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Azul shakes up Brazil market with A330s & US routes, becoming first long-haul LCC from the Americas

Brazi’s LCC Azul is set to become the first low-cost carrier in the Americas to establish a long-haul operation. Azul was founded by David Neeleman, who also founded highly successful New York-based JetBlue. The hereto-domestic LCC has made commitments for six second-hand A330-200s and five new A350-900s. The A330s will be delivered from early 2015 and be used to launch services to the US; the A350s will be delivered from early 2017.

Widebodies and long-haul services represent a gigantic leap for Azul as the carrier now only operates Embraer regional jets and ATR turboprops. Azul has quickly expanded since launching in late 2008 and has already surpassed 100 aircraft and 100 destinations while capturing a 17% share of the world's fourth largest domestic market. But it has never operated scheduled international services.

The sudden move to long-haul services will shake up the Brazilian market, prompting a potential move from leading Brazilian LCC Gol, which operates an all-737 fleet including an unusual one-stop product to the US.

Azul will have an unusual LCC fleet as A330s join E190s and ATRs

Azul unveiled plans on 23-Apr-2014 to begin a long-haul operation in early 2015 with flights to the US from its main hub, the Sao Paulo alternative airport Campinas. It also announced plans to lease six Rolls Royce-powered A330-200s for delivery from early 2015 and five Rolls Royce-powered A350-900s for delivery from early 2017. Azul and ILFC have concluded agreements covering three A330-200s and all five of the A350-900s.

Azul currently operates a fleet of 137 aircraft consisting of ATR 42/ATR 72 turboprops and E190/E195 regional jets, according to the CAPA Fleet Database. Growth of the fleet was accelerated in 2012 following the acquisition of TRIP, which also operated ATR turboprops and E-jets.

The integration process with TRIP, which followed a regional hybrid model, is now in the final phases and should be complete within the next couple of months.

Azul Fleet Summary: as at 25-Apr-2014

Aircraft In Service In Storage On Order*
Total: 137 3 22
Airbus A350-900XWB 0 0 5
ATR 42-300 0 1 0
ATR 42-320 0 2 0
ATR 42-500 9 0 0
ATR 72-212A(72-500) 14 0 0
ATR 72-212A(72-600) 34 0 6
Embraer E175LR 5 0 0
Embraer E195AR 52 0 11
Embraer ERJ190-100IGW(AR) 10 0 0
Embraer ERJ190-100LR 13 0 0

The A350-900s join an order book which currently includes only 12 additional E190/E195s and six additional ATR 72-600s. (Azul, however, could easily source more E190s as lead times for new E190s are short and there is also a supply of second-hand aircraft.)

Azul is the only LCC in the Americas currently operating turboprops and is one of only three LCCs in the Americas operating regional jets. The others are Mexico’s Interjet and New York-based JetBlue, which was founded by Azul CEO and founder David Neeleman and leased Azul its first two aircraft.

Azul now will also gain the distinction of being the first LCC in the Americas to operate widebody aircraft. But, paradoxically, it will remain the only LCC in the Americas not to operate Airbus or Boeing narrowbody aircraft.

Azul will become the world's seventh long-haul LCC, but will continue with its hybrid model

There are currently six LCCs with widebody operations, including four in Asia-Pacific where the long-haul low-cost model was pioneered. Australia’s Jetstar International and Malaysia’s AirAsia X became the first of the current generation of long-haul low-cost carriers in 2006 and 2007 respectively.

Singapore’s Scoot launched services in 2012 while the PhilippinesCebu Pacific and European group Norwegian began long-haul operations in 2013. Saudi Arabia’s flynas became the latest LCC to begin long-haul operations, adding its first A330 at the beginning of Apr-2014. (Indonesia’s Lion, which operates two 747-400s, is excluded from this list as its long-haul operation is - for the time being - limited to religious flights to Saudi Arabia following a full-service leisure carrier model.)

Azul plans to configure its A330-200s with 245 seats. The aircraft, which are currently operated by Emirates, will reportedly be reconfigured with 35 lie-flat business class seats, 50 extra-legroom economy seats and 160 normal economy seats. Azul already offers an extra-legroom economy seat product at the front of its E190/E195.

In-flight entertainment monitors will be included at every seat, following the typical Azul and JetBlue model (both carriers offer LiveTV). Azul and JetBlue have always followed hybrid models, offering complimentary snacks, drinks, checked luggage and IFE.

Of the long-haul LCCs, flynas and to a lesser extent AirAsia X and Jetstar follow hybrid models while Cebu Pacific, Scoot and Norwegian are "purer" LCCs.

Azul’s A330s will be unusually roomy for an LCC

Azul will have the lowest seating density of all the widebody LCC operators. The six existing long-haul LCCs currently configure their widebody aircraft with between 291 and 436 seats. The 291 seat count is on the relatively spacious 787-8 operated by Norwegian.

Jetstar and flynas are the only carriers in the long-haul LCC grouping operating A330-200s (excluding AirAsia X which has just one A330-200 that is due to be returned in 2015). Jetstar’s A330-200s, which are now in the process of being replaced with 787-8s, has 302 seats and flynas’ A330-200s, which are being leased from Hi-Fly, has 335 seats.

Several full-service carriers have A330-200s with more than 250 seats.

Widebody long-haul LCC configurations: as of Apr-2014

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Airline Aircraft Type Economy Premium Seats Total
AirAsia X A330-300

365

(3-3-3)

12 Business

(2-2-2)

377
Cebu Pacific A330-300

436

(3-3-3)

0  436
flynas (one configuration) A330-200

 283

(2-4-2)

 12 Business

(2-2-2)

40 Economy Plus

(2-4-2)

335 
Jetstar A330-200

265

(2-4-2)

38 Business

(2-3-2)

303
Jetstar 787-8

314

(3-3-3)

21 Business

(2-3-2)

335
Norwegian 787-8

 259

(3-3-3)

32 Business

(2-3-2)

291
Scoot 777-200

370

(3-4-3)

32 Business

(2-4-2)

402

Azul will also be only the second LCC with a lie-flat product, joining AirAsia X. flynas offers an angled lie-flat seat in its business cabin while Jetstar, Norwegian and Scoot have recliner style business class seats (which are similar to premium economy on some full service airlines). Cebu Pacific is the only carrier in the group that has opted for an all-economy configuration, with no premium seating.

Azul plans to offer the same three products (economy, economy with extra legroom and business) in the A350, which reportedly will be configured with 323 seats. Mr Neeleman stated that Azul has no intention of adding A320 family aircraft, meaning the carrier will not operate any aircraft with more than 120 seats or less than 240 seats. The most common aircraft for LCCs are in the 150-seat to 200-seat range.

Leapfrogging the most common size aircraft for LCCs could make it difficult for Azul to expand into the regional international market or domestic trunk routes. But Azul has built up a successful niche by focussing on thin Brazilian domestic routes, a majority of which are not operated by any other carrier. TAM and Gol do not operate aircraft smaller than the A319 and 737-700 respectively.

Azul’s new long-haul operation will leverage its Campinas hub

Brazil’s vast size and the rapid growth of secondary cities have opened up opportunities on point to point routes bypassing major cities. Campinas also has grown rapidly as Sao Paulo’s two main airports, Congonhas and Guarulhos, have become congested. Congonhas, located near the centre for Sao Paulo, only handles domestic flights and is slot restricted. As a start-up Azul does not have any weekday slots at Congonhas but is able to operate a limited number of flights on weekends.

Guarulhos is the major international gateway to Brazil and is also the largest domestic airport in Brazil. Campinas is currently the seventh largest domestic airport in Brazil based on current seat capacity. Azul currently accounts for 89% of total seat capacity at Campinas, according to CAPA and OAG data.

Campinas capacity share (% of seats) by carrier: 21-Apr-2014 to 27-Apr-2014

Campinas (VCP) is by far Azul’s largest hub, accounting for 42% of its total seat capacity. Its second largest operation is at Belo Horizonte (CNF).

Azul top 10 bases/hubs/stations based on seat capacity: 21-Apr-2014 to 27-Apr-2014

Campinas has primarily been used for domestic services and cargo but has started to attract some international services, including from TAP Portugal and Pluna before the Uruguayan carrier ceased operations in 2012. Gol also recently announced plans to launch from 18-Jul-2014 three weekly flights from Campinas to Santo Domingo with continuing service to Miami. This will be Gol’s first international service at Campinas and will be only the second scheduled international passenger service at the airport after TAP’s twice weekly service from Lisbon.

Campinas is the most logical hub for Azul’s new long-haul operation as the carrier will be able to tap into the largest source market in Brazil, the Sao Paulo metropolitan area, and offer connections. Azul currently operates about 50 domestic routes from Campinas, giving the carrier a huge base of potential feed for its new US routes.

Brazil’s largest carrier, TAM, currently only operates two domestic routes from Campinas. Gol operates four domestic routes and is about to launch a fifth, a high frequency service on Azul’s biggest route Campinas-Rio de Janneiro Santos Dumont (SDU), which along with the new Campinas-Santo Domingo-Miami service is an indication of a brewing battle between Brazil’s two LCCs.

The large US market attracts Azul

Although much smaller than Gol, Azul has the largest domestic network among Brazilian carriers, which could give the carrier an advantage as it enters the Brazil-US market.

The US is by far the largest international destination from Brazil, accounting for 25% of the country’s international seat capacity. Such a large pie persuaded Azul to skip over the regional international market and focus on the biggest market.

Brazil international capacity share (% of seats) by country: 21-Apr-2014 to 27-Apr-2014

Azul could still potentially enter some regional international markets using its E190/E195 fleet. Argentina and Uruguay would both be easily within range of the E190/E190s, giving Azul an option without needing to add A320s or 737s. Argentina accounts for 17% of total Brazilian international seat capacity and about half of all intra-South America international capacity while Uruguay accounts for about another 3%.

The US-Brazil market also presents Azul with an attractive opportunity as it will be only the second Brazilian airline (after TAM) with non-stop services to the US. In regional international markets Azul would be the third Brazilian carrier after Gol and TAM.

Gol pursues international expansion but an all-737 operation has its limits

Gol has been increasing its focus on the international market over the last two years as domestic market conditions have become challenging. In the first two months of 2014, Gol’s international RPKs were up 19% while TAM’s RPKs were down 5% year over year. Gol is still a much smaller international carrier, with a 15% share among Brazilian carriers compared to 85% for TAM, but is eager to close the gap.

See related report: Profitability eludes Brazil’s Gol for a third consecutive year and a turnaround still looks distant

Gol’s international expansion included the late 2012 launch of services to Miami and Orlando. But both destinations are served with a one-stop product via a mini-hub in Santo Domingo as Gol has been adamant to keep its single-fleet strategy.

Gol briefly operated long-haul flights with 767s in 2007 and 2008, following its acquisition of bankrupt flag carrier Varig. But its non-stop flights to the US and Europe were highly unprofitable and were soon suspended. (Lease commitments forced Gol to keep 767s in its fleet until 2011, alternating between grounded status and charters, before it finally was able to phase out the type and pledged to never again operate widebodies.)

Miami and Orlando are served from Santo Domingo, where passengers arrive from Sao Paulo Guarulhos, Rio de Janeiro Galeao and, soon, Campinas. But Gol has payload restrictions on the Brazil-Santo Domingo legs, making the operation relatively inefficient while the inconvenience of the stopover has made it challenging to sell.

See related report: Gol’s latest attempt to serve the booming Brazil-US market faces challenges

Azul’s entrance will make it even more challenging for Gol as Azul comes in with a competing low fare product plus the convenience of non-stops. Gol has had some success stimulating demand in the Brazil-US market, perhaps convincing Azul of the potential. But once there is a non-stop low-cost option, Gol’s niche could be compromised. Gol could eventually be faced with the difficult decision of withdrawing from the US or adjusting its strategy once again by acquiring widebody aircraft.

The Brazil-US market is highly competitive but dominated by oneworld

Even if Gol retreats, Azul will have its share of competition. While the US is a popular destination for Brazilians, total non-stop capacity between the two countries has increased by about 40% over the last two years. US carriers in particular have expanded rapidly, taking advantage of traffic rights made available from a new liberal bilateral agreement.  

The three main US airline groups (American/US Airways, Delta and United) now account for 71% of total seat capacity in the Brazil-US market. LATAM subsidiary TAM, a close partner with American and now a member of oneworld, accounts for about 28%, according to CAPA and OAG data.

Brazil to US total capacity (one-way seats per week): 19-Sep-2011 to 19-Oct-2014

Azul could potentially partner with United, which has only a 14% share of seat capacity in the Brazil-US market compared to 37% for American and a powerful 69% share for the American/TAM combination (includes flights operated by US Airways).

Azul recently began interlining with United and the two carriers also now have a reciprocal frequent flier arrangement. Azul’s initial US routes would not overlap with United as Azul is looking at Florida – most likely Fort Lauderdale near Miami and Orlando – while United serves Brazil from its hubs in Chicago, Houston, Newark and Washington Dulles.

United and JetBlue would be logical partners for Azul

A stronger partnership between Azul and United could give United access to the largest Brazil-US market. Sao Paulo-Miami is now the largest Brazil-US route while Sao Paulo-Orlando is the seventh largest. United can now only serve these markets with significant backtracking.

Brazil-US routes ranked by seat capacity: 21-Apr-2014 to 27-Apr-2014

Rank Origin Destination Total Seats
1 GRU Sao Paulo Guarulhos International Airport MIA Miami International Airport 11,802
2 GRU Sao Paulo Guarulhos International Airport JFK New York John F Kennedy International Airport 8,651
3 GRU Sao Paulo Guarulhos International Airport ATL Hartsfield-Jackson Atlanta International Airport 3,150
4 GIG Rio de Janeiro Galeão International Airport JFK New York John F Kennedy International Airport 2,961
5 GIG Rio de Janeiro Galeão International Airport MIA Miami International Airport 2,961
6 GRU Sao Paulo Guarulhos International Airport LAX Los Angeles International Airport 2,686
7 GRU Sao Paulo Guarulhos International Airport MCO Orlando International Airport 2,453
8 GRU Sao Paulo Guarulhos International Airport DFW Dallas/Fort Worth International Airport 2,170
9 GIG Rio de Janeiro Galeão International Airport IAH Houston George Bush Intercontinental Airport 1,904
10 GRU Sao Paulo Guarulhos International Airport IAD Washington Dulles International Airport 1,904
11 GRU Sao Paulo Guarulhos International Airport ORD Chicago O'Hare International Airport 1,904
12 MAO Manaus Eduardo Gomes International Airport MIA Miami International Airport 1,775
13 BSB Brasilia International Airport MIA Miami International Airport 1,725
14 GIG Rio de Janeiro Galeão International Airport ATL Hartsfield-Jackson Atlanta International Airport 1,722
15 GRU Sao Paulo Guarulhos International Airport EWR New York Newark Liberty International Airport 1,645
16 GRU Sao Paulo Guarulhos International Airport DTW Detroit Wayne County Airport 1,575
17 POA Porto Alegre Salgado Filho Airport MIA Miami International Airport 1,526
18 CNF Belo Horizonte Tancredo Neves International Airport MIA Miami International Airport 1,487
19 GRU Sao Paulo Guarulhos International Airport IAH Houston George Bush Intercontinental Airport 1,456
20 GRU Sao Paulo Guarulhos International Airport CLT Charlotte Douglas International Airport 1,428
21 GIG Rio de Janeiro Galeão International Airport CLT Charlotte Douglas International Airport 1,428
22 BSB Brasilia International Airport ATL Hartsfield-Jackson Atlanta International Airport 1,281
23 REC Recife Guararapes International Airport MIA Miami International Airport 724
24 SSA Salvador Luis E Magalhaes Airport MIA Miami International Airport 724
25 GIG Rio de Janeiro Galeão International Airport DFW Dallas/Fort Worth International Airport 654
26 BEL Belem Val de Cans Airport MIA Miami International Airport 410

Azul would also potentially give United access to more secondary cities via Campinas. Currently Azul interlines with United at Sao Paulo Guarulhos and Rio de Janeiro Galeao, where Azul offers fewer destinations than Campinas.

Azul also has the potential option of working with JetBlue. Mr Neeleman told Bloomberg that Azul is currently in talks with JetBlue over a codeshare partnership which would begin when Azul enters the US market in 2015.

A JetBlue deal would provide Azul with better offline access in the US than United as Azul is targeting JetBlue hubs. Currently Fort Lauderdale is JetBlue’s third largest hub while Orlando is fourth largest. Mr Neeleman has said service to New York, which is JetBlue’s largest hub, is also a possibility after Fort Lauderdale and Orlando. (Boston is JetBlue’s second largest hub but is unlikely to support service from Brazil.)

Ideally Azul will find a way to work with both United and JetBlue. Both are natural partners, with United keen to find a replacement for TAM, which left Star when it joined oneworld in Mar-2014. Avianca Brazil is now in the process of joining Star but is a smaller carrier with a much smaller network (about 25 destinations compared to just over 100 for Azul).

See related report: Star Alliance considers new platform for low-cost airlines, targeting Brazil's Azul & India's IndiGo

JetBlue codeshares with several foreign carriers and is generally open to partnerships. While JetBlue and Azul are naturally linked through Mr Neeleman and common business models, there has never been a need to pursue a partnership as JetBlue only serves the northern part of Latin America while Azul has so far stuck to domestic operations.

With Azul now preparing to enter the US market, the Azul-JetBlue dynamic obviously changes considerably. Indeed, it is unlikely that Mr Neeleman would have made the move to enter the US market without having first shared views with former colleague Dave Barger.

Azul’s long-haul strategy bears risks - but high potential

JetBlue has also looked at acquiring A330s to enable expansion deeper into South America. With Azul making the first move, JetBlue is likely to be intrigued and could learn from Azul as it becomes the first LCC in the Americas to operate long-haul flights.

Few would have predicted Azul expanding into widebody aircraft and entering the US before JetBlue acquired widebodies and launched services to Brazil. But the market conditions and opportunities Azul faces in Brazil are much different from what JetBlue faces in the US.

Azul has quickly expanded domestically to become Brazil’s third largest carrier, with a 17% share of domestic RPKs in 2013 and again a 17% share in the first two months of 2014, according to Brazil ANAC data.

Azul is already almost half the size domestically of Gol and TAM, which accounted for 37% and 38% shares respectively of the domestic market in the first two months of 2014. Avianca Brazil, which only operates domestic services and could now be tempted to make a move on its long-held ambitions to expand into widebody aircraft, accounted for 8% of domestic RPKs in the first two months of 2014.

However, Azul’s opportunities for further domestic expansion are limited. Azul needs the international market to continue its growth trajectory and given Brazil’s geography the options for international expansion are limited without widebody aircraft.

See related report: Azul’s IPO prospects during 2014 will be challenged by tenuous market conditions

The opening exists for a second Brazilian long-haul carrier and by pouncing now Azul is able to put its stake in before a competitor is able to make a move. But making the leap from a regional fleet to A330s necessarily contains risk, particularly as it comes before Azul has been able to complete an initial public offering.

The right partnerships will be key to success

A key component in reducing the level of risk exposure will be the nature of Azul's partnerships. Existing independent long-haul low cost operations rely heavily on short-haul connectivity at their bases; Azul's domestic network alone is unlikely to be sufficient to deliver the necessary feed to support a long-haul operation.

While the predominant traffic flow is from the US to Brazil, a potential JetBlue feed into Azul widebody services would go a long way to securing a profitable operation.

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