Copa Airlines: 737 MAX 9 and MAX 10 to drive new expansion phase, lower CASK from upgauging

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Copa Holdings CEO Pedro Heilbron discusses market conditions in Latin America, the group's plans for the 737 MAX 8 and its new LCC unit Wingo

Source: CAPA TV

Copa pursues slower growth as profits are pressured

Copa has been one of the fastest growing and most profitable airline groups in the Americas over the last two decades.

The group has had a double digit operating profit margin every year since its 2005 initial public offering. The group also grew ASKs at a double digit or near double digit clip every year until 2015, when Copa slowed its growth rate significantly due to challenging economic conditions in Latin America.

The group's ASKs increased by 4.4% in 2015 and by only 1.5% in 2016. Copa was able to maintain profitability during this challenging period and maintain a double digit operating profit margin. However, the group's 12% operating margin in 2015 and 2016 represented by far its lowest margin since the 2005 IPO.

Copa annual operating profit margin and ASK growth: 2004 to 2016

	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016
Operating margin	20.6%	17.9%	19.5%	19.2%	17.4%	17.8%	20.5%	21%	17.9%	19.9%	19.8%	11.8%	12.4%
ASK growth	N/A	N/A	19.7%	15.3%	11.7%	12.1%	10.5%	21.9%	24.1%	14.4%	9.5%	4.4%	1.5%

Source: CAPA - Centre for Aviation and company reports.

Copa Holdings turned an operating profit of USD277 million in 2016 and an operating profit of USD266 million in 2015. The last time Copa's operating profit was below USD300 million was 2010, when the group had a much smaller revenue base and generated half the ASKs.

Copa Holdings annual operating profit (in USD millions): 2008 to 2017

Source: CAPA - Centre for Aviation and company reports.

Copa reaccelerates expansion in 2017

After two difficult years, Copa Holdings is entering a new phase of growth. While it is not expecting to return to double digit growth the group believes it can sustain a growth rate in the mid to high single digits.

The group plans to grow ASKs by 7% in 2017, representing the fastest growth rate since 2014 but still the third slowest growth rate since the 2005 IPO. Copa expects to grow at a similar rate over the next several years, projecting annual average capacity growth of 6% over the next 20 years.

See related report: Copa Holdings believes a recovery in demand will support marked rise in 2017 capacity growth

While 6% to 7% growth is modest in terms of Copa's historical standards it is relatively high given that its network is approaching maturation. Over the last two decades Copa has steadily grown its network, which now reaches 75 destinations in 31 countries.

Copa continues to pursue network expansion opportunities and will add two more destinations, Denver in the US and Cordoba in Argentina, in 4Q2017. However, most of Copa's growth in 2017 is being achieved by reinstating off season flights which were cancelled over the last year or two due to the weak demand environment.

Copa to continue with all narrowbody model

Copa will likely continue to add two to three destinations per year. However new destinations will represent a relatively small portion of its future expansion. During the peak rate of its network expansion in 2011 and 2012 Copa added 14 destinations per year.

As Copa already links its main hub in Panama City with virtually every viable destination in the Americas the focus needs to shift to density and adding capacity to existing destinations. The only other alternative would be expanding the network beyond the Americas, but this would require widebody aircraft, putting Copa outside its comfort zone.

Copa Holdings CEO Pedro Heilbron told CAPA on the sidelines of the Jun-2017 IATA AGM the group has no intention of launching long haul services across the Atlantic or Pacific. Copa believes it is best off sticking with its all narrowbody model and focusing on offering the best one-stop product within the Americas via Panama, which has a nearly perfect geographic position in the middle of the Americas.

"I think one of the things that is important in any business and especially in aviation is to understand what is the business model that makes the most sense to you and to stick to it," Mr Heilbron said. "We know we what makes sense for us. We know what we want to be. We don't want to do anything that goes outside the range of the business model that works for us. Widebodies don't really fit our business model and we have no plans."

737 MAX aircraft enable Copa to reduce CASK while sticking with the same model

It is hard to argue with Copa's all narrowbody model given the group's success over the last two decades. With the advent of new generation narrowbody aircraft, it has become even more sensible for Copa to stick entirely with narrowbody aircraft.

The 737 MAX family provides Copa, which has always been a 737 operator, with an opportunity to reduce its unit costs while keeping a simplified fleet. Reducing its already low CASK is crucial given the yield pressure Copa has been facing. The group's average yield was down 19% in 2015 and another 9% in 2016.

Copa already has one of the lowest unit costs among full service all narrowbody airlines. In 2016 the group achieved a cost per ASK of USD5.5 cents and an ex-fuel cost per ASK of USD4 cents. Copa's future 737 MAX fleet will drive a reduction in both set of figures as all its MAX aircraft will have more seats than the aircraft being replaced and will also generate significant fuel savings.

"We are one of the leading airlines in our segment - traditional legacy airline - in terms of unit cost and we are expecting the MAX fleet to make us even better in that sense," Mr Heilbron said.

Copa does not necessarily need the improved range of the 737 MAX

The 737 MAX family also offers improved range over the 737NG family. Copa could potentially open up destinations that are not feasible with its existing 737NG fleet.

For example, the airline does not yet serve any destinations in the Pacific Northwest of the US or Western Canada. Copa's longest route to North America is now Panama City to San Francisco, which has a block time of 7hrs37mins (ironically) on the outbound leg and 7hr21min on the return leg. Its longest routes to South America - Panama City to Buenos Aires and Montevideo - have similar block times, ranging from 7h01min to 7h28min for Buenos Aires and from 7hr09min to 7hr42min for Montevideo (depending on the flight).

However, the Pacific Northwest and Western Canada are relatively small markets for travel to Panama and Latin America. Seattle and Vancouver are likely the only potentially viable destinations but are not sure bets. In South America, only the remote Patagonia region of Argentina and Chile would be opened up by the MAX and it is unlikely this would be a viable route on a year-round basis.

737 MAX are ideal aircraft for Copa's longer routes

Given Panama's geography the primary (and perhaps only) benefit of the 737 MAX will be deploying the aircraft on Copa's existing long narrowbody routes.

The Buenos Aires, Montevideo and San Francisco routes are the most obvious candidates as they are all over seven hours. However, Copa has several other routes of at least six hours which would also benefit significantly from the MAX. "We will be operating the MAXs on our longest routes into deep South America and to North America," Mr Heilbron told CAPA.

Copa Holdings length of flight by number of weekly frequencies: 3-Jul-2017 to 9-Jul-2017

Source: CAPA - Centre for Aviation & OAG.

The efficiency of the 737 MAX family is more pronounced on longer sector, resulting in a larger fuel benefit compared with the 737NG family. Copa's longest routes do not generally have payload limitations but the 737 MAX will significantly reduce fuel costs and should provide an opportunity to carry more cargo.

The 737 MAX family also provides Copa with an opportunity to upgauge. This is the perhaps the biggest benefit of the MAX as the airline has several routes, including some of its longest routes, which are able to absorb additional capacity.

For example, Buenos Aires, San Francisco and Montevideo are all served with at least 14 weekly frequencies (or two daily flights). Copa does not necessarily need to add frequencies in these markets as it is already hitting the main connecting banks at Panama City. However, it could benefit from upgauging these routes, which would give it more capacity while reducing its per seat costs.

Growing in some of its biggest and most profitable markets by upgauging rather than adding flights is an ideal scenario given the resulting reduction in unit costs and the maximising of slots.

Copa is expecting to expand the fleet as it takes delivery of the more 70 MAX aircraft it has so far ordered. However, the rate of fleet expansion will be very modest as upgauging will be able to drive most of the projected capacity growth over the next decade.

Copa to take delivery of 737 MAX 9s from 2H2017 with upgraded premium product

Copa is still working on determining a configuration for its future 737 MAX fleet. However, the 737 MAX 9 is designed to carry 20 more passengers than the 737 MAX 8 and 31 more passengers than the 737-800. The 737 MAX 10, which involves stretching the 737 MAX 9 by 66in, is designed to carry 10 passengers more passengers than the 737 MAX 9.

Most of Copa's 737-800 fleet has 160 seats, including 144 economy seats at 31in pitch and 16 business class seats at 38in pitch. A subfleet used mainly on its longest routes has 154 seats, including 16 business class seats with a roomier 50in pitch (offering a bigger recline but still not lie-flat) and 138 economy seats at the same 31in pitch. Mr Heilbron said Copa will have a similar product on its 737 MAX 9s as the 737-800 subfleet with the upgraded premium product but has not yet finalised a configuration.

Mr Heilbron said Copa's first 15 MAX deliveries will consist of the MAX 9. This includes five deliveries in 2H2017 and 10 deliveries in 2018. Copa's first MAX 9 delivery is slated for Aug-2018.

Copa is able to expand capacity without growing the fleet

Based on a similar pitch and configuration to the 154 seat 737-800, which is 35 seats below the maximum all economy configuration, the 737 MAX 9 on Copa should seat approximately 185 passengers. Therefore the 737 MAX 9 will enable Copa to increase capacity on routes now served with the 154-seat 737-800 by approximately 20%. Routes now served with the 160 seat 737-800 could experience capacity growth of approximately 16%.

The initial fleet of 15 737 MAX 9s will mainly be used on routes now operated with the 154 seat 737-800s as the idea is to use the MAX 9 on Copa's longest routes which are now generally served with the 154 seat subfleet. However, due to aircraft rotations and scheduling, there will also be some short haul flights with the 737 MAX 9. Copa already uses 154 seat 737-800s on some short routes for aircraft rotation reasons - although from a product standpoint it is not necessary to provide the upgraded premium product on short flights.

The 737 MAX 9 also provides an opportunity to increase capacity on popular short haul routes, particularly during peak times of the day, where there is strong demand. However, Copa is better off waiting for the 737 MAX 10 for such routes.

Copa to pursue further upgauging with the 737 MAX 10

Copa's 737 MAX 10 could potentially be configured with the standard 38in pitch in business, resulting in a configuration of approximately 190 seats, and be used on shorter routes than the MAX 9. The MAX 10 will have a reduced range compared to the 737 MAX 8 and 737 MAX 9, making the new type more suitable for shorter routes.

Copa was one of 16 airlines and leasing companies to announce commitments to the MAX 10 at the 2017 Paris Air Show, where the aircraft was formally launched. Copa announced conversions of 15 MAX orders to the MAX 10.

See related report: 2017 Paris Air Show produces an unexpected flurry of ordering. Lessor purchasers were prominent

Copa has not specified a delivery date for the MAX 10 but the new type enters service in 2020. As one of the launch customers, first delivery is likely in 2020 or 2021.

The 737 MAX 10 should enable Copa to further reduce its unit costs as the 737 MAX 10 will have, according to Boeing, the lowest unit costs of any narrowbody aircraft.

Copa to also take 737 MAX 8s

Copa initially placed orders for 61 MAX aircraft in Apr-2015. Copa has since increased its MAX commitments, partially by converting some of its remaining 737-800 orders to the MAX.

The group has so far specified that 15 of its MAX commitments are for MAX 9s and another 15 will be MAX 10s. It has not specified a breakdown for the remaining part of the order but Mr Heilbron told CAPA the group expects to eventually also operate the MAX 8.

The 737 MAX 8 is already in service while the 737 MAX 9 is expected to enter service in 2018. Copa is in line to be one of the first operators of the 737 MAX 9.

Not all of Copa's routes are thick enough to support the MAX 9 or MAX 10, making at least a small fleet of MAX 8s necessary. Copa at least for now also plans to keep a fleet of Embraer E190s, which are used in smaller short haul markets. However, clearly the focus is on upgauging where possible.

Copa slows down fleet expansion

As highlighted earlier in this report, the upgauging enables Copa to grow capacity without pursuing rapid fleet expansion.

The group's fleet currently consists of 101 aircraft and has been at approximately the 100 aircraft level the last two years. Fleet expansion will likely resume over the next few years but the total number of units will increase modestly and the rate of fleet growth that was achieved in the first half of this decade is unlikely to be repeated.

Copa Holdings fleet summary: as of 5-Jul-2017

Source: CAPA Fleet Database.

Copa reached the 100-aircraft milestone in 2015, completing a rapid phase of fleet expansion. The group's fleet consisted of only 55 aircraft at the end of 2009, 73 aircraft at the end of 2011 and 90 aircraft at the end of 2013.

During the first part of this decade, Copa upgauged some of its fleet from the 737-700 to 737-800 but the main driver of the growth was additional aircraft. At the end of 2009, Copa only operated nine 737-800s compared to 20 737-700s and 26 E190s. The 737-800 fleet has since expanded from nine to 66 aircraft. Of the 57 additional aircraft, only 11 have replaced smaller aircraft, resulting in some upgauging, while the other 46 aircraft were purely growth aircraft.

In mid 2015, Copa stopped expanding its fleet, slowing down deliveries of 737-800s and focusing on replacements rather than growth. Over the last two years the 737-800 fleet has grown slightly while the E190 fleet was cut by three aircraft and the 737-700 fleet was maintained at 14 aircraft. (The 737-700 fleet was cut in the early part of this decade, from 20 aircraft to 14 aircrafft.)

According to the CAPA Fleet Database, Copa took delivery of only one 737-800s in 2016 compared to eight aircraft in 2014 and eight aircraft in 2015. The group took two 737-800s in 1H2017 and has just two more 737-800s on order.

Copa uses 737-700s to launch new LCC brand

Of the 14 remaining 737-700s, seven are operated by Copa Colombia including four aircraft for low cost unit Wingo. The Wingo aircraft are in 142 seat all economy configuration while the rest of the 737-700 fleet is configured with 124 seats, including 112 economy seats at 31in pitch and 12 business class seats at 38in pitch. Copa does not have seatback IFE monitors on any of its 737-700s although this product is provided on the 737-800 fleet.

Copa's E190s have 94 seats, including 84 in economy at 31in pitch and 12 in economy at 38in pitch. Copa Colombia currently operates nine of the group's 21 E190s, according to the CAPA Fleet Database.

Copa Colombia's E190s and three of its 737-700s are operated under the full service Copa brand while four 737-700s are operated under the Wingo brand. Wingo was launched in Dec-2016 as an experiment of sorts with LCC operations. CAPA will examine Wingo in a separate upcoming analysis report.

Copa's outlook brightens as fleet is renewed and Latin America's economy improves

Copa remains primarily focused on expanding its full service operation. The combination of efficiency improvements, which will be generated by the 737 MAX, and an improvement in market conditions, should lead to a brighter outlook.

The Latin American market is starting to show some signs of recovery after a challenging two years. "Currencies have stabilised and, overall, the economies are projected to expand, after two years of negative GDP growth," Mr Heilbron said in an interview with CAPA prior to the start of the IATA AGM. "In regards to 2017, we are seeing positive demand trends, which we hope remain for the rest of the year and beyond."

See related report: Latin America's airline CEOs discuss the market, liberalisation, challenges & opportunities. Part 2

However Mr Heilbron warned that Copa is "not expecting demand to be back at 2012-2014 levels in the near future". Venezuela, which has traditionally been an important market for Copa, particularly remains a concern.

"Venezuela is kind of getting more difficult by the day. It's been struggling for a few years. This year with everything that's going on both political and economic it's doing even less well," Mr Heilborn said. He added Copa has cut frequencies to its three Venezuela destinations but will maintain a presence unlike other airlines in order to provide essential connectivity to Venezuelans, including those who have moved to Panama and other Latin American countries.

Copa obviously still faces challenges but seems to have weathered the worst part of the storm while maintaining its profit streak. Capacity expansion of 7% may seem ambitious given the still relatively weak demand environment. However, with the reduction in unit costs that will be generated by the new 737 MAX fleet the group should be able to maintain profitability even if yields continue to decline.