Brazilian aviation: airlines face fast moving changes in early 2019

Summary

• Avianca Brazil posted solid gains in domestic passenger share in 2018 but fuel and currency pressure created tough headwinds for the airline, resulting in a bankruptcy filing.
• Avianca Brazil's capacity reductions could benefit GOL and LATAM Airlines Brazil.
• Potential changes to foreign ownership caps in Brazilian occur as the chessboard of JVs in the region starts to be set up.

Fuel and currency drive Avianca Brazil to seek bankruptcy protection

Unstable fuel prices and devaluation of the BRL were major challenges for Brazil's airlines in 2018, but despite those headwinds the country's domestic operators posted 3.3% passenger growth for the 11M ending Nov-2018, to 85 million.

GOL maintained the highest passenger share year-on-year of 33%, whereas LATAM Airlines Brazil's share fell 1.7% and Azul's share slid by 0.6%.

As 2018 drew to a close, LATAM Airlines Group concluded that domestic demand in Brazil was healthy.

Domestic passenger share for Brazilian airlines and year-on-year change for the 11M ending Nov-2018

Airline	Domestic passenger share	Year-on-year change
GOL	33.4%	Flat
LATAM Airlines Brazil	30.5%	1.7% decrease
Azul	22.8%	0.6% decrease
Avianca Brazil	12.5%	6.9% increase

Source: Brazil ANAC.

Avianca Brazil's share jumped 6.9% year-on-year as it posted the largest increase in ASK growth of 9.9%. Its traffic grew 8.8% during the 11M ending Nov-2018, which resulted in an approximately 1% drop in load factors to 84%.

But its strong passenger growth and high loads could not shield Avianca Brazil from the effects of currency devaluation and fuel cost pressure. In late 2018 the company sought bankruptcy protection; Reuters reported that the airline owed lessors close to USD100 million. The news outlet also reported that Avianca Brazil had returned four aircraft to lessors in the period leading up to the bankruptcy filing.

Avianca Brazil explained it sought creditor protection "due to resistance by aircraft lessors to an amicable agreement". Reuters has reported lessors are working to take back broadly 30% of the airline's fleet of nearly 60 Airbus narrrowbody jets.

Although Avianca Brazil was profitable in 2017, the airline has struggled financially during the past few years. According to data from ANAC, the airline lost nearly USD37 million in 2Q2018 and posted a negative net margin of 15%.

Reductions by Avianca Brazil could benefit the country's other airlines

It remains to be seen how Avian Brazil's bankruptcy filing will affect the country's aviation sector. The capacity cuts resulting from the airline returning four aircraft to lessors (and possibly more jets) will benefit the country's other largest airlines - GOL, LATAM Airlines Brazil and Azul - as capacity falls in the country's domestic market.

Given overall global economic uncertainty, those three airlines are not likely to backfill that capacity aggressively, unless demand grows dramatically. Avianca Brazil serves 27 domestic destinations, according to CAPA and OAG, and caters more towards higher end, corporate passengers.

The airline's largest base is São Paulo Guarulhos and it does not hold a majority seat share on any of its top domestic routes by seats. Its major competitors are Brazil's two largest airlines GOL and LATAM Airlines Brazil.

Azul's network strategy is different from those of its competitors. It serves a lot of secondary markets and is based at Campinas Viracopos, approximately 100km north of São Paulo.

Airline seat share on Avianca Brazil's top 10 domestic routes as of early Jan-2019

Route	Airline seat share
Rio de Janeiro Santos Dumont - São Paulo Congonhas	GOL42% LATAM Airlines Brazil 42% Avianca Brazil 16%
São Paulo Guarulhos - Salvador	LATAM Airlines Brazil 44% GOL 22% Avianca Brazil 34%
São Paulo Guarulhos - Fortaleza	LATAM Airlines Brazil 51% Avianca Brazil 24% GOL 23.6% Azul 1.5%
São Paulo Guarulhos - Porto Alegre	LATAM Airlines Brazil 40% GOL 28% Avianca Brazil 20% Azul 12%
São Paulo Guarulhos - Rio de Janeiro Galeão	LATAM Airlines Brazil 41% GOL 29% Avianca Brazil 29%
São Paulo Guarulhos - Recife	LATAM Airlines Brazil 40% GOL 25% Avianca Brazil 19% Azul 17%
Rio di Janeiro Galeão - Salvador	GOL 61% Avianca Brazil 39%
São Paulo Guarulhos - Curitiba	LATAM Airlines Brazil 47% GOL 25% Avianca Brazil 20% Azul 7%
São Paulo Guarulhos - Florianópolis	GOL 37% LATAM Airlines Brazil 28% Avianca Brazil 21.5% Azul 13%
Brasilia - São Paulo Congonhas	LATAM Airlines Brazil 49% GOL 34% Avianca Brazil 16%

Source: CAPA - Centre for Aviation and OAG.

Brazil changes foreign ownership limits as the JVs start to multiply

After Avianca Brazil sought bankruptcy protection, the outgoing administration of former Brazilian President Michel Temer signed an order to lift foreign ownership percentages in the country's airlines from 20% to 100%.

Reuters has reported that Brazil's Congress has up to 180 days to approve the decree. It appears the situation could be fluid, but the prospect is promising for Brazilian airlines, which largely welcomed the proposed change. Brazil's 20% cap was one of the most restrictive, both worldwide and among some of Latin America's largest aviation markets.

Interest from outside investors in Brazil's airlines is hard to predict. As Latin America's largest aviation market with trips per capita of just 0.5 in 2017, Brazil holds long term opportunities, and US airlines have taken varying approaches to ensure their coverage in Brazil is robust.

American Airlines is in the midst of forging a JV with LATAM Airlines Group encompassing several Latin American countries, including Brazil, but largely shies away from investing in other airlines, with the exception of its 2.76% stake in China Southern.

Delta Air Lines holds a 9% share in GOL and in late 2018 stated its desire to forge a JV with Brazil's largest domestic airline. Its aim to form a joint venture with GOL does not necessarily mean Delta will expand its stake in GOL, but there is a high likelihood Delta and GOL are examining what the ownership changes in airlines mean for Brazil over the long term.

In Aug-2018 United increased its stake in Azul from 3.7% to 8%, and Azul has repeatedly stated its desire to forge a joint venture with United, which is the process of creating a JV with Avianca and Copa.

If joint ventures between United and Azul and Delta and GOL do materialise, United and Delta could evaluate considering increasing stakes in their Brazilian partners - given that they would be essentially be operating as a single airline in some markets.

The Star partners United, Avianca and Copa are in the midst of attempting to forge a JV, and in late 2018 United also agreed to lend Synergy USD456 million, secured by shares of Avianca's common stock. Synergy owns Avianca Brazil and is also Avianca's largest shareholder; however, Avianca and Avianca Brazil operate separately. There have been on and off merger negotiations between Avianca and Avianca Brazil for years, but nothing has ever materialised.

For now, there's no Brazilian representation in the proposed joint venture, but eventually Avianca, Copa and United will need a strategy covering Brazil. And some level of uncertainty regarding Avianca Brazil will affect how the JV partners approach ensuring they have a competitive presence within, and to and from, Brazil.

Brazil's aviation markets starts 2019 with fast moving changes

Brazil is one of the most important aviation markets in Latin America and the country's airlines have faced their fair share of challenges during the past few years.

Avianca Brazil's decision to seek bankruptcy protection will no doubt change the dynamics of Brazil's market in 2019, and airlines working to establish JVs in Latin America need to study the rapid changes moving through the country.