03-Sep-2013 12:30 AM

Latin America remains drastically under-served by low-cost airlines outside Brazil and Mexico

Analysis

Latin America provides huge growth opportunities for low-cost carriers given the region's expanding middle class and miniscule LCC penetration rate outside the two largest domestic markets. The existing small field of six LCCs are best positioned to benefit from the anticipated growth and leverage their first mover advantage. Four of the carriers are eyeing initial public offerings (IPOs), which could give them the cash to accelerate expansion in their home markets and regionally.

Latin America's LCC sector is now concentrated in only three countries - Brazil, Mexico and Colombia. The other 18 countries that comprise Latin America (excluding the Caribbean) account for about 35% of seat capacity but, remarkably, do not have a single local LCC. These markets are only served by foreign LCCs, resulting in limited and in some cases no LCC services at all. The overall LCC penetration rate in these 18 countries is approximately 2%.

Summary

Latin America has a low penetration rate of low-cost carriers (LCCs) outside of Brazil, Mexico, and Colombia.
The LCC penetration rate in Latin America is below 10% in most countries, with some countries having no LCCs at all.
Brazil and Mexico have the highest LCC penetration rates in the region, with rates above 40% and 50% respectively.
The LCC market in Latin America is currently dominated by six carriers, with Gol and Azul being the largest.
Latin America has significant growth potential for LCCs, especially in the international market where LCCs account for only 10% of capacity.
The establishment of more LCCs in Latin America, particularly in untapped markets like Ecuador, Peru, and Chile, could drive further growth in the region.

Most of Latin America has LCC penetration rates below 10%

Latin America has five medium size domestic markets which are still not served by any LCCs -Argentina, Chile, Ecuador, Peru and Venezuela. Of the 37 domestic markets in the world that have at least 100,000 weekly seats there are only two others that have the distinction of having zero LCC penetration rates - Iran and Russia. (Russia had local LCCs previously and is expected to see the launch of at least one LCC in 2014.)

The LCC penetration rate is over 40% in Brazil, whose market accounts for nearly 40% of total capacity in Latin America. The region's second largest market, Mexico, has a LCC penetration rate of over 50%. The exclusively domestic penetration rate in both these countries is around 60%. Three of Latin America's six LCCs are Mexican - Volaris, Interjet and VivaAerobus - while the region's two largest LCCs are Brazilian - Gol and Azul.

The sixth and newest LCC is VivaAerobus' Colombian sister carrier VivaColombia. Colombia, Latin America's third largest market, currently has a LCC penetration rate of about 8%, including 9% domestically. It should reach double digits in 2014 as VivaColombia, which launched services in May-2012, pursues further expansion.

The only Latin American market besides Brazil and Mexico that is currently in the double digits is Costa Rica, where six foreign LCCs account for about 11% of total capacity. In the rest of the region the LCC penetration rate is likely to remain, at least for the short to medium term, in the low single digits and in some cases zero.

Chile is the largest aviation market in the world that is not served by any LCC (foreign or local). Peru and Panama have LCC penetration rates of less than 1%, El Salvador a rate of about 1% and Venezuela about 2%.

Peru, Panama, El Salvador and Venezuela are currently served by just one LCC - US-based Spirit Airlines in the case of Peru, Panama and El Salvador and Gol in Venezuela, although JetBlue will become the second LCC in Peru in Nov-2013. The other main markets (at least 100,000 weekly seats) in Latin America - Argentina and much smaller Bolivia - have LCC penetration rates of 5% and 4%. Gol is the only LCC currently serving both of these countries.

LCC penetration rates (% of total seats) in Latin America by country

From a LCC perspective, Latin America could become the next Southeast Asia

Combined, the region's six LCCs, or five LCC groups, currently offer about 2.1 million seats weekly. Only 5% of these seats are in the international market.

North American LCCs provide about another 79,000 weekly seats to and from Latin America (excluding the Caribbean), resulting in a total LCC market of about 2.2 million seats.

LCC capacity to/from/within Latin America by airline group: 2-Sep-2013 to 8-Sep-2013

Rank	Airline Group	Weekly seats	International seats	% of LCC seats
1.	Gol	1,023,256	50,024	47%
2.	Azul	515,977	0	24%
3.	Interjet	236,436	25,200	11%
4.	Volaris	196,608	31,152	9%
5.	Viva Group	126,160	888	6%
	Foreign LCCs*	79,044	79,044	4%
	TOTAL	2,177,481	186,308

In comparison, Southeast Asia has over 3.3 million weekly LCC seats although it has almost the same number of total seats as Latin America. Southeast Asia has a LCC penetration rate of over 40% compared to less than 30% for Latin America. There are currently 22 LCCs based in Southeast Asia compared to six LCCs in Latin America.

The significantly higher LCC penetration rate in Southeast Asia's international market particularly highlights the untapped potential of Latin America. LCCs currently account for about one quarter of international capacity in Southeast Asia but only about 10% of international capacity in Latin America. LCCs account for roughly one half of international capacity within Southeast Asia but less than 5% of international capacity within Latin America.

While Latin America is a bigger region geographically, most international routes in Latin America are within narrowbody range. Demand is growing, driven by strong economies and a push to bolster regional trade and rely less on traditional economic ties with the US and Europe.

Fares on international routes within Latin America remain high, providing an opening for significant stimulation if LCCs successfully penetrate the market. Taxes are also high which limits the ability to offer really low fares but there should still be opportunity to reduce average fares significantly and stimulate new demand.

Latin America LCC Capacity Share (% of total seats): 2001 to 1H2013

Gol starts to focus more on international markets but remains predominately domestic

Latin America's leading LCC Gol is slowly starting to focus more on international markets, both within Latin America and beyond, partially in response to unfavourable domestic market conditions. Gol has been steadily slashing domestic capacity over the last year in an attempt to restore rationality after a period of intense competition and over-capacity.

Gol captured 35% of Brazil's domestic market in 1H2013, down from 40% in the same period of 2012, according to RPK data from Brazil's ANAC. The group's domestic ASKs were down 11% year-over-year.

Gol expects its full year capacity to be down 9% compared to 2012 levels. The cuts have been driven by the late 2012 closure of Webjet, a smaller LCC which Gol acquired in 2011.

While Gol has significantly shrunk its presence domestically, its international ASKs were up 32% in the first seven months of 2013, according to ANAC data. The increase was mainly driven by new services to the Caribbean and the US state of Florida. Gol is preparing to further expand its international network in 2H2013 by launching services to Nigeria. The carrier has said that over the long term it aims to have international services account for 15% to 16% of total revenues, up from only 8% currently.

But Gol over time will likely be persuaded to accelerate international expansion within Latin America, organically and potentially by establishing joint ventures in other countries. Gol also continues to expand its virtual network through its alliance strategy, which it began pursuing in 2009 and initially resulted in codeshare deals with Air France-KLM and Iberia. Gol has since added several codeshares and also now interlines with about 30 carriers, an example of hybridisation.

Gol in some respects has been a hybrid carrier for several years, pursuing corporate passengers and becoming one of the world's first LCCs with a frequent flyer programme. It inherited the FFP as part of the 2007 acquisition of former flag carrier Varig, a deal which also gave it a long-haul operation. But scheduled long-haul flights were dropped after only one year as Gol decided to return to its roots as a LCC; but, in the process it did retain some elements of the hybrid model.

Only about 5% of Gol's seat capacity is currently allocated to the international market. Relying so heavily on the domestic market has proven to be a weakness as Brazil's economy has slowed down significantly. RPK growth in Brazil's domestic market slowed to 7% in 2012 after growth of 16% in 2011 and 24% in 2010. Domestic RPKs were flat through the first seven months of 2013 and the outlook for Brazil's air transport market for the rest of 2013 is bleak due to Brazil's sluggish economy.

Azul remains entirely a domestic operator - for now

Brazil's other LCC, Azul, currently only operates domestic services but inevitably will also need to expand into the international market. To date, expansion in the domestic market has kept Azul busy, including the merger with regional hybrid carrier TRIP (all TRIP flights now operate under the Azul brand).

TRIP was a regional carrier following a hybrid model while Azul launched at the end of 2008 along the lines of the JetBlue hybrid LCC model. Azul means blue in Portuguese and was established by JetBlue founder David Neeleman. There are currently no ties between the two companies although a partnership would perhaps be logical once Azul starts to look beyond the domestic market and as JetBlue continues to pursue expansion in Latin America from its bases in Fort Lauderdale, Orlando and New York.

Azul is confident it can continue to expand domestically, but opportunities could start to become limited as Brazil's economic environment deteriorates and given that Azul has already grown to account for 20% of seat capacity in the Brazilian domestic market. Based on RPKs flown in the first seven months of 2013, the Azul Group captured 17% of Brazil's domestic market compared to 14.6% during the same period of 2012 (includes Azul and TRIP). ASKs were up 12% but that represents a dramatic slowdown for the young and ambitious Azul, which recorded ASK growth of 32% in 2012.

In late May-2013 Azul unveiled plans for an IPO, which was likely to have led to a re-acceleration of fleet and network growth, including potential international expansion. But Azul in Aug-2013 announced it had decided to delay the IPO, apparently a victim of Brazil's deteriorating economy. The carrier still aims to pursue an IPO in future once market conditions are more favourable.

In less than five years Azul has quickly grown to become Latin America's second largest LCC. It will need international expansion and a successful IPO to unlock a second phase of rapid growth.

Volaris IPO could lead to further growth

Volaris, which is also focused primarily on domestic expansion, followed Azul by unveiling its own IPO plans in Jun-2013. A successful IPO could support international expansion in the medium to long term, both organically and potentially through the establishment of new joint ventures in other Latin American markets.

Volaris currently allocates 16% of its seat capacity to the international market, more than any LCC in Latin America. But all its international flights are to the US. It currently has no plans to serve other Latin American markets but inevitably it will look south as the domestic Mexican market becomes saturated.

Volaris maintained its focus on domestic expansion over the last year as that operation has performed better than its US ventures. Rapid expansion in the US was pursued in the initial two years after launching international services in mid-2009. But a planned codeshare with Southwest, which could have enabled further US expansion, failed to materialise and is now unlikely. Volaris has elected not to pursue alliances with any other carriers, including with Avianca-TACA, despite some common ownership.

Hybridisation could come later but for now Volaris is focused on a relatively pure LCC model and the domestic market. The carrier's system-wide ASKs grew by 17% in 2012 and are projected to be up by about 20% in 2013, with nearly all of the expansion coming domestically.

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Volaris captured 20% of the domestic Mexican market in 2012, compared to 18% in 2011, according to passenger figures from Mexico's DGAC. Volaris has recorded further market share gains so far in 2013, accounting for 23% of passengers through the first seven months of the year.

The overall Mexican domestic market grew by 10% in 2012, providing the first double digit figure expansion in five years. Growth has slowed to 7% in the first seven months of 2013 but market conditions in Mexico, which for several years were impacted by a listless economy and over-capacity, remain relatively favourable. As a result the outlook for all three of the country's LCCs is bright.

Interjet plans further domestic growth as Superjet deliveries begin

Interjet is positioned as more of a hybrid carrier, with a product targeted at business travellers. It seats only 150 passengers on its A320s compared to the standard LCC configuration of 180.

Interjet is further hybridising and attempting to differentiate itself from the other Mexican LCCs by diversifying into smaller aircraft with the Sukhoi Superjet. Interjet recently took the first of at least 20 Superjets and plans to operate its first Superjet revenue flight this week on the Mexico City-Torreon route. The carrier intends to use the new type to launch services on thinner routes which generally have not previously been served by LCCs. This will put Interjet more in competition with Aeromexico Connect, the full-service regional subsidiary of Mexico's only remaining flag carrier.

The delivery of all 20 Superjets to Interjet by the end of 2014, along with several additional A320s, will result in accelerated growth, both domestically and in the international market. Interjet accounted for 25% of the domestic market in 2012, compared to 24% in 2011. Through the first seven months of 2013 it again captured 25% of the domestic market, according to Mexico DGAC data.

Interjet has also been pursuing modest international expansion since launching international services in 2H2011. It currently allocates 11% of seat capacity to the international market and serves five US destinations along with two destinations in Central America, one in South America and one in the Caribbean.

Bogota was launched in Jul-2013, becoming the first South American destination to be served by a Mexican LCC. More international expansion for Interjet is likely, particularly if the carrier is successful with its second attempt at an IPO. Interjet initially delayed a planned IPO in mid-2011.

Volaris, Interjet and VivaAerobus monthly traffic: Jan-2010 to Jul-2013

VivaAerobus is Mexico's smallest LCC but could accelerate growth following IPO

VivaAerobus has also been pondering an IPO and along with Interjet will likely see how the market responds to Volaris before moving forward. (Gol is currently the only publicly traded LCC in Latin America.)

VivaAerobus is Mexico's smallest LCC but is part of a group with big and broad ambitions. VivaAerobus and VivaColombia are backed by aviation investment firm Irelandia, which is keen to create the first pan-regional LCC group in Latin America.

VivaAerobus and VivaColombia for now are focused on their respective domestic markets, where they see further opportunities to expand. But international expansion for both carriers and the establishment of new Viva affiliates in other Latin American markets is needed if it is to establish a successful regional presence.

VivaAerobus currently allocates 99% of its seat capacity to the domestic market as it serves only one destination in the US, where unlike Interjet and Volaris it has been shrinking in recent years. The carrier has not yet ventured southward into other Latin American countries.

VivaAerobus has been focused on the bottom end of the Mexican market, sticking with a pure LCC model and offering low frequency service on under-served point-to-point routes. Owner Irelandia - which has consistently retained a core LCC approach in its other investments - has stated it is not a proponent of the hybrid model, making it unlikely that VivaAerobus or VivaColombia will follow other Latin American LCCs in hybridising.

VivaAerobus captured 13% of Mexico's domestic market in 2012, up from 12% in 2011. Through the first seven months of 2013 the carrier again accounted for 13% of domestic passengers. VivaAerobus has not been growing as rapidly as Interjet or Volaris but a possible IPO could lead to accelerated growth, both domestically and internationally.

VivaColombia starts to penetrate Colombian domestic market

VivaColombia currently only operates domestically, where it captured an 8% share of the Colombian market in 1H2013, according to passenger data from the Colombian CAA. As the only Colombian LCC there is room for significantly more domestic growth before VivaColombia needs to focus on the international market.

Market conditions in Colombia are favourable. The domestic passenger market grew 21% in 1H2013, representing a further acceleration of the rapid 15% growth recorded for the full year in 2012. A relatively strong economy, particularly compared to Brazil, and a fast-growing middle class provides opportunities for LCCs.

Like its sister carrier, VivaColombia is focused on the pure LCC model and stimulating demand on point-to-point markets that were previously not served or were under-served. The carrier has been successful so far at growing routes that bypass congested Bogota, giving it confidence it can continue to grow domestic market share without having to operate international services for at least the short to medium term. As it only launched services in May-2012, VivaColombia is only just starting to penetrate the Colombian market.

VivaColombia monthly passenger traffic: May-2012 to Jun-2013

The potential establishment of a third and even fourth Viva franchise could prompt VivaColombia to move more quickly into the international market. Additional franchises would provide greater brand recognition regionally and network synergies, making international services (particularly those connecting existing dots) more attractive.

Given Colombia's more central geographic position compared to Mexico, VivaColombia would more likely benefit from a network synergy perspective as more affiliates are added. Ecuador and Peru, both of which are within a short flight of Colombia and are barely penetrated by LCCs, could be potential Viva markets.

Latin America needs more LCCs

Ecuador, Peru and Chile are liberal markets that would welcome a local LCC. The larger markets of Argentina and Venezuela are at least for now closed and remain government-protected, but outside these two countries there are plenty of opportunities.

Having an international presence would be critical in establishing LCCs in Ecuador, Peru or Chile because the domestic markets in these countries, while they could benefit from LCC competition, are relatively small.

As LCCs inevitably become established in more Latin American countries, they will need to focus more internationally and will not be able to rely as heavily on the domestic market like the pioneers in Brazil, Mexico and Colombia. Latin America's international market is ripe for LCC growth and new LCCs can successfully become established in smaller markets if they are part of groups, thereby providing the economy of scale and network synergies to survive a battle with full-service incumbents.

Full-service carriers now account for about 95% of international capacity within Latin America. Incredibly there are only two LCCs currently operating international flights within Latin America.

Latin America international LCC capacity by carrier: 2-Sep-2013 to 8-Sep-2013

Rank	Airline	Weekly seats
1.	Gol	36,040
2.	Interjet	6,300

If Viva successfully leads the way in finally establishing LCCs in new Latin American markets, others will almost certainly follow. The LCC chapter of Latin American aviation history remains largely unwritten. Six LCCs for a region of nearly 600 million people is an absurdly low figure.

Note: a version of this article was originally published in the August/September-2013 edition of CAPA's strategy journal Airline Leader.