passengers Emirates carried jumped 14 percent to 31.4 million in the 12 months to March.

At the same time, fuel is becoming cheaper. Oil tumbled 6.8 percent this quarter and was trading at US$88.94 a barrel as of 7:10 p.m. yesterday in Dubai. Fuel made up 34 percent of the airlines' costs in the past fiscal year, according to its annual report. The United Arab Emirates, which Dubai and Abu Dhabi are a part of, holds about seven percent of the world's proven crude oil reserves.

Emirates' bonds have mostly traded higher than Dubai government's 2015 security since being sold in June, except between July 28 and Aug. 22.

That's expected to continue since the airline's "not likely to come back to the market any time soon," while Dubai "is likely to be an ongoing issuer when market conditions allow," said Abdul Kadir Hussain, who helps oversee US$2 billion in fixed-income assets as chief executive officer at Mashreq Capital DIFC Ltd. in Dubai.

2009 Bailout

Dubai, the Middle East's tourism and trade hub, suffered since the onset of the global credit crisis in 2008 as property prices crashed and credit markets froze. Tourism, trade and transport are recovering after a US$20 billion bailout in 2009 from the UAE's central bank and neighboring Abu Dhabi to repay part of its debt. The emirate and its state-owned companies borrowed about US$113 billion, according to an International Monetary Fund report in June.

The cost to insure Dubai's debt against default has risen to 410 yesterday since hitting this year's low of 316.6 on June 7, according to five-year credit default swaps from data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Dubai's credit default swaps reached 655 basis points in November 2009 after state-owned Dubai World announced plans to restructure about US$25 billion of debt. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent, should a government or company fail to adhere to its debt agreements.

Dubai Sovereigns

Still, "in the current environment, global risk aversion is probably going to be a more important driver of Dubai or Emirates bond prices than issuer-specific news flow," said Nick Stadtmiller, a fixed-income analyst at Emirates NBD PJSC. "Investors tend to treat Dubai names as birds of the same feather," with Emirates 2016 notes likely to perform in line with Dubai sovereigns over the next few months, he said.

Employment in the U.S. unexpectedly stagnated in August, raising the odds the world's biggest economy will slip into recession. Political squabbling over the U.S. budget deficit that led to the country being stripped of its AAA credit rating and mounting concern about a default in Europe has caused the S&P 500 share index to drop 5.7 percent in August.

Declining Yield

The yield on Dubai government's 6.7 percent bond due October 2015 fell 143 basis points this year to 5.44 percent yesterday, according to data compiled by Bloomberg. The average yield on Middle East sovereign bonds fell 46 basis points over the same period, according to the HSBC/Nasdaq Dubai Middle East Conventional Sovereign U.S. Dollar Bond Index.

Dubai has been spared the political unrest that swept through other Middle Eastern countries. Uprisings in the region this year have toppled governments in Egypt and Tunisia and sparked conflict in Libya, Syria and Yemen. Emirates airline is part of Dubai's plans to establish itself as a global logistics and aviation hub.

Emirates, which is investing in a wide-body jet fleet including 90 Airbus SAS A380 superjumbos worth US$34 billion at list prices, isn't concerned about financing the planes and is fully funded through July 2012, Gary Chapman, president for group services, said July 11. Emirates plans to spend about US$4 billion annually over the next three to four years, he said. About 199 planes are slated for delivery through 2019.

Airline Traffic

Passenger traffic at Middle Eastern airports grew 7.7 percent in July year-on-year, the second-highest pace after Latin America, which posted a 10 percent increase, according to the Airports Council International in Geneva. Traffic in Europe grew 6.7 percent in July, Asia Pacific 5.5 percent and North America 2.5 percent.

The yield on Singapore Airlines' 2.15 percent bond maturing in September 2015 fell 107 basis points this year to 1.43 percent today.

"Emirates airline has a wide appeal to high yield bond investors and is perceived by many as an indirect play on the sovereign," said Alanani. "For now, the premium to the sovereign can be justified as this is a credit that can stand on its own in the current context, independent of the sovereign."