16-Feb-2013 1:45 AM

Aeromexico plans more capacity growth in 2013 as delayed 787s are deployed to Europe and New York

Analysis

Aeromexico saw its profits drop for the second consecutive year in 2012 as it was only able to grow passenger traffic by 3% despite double-digit growth for the overall Mexican market. But Mexico's only surviving legacy airline group remains in the black and its outlook remains relatively bright given its strong position in the Mexican market and the resurgence of the country's economy.

Grupo Aeromexico is planning to grow capacity (ASKs) by a further 6% in 2013, matching the 6% capacity increase from 2012. But the group is targeting higher RPK growth and load factors, which it hopes will allow it to regain the share of the domestic market it lost in 2012.

Internationally, Aeromexico is planning to grow capacity by up-gauging routes, including replacing 767-200s with new 787-8s to London and Paris. Aeromexico also plans to deploy its first batch of 787s to New York, which it currently only serves with 737s. Aeromexico now expects it will receive three 787-8s in 4Q2013, representing a delay of about three months due to the current grounding of the global 787 fleet.

Summary

Aeromexico's profits dropped for the second consecutive year in 2012, despite the overall growth of the Mexican market.
Grupo Aeromexico plans to grow capacity by 6% in 2013, focusing on higher RPK growth and load factors to regain lost market share.
Aeromexico plans to up-gauge routes internationally, replacing 767-200s with new 787-8s to London and Paris.
The delivery of the first batch of 787s has been delayed due to the global grounding of the fleet.
Aeromexico aims to recapture a 40% share of Mexico's domestic market in 2013, focusing on load factors and lower fares.
The airline is optimistic about Mexico's economic outlook and expects the recent changes in ownership structure to have a positive impact.

Aeromexico reports drop in profits and load factors for 2012

Aeromexico recorded a net profit of MXP1.32 billion (USD104 million) in 2012, representing a 25% drop compared to 2011. In 2011 a weak second half resulted in its profits dropping by 11% compared to 2010, which was a landmark year for Aeromexico as the suspension of services at rival Grupo Mexicana paved the way for a return to profitability after several years in the red.

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The group recorded an 11% increase in revenues for 2012 to MXP39.6 billion (USD3.1 billion) but operating expenses increased 15% to MXP32.8 billion (USD2.6 billion). Aeromexico's operating profit dropped 32% to MXP2.53 billion (USD200 million) and its operating profit margin dropped 4ppts from 10.4% in 2011 to 6.4% in 2012.

In 2011, Aeromexico grew ASKs by 20% and revenues by 28% as it moved, along with Mexico's three low-cost carriers, to quickly fill the void left by Mexicana. Aeromexico didn't have any problems filling the capacity added in 2011 as RPKs grew by 21% and its load factor improved to 78.4%. But in 2012 Aeromexico struggled to fill the seats it added to the market as its load factor fell by 1.8ppts to 76.6% (see background information).

In discussing 4Q2012 results with analysts on 14-Feb-2013, Aeromexico CEO Andres Conesa said the focus for 2013 will be on adding capacity in existing markets and improving the performance of the 18 routes added in 2012. "On the network side it will be a year of consolidation," Mr Conesa said.

As most of the capacity expansion in 2012 was directed to the domestic market with seven new domestic destinations opened, Aeromexico plans to focus more on the international market in 2013. Grupo Aeromexico currently allocates 73% of its seats and 40% of its ASKs to the domestic market, according to Innovata data. On a revenue basis, domestic flights generated 48% of Aeromexico's revenues in 2012 while international flights generated 42% with charters, cargo and other revenues accounting for the remaining 10%.

The international expansion in 2013 will be driven by the up-gauging of existing international flights to Europe and the US. Aeromexico plans to replace three 767-200s with larger 787-8s and two 737-700s with four 737-800s, leaving two 737-800s for growth on medium-haul international routes.

Aeromexico now expects to receive first batch of 787s in 4Q2013

The 6% increase in ASKs for 2013, which includes about a 5% increase in 1H2013 followed by a 7% to 8% increase in 2H2013, is based on the current fleet plan which envisions the first 787-8 being placed into service in Aug-2013. But Mr Conesa acknowledged the carrier's first batch of three 787s will now most likely be delivered in 4Q2013, which will have a slight impact on its capacity production for the full year. Boeing has halted all deliveries of 787s since the global in-service fleet was grounded in mid-Jan-2013 and it is unclear when the grounding will be lifted and how long it will take for the delivery schedule to be recovered.

"Certainly it will be delayed [but] we expect the plane to be delivered this year for sure," Mr Conesa explained. "Officially we haven't received from Boeing any new date. The planes will fly but probably instead of flying in the third quarter they will be flying in the fourth quarter. And that will mean less ASK production in the international market because of the delay."

Mr Conesa said the plan is to have the 787s operate from Mexico City to London Heathrow, Paris CDG and New York JFK starting from Aug/Sep-2013. If there are delivery delays as expected, Aeromexico will slightly extend the leases on three 767-200s and postpone the training of 100 pilots which have been selected to transition from the 767 to 787.

Aeromexico to use 787 to increase capacity to New York

New York JFK is currently served with four daily 737-800 flights but Mr Conesa said they had determined that the 787, unlike the 767, can be "competitive" on the Mexico City-New York route. Aeromexico already has a leading 47% share of capacity between Mexico City and New York (includes all New York area airports), which it will expand on after it up-gauges some of its Mexico City-New York frequencies to the 787.

Mexico City-New York JFK is now also served by SkyTeam partner Delta Air Lines and Mexican LCC Interjet while Mexico City-Newark is served by United. Delta, which has a hub at JFK, acquired a 4% stake in Aeromexico in 2012, cementing a partnership which now includes codeshares on over 200 flights. Cancun to New York JFK and Mexico City to Delta's fortress hub in Atlanta were two of 11 international routes Aeromexico added in 2012 as it looked to exploit synergies from the newly expanded partnership with Delta.

Mexico City to New York* capacity by carrier (one-way seats per week): 19-Sep-2011 to 04-Aug-2013

Aeromexico currently operates a daily flight to Paris using a mix of 767-200s and 767-300s, according to Innovata. The carrier launched in Dec-2012 three weekly 767-200 flights to London, using slots acquired from SkyTeam partner Air France. Aeromexico competes on the Mexico City-London Heathrow route with British Airways, which operates three weekly 747-400 frequencies to Mexico City, while Air France operates alongside Aeromexico on Mexico City-Paris with a daily 747-400 flight.

Aeromexico currently has a fleet of seven 767s which it uses to serve Buenos Aires, Tokyo Narita and Santiago as well as London Heathrow and Paris CDG. It also has a fleet of four 777-200ERs which are currently used to serve Madrid, Sao Paulo, Shanghai Pudong as well as some frequencies to Buenos Aires.

Aeromexico plans to begin deploying 787s on Asian routes in early 2014

Mr Conesa said Aeromexico intends to use its second batch of 787-8s, which are slated to be delivered in early 2014, on the Tokyo and Shanghai routes. He said Aeromexico is not using its first batch of three 787s for its Asia routes because the second batch will be the first aircraft with higher thrust engines, allowing "probably under certain conditions non-stop flights from Mexico City to Narita".

Aeromexico currently serves Tokyo with three weekly 767 flights that operate via Tijuana on the outbound sector and non-stop on the return leg. Shanghai is served with two weekly 777 flights with stops in Tijuana on both the outbound and return sectors. The 767-200/300 and 777-200ER is unable to operate non-stop to Asia from Mexico City due to the city's high altitude.

The 787 represents a game changer for Aeromexico's Asia operation, which has suffered over the years although Mr Conesa said it performed better and contributed positively in 2012. The 787 will significantly improve the economics and product of the carrier's trans-Pacific offering. Mr Conesa said Aeromexico expects to add frequencies to both Tokyo and Shanghai "as more 787s kick in".

Aeromexico is now committed to acquiring nine 787-8s, including two aircraft purchased directly from Boeing in 2006 and seven leased aircraft. In 2012 the group added an order for six 787-9s with purchase rights for four additional 787-9s (at the same time it also placed an order for 60 737 MAX aircraft plus 30 purchase rights). The new widebody fleet of at least 13 787s allows for modest growth as well as the replacement of the current fleet of seven 767s and four 777s.

The decision to use the 787 to New York indicates that Aeromexico may not opt to expand its long-haul network but instead use the additional capacity to up-gauge some medium-haul routes now operated with 737s as well as add frequency to its two Asian routes. Los Angeles could be a potential second US route for Aeromexico's 787s. Aeromexico currently serves Los Angeles from Mexico City with 33 weekly flights.

Mexico City-Los Angeles is the carrier's largest international route based on seats while Mexico City-New York is the second largest. Based on ASKs, Mexico City-New York is the carrier's biggest US route and its fourth biggest international route overall as it is a longer flight (over five hours compared to under four hours for Mexico City-Los Angeles).

Aeromexico top 10 international routes based on capacity (ASKs): 10-Feb-2013 to 17-Feb-2013

Aeromexico plans to wait for its 787-9s before placing the 787 on Madrid and Sao Paulo, its two biggest long-haul routes, while the nine 787-8s will be used for Buenos Aires, London, Paris, New York, Tokyo, Santiago and Shanghai. Buenos Aires and Santiago are the last of the current 767 routes that are slated to be up-gauged to the 787-8.

Aeromexico plans slight increase in domestic capacity as ERJs are replaced with EJets

Aeromexico also plans to up-gauge some domestic flights during 2013 as six ERJ-145s are replaced with five E170/175s, giving regional subsidiary Aeromexico Connect a year-end fleet of 32 ERJ-145s, eight E170/175s and 19 E190s. But the ASK impact from these changes are relatively small compared to the increase in international ASKs brought about by the introduction of 787-8s and 737-800s.

In 2012 Aeromexico Connect significantly increased domestic capacity as three second-hand E170s and eight new E190s were added to the fleet while only one ERJ145 was returned. Aeromexico mainline also took delivery of three new 737-800s in 2012 while an older 737-800 was returned. Aeromexico mainline currently operates a fleet of 45 737-700/800s along with its 11 widebodies while Aeromexico Connect currently operates a fleet of 60 regional jets.

Aeromexico fleet: 4Q2012 vs 4Q2011

Aeromexico Connect recorded a 7% increase in scheduled domestic traffic in 2012 to 5.5 million passengers, according to Mexican DGAC data. Aeromexico mainline saw only a 1% increase in scheduled domestic traffic to 5.0 million passengers.

Aeromexico Connect also recorded a 61% increase in scheduled international traffic in 2012 to 653,000 passengers while Aeromexico mainline recorded a 3% increase in scheduled international traffic to 3.3 million passengers. As a result the total Grupo Aeromexico scheduled domestic traffic only grew by 4% in 2012 from 10.2 to 10.6 million passengers while the group's scheduled international traffic grew at a 10% clip to 3.9 million passengers.

Aeromexico was able to grow its share of Mexico's international market as the total international market expanded by 7% in 2012 to 27.1 million passengers (including 21.2 million passengers carried by foreign carriers). Aeromexico, however, saw its domestic market share shrink in 2012. Mexico's total domestic market grew by 10% to 28.1 million passengers, leaving Grupo Aeromexico with a 38% share of the market compared to a 40% share in 2011.

Mexico domestic market share (% of scheduled passengers) by carrier: 2012

Mr Conesa said the group aims to recapture a 40% share of Mexico's domestic market in 2013. He is confident this can be achieved despite only a marginal increase in domestic capacity from Aeromexico and despite the fact the overall market is expected to grow in the high single digits.

Mr Conesa explained the group will focus more on load factors and lower fares if necessary to drive up domestic traffic. He said there is particularly room for higher loads on flights to the seven domestic stations Aeromexico added in 2012. "We will change the strategy a little bit and be more aggressive with yields to have better load factors," he added.

Such a strategy could result in more intense competition, particularly as Mexico's three LCCs will almost certainly expand faster domestically than Aeromexico in 2013. For example, Volaris, which grew its domestic traffic by 25% in 2012, is planning to again grow capacity by about 20% in 2013 with a focus on the domestic market.

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Aeromexico is bullish on Mexico's economy

The ultimate success of Aeromexico's more aggressive domestic strategy could hinge on how the Mexican economy performs in 2013. Mexico's economy, which grew by about 4% in 2012, is expected to grow by another 4% in 2013. If the economic growth figures hold up and inflation stays low, domestic demand should increase sufficiently to support higher load factors from Aeromexico as well as significant capacity increases from Mexico's three LCCs - Volaris, Interjet and VivaAerobus.

Mr Conesa is bullish on Mexico's economic outlook and pointed out that the new policies being implemented by the country's new president is expected to lead to a higher growth rate in the medium-term. "GDP growth did de-accelerate slightly in the fourth quarter however Mexico's outlook remains strong," he said.

Aeromexico has the flexibility to accelerate expansion in 2013 should economic conditions be even better than expected as it has several aircraft with leases expiring. The group also has the flexibility to cut capacity should market conditions deteriorate and shrink its fleet below the current level of 116 aircraft.

Change in ownership structure should have positive impact

Mr Conesa is also optimistic the recent changes in Aeromexico's ownership structure and board will have a positive impact on the group. Aeromexico announced on 12-Feb-2013 that an affiliate of Mexican bank Banamex had sold an additional 20% stake in Aeromexico to a group of Mexican investors led by Eduardo Tricio.

Banamex acquired Aeromexico in 2007, when the airline group was privatised, and had earlier sold a portion of its stake as part of the group's Apr-2011 initial public offering. Banamex is now left with only a 16% stake in Aeromexico.

Mr Tricio, who has been a shareholder in Aeromexico alongside Banamex since 2007, has been appointed Aeromexico's new chairman. Mr Conesa pointed out that Mr Tricio has in-depth knowledge of Aeromexico and his investor group also has extensive experience with Mexican business and industry, which Aeromexico can now benefit from. "The new ownership, which has a longer term view, will provide additional dynamism to complete important projects, adding more value to our company," Mr Conesa said.

Mr Conesa would not elaborate on which projects or initiatives will come up for board approval in 2013. But the group should now be better positioned to respond to changes in Mexico's dynamic market. "Certainly some things will happen. We expect them to be on the positive side. As we now have an investor with a longer term view, the projects we have in the pipeline will be implemented faster," Mr Conesa explained. "There is no change in terms of strategy but certainly there will be changes regarding certain projects we are looking for."

Aeromexico should be able to extend recent string of profits

Aeromexico enters 2013 with a bright outlook. While the group has seen its profits drop since the peak in 2010 and early 2011, it has been in the black for three consecutive years - a noteworthy achievement for the historically unstable Mexican airline industry. Aeromexico should be able to continue to generate profits and cash in on its leading position in Mexico's domestic and international markets.

The upcoming arrival of the 787, and later the 737 MAX, will improve operating economics and help cement Aeromexico's leading position in the Mexican market. There will be challenges, including from fast-expanding LCCs. But Aeromexico has the strategy and initiatives in place to pursue modest and profitable growth.

Currency conversion used: USD1=MXP12.68

Background information

Grupo Aeromexico financial and operational highlights: 2012 vs 2011 and 4Q2012 vs 4Q2011

Grupo Aeromexico financials: 2012 vs 2011