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Copa Airlines: returning to positive unit revenue as its crucial LCC transition in Colombia begins

Cautious optimism exhibited by Copa Airlines at the end of 2Q2016 that challenging conditions in Latin America were showing some signs of improvement has turned into a full-blown declaration that the worst is over in the region.  Although yields remain depressed, Copa turned a corner in its passenger unit revenue performance in 3Q2016, posting positive results driven by healthy load factors. Copa continues to experience strengthening demand, and believes it is only a matter of time before yields turn a corner.

The changing conditions have resulted in Copa issuing a slight upward revision to its margin guidance for 2016, and the airline has outlined a framework for restoring its operating margins to the high teens during the next couple of years. Copa’s preliminary growth project for 2017 is an ASM increase of approximately 5% driven largely by aircraft ultilisation.  

As optimism builds that Latin America is starting to turn an economic corner, Copa is undertaking a strategic business move by shifting its business model in Colombia to a low cost operation. The new entity Wingo is debuting in Dec-2016; Copa holds the view that the shift in business model is low-risk, and highlights the fact that Wingo does not carry the same challenges as low cost subsidiaries created by other airlines.

Copa rare among Latin American airlines posting positive 3Q2016 unit revenue

Copa was one of the few airlines operating in the Americas to post a positive unit revenue performance in 3Q2016, recording a 2.1% increase year-on-year in the metric. Its total unit revenues increased 1.8%. The results are a marked improvement from Copa’s performance during 1H2016.

Copa Holdings yield and unit revenue performance: 4Q2015 to 3Q2016

Quarter Year-on-year yield performance Year-on-year RASM performance
4Q2015 20.4% decrease 20.2% decrease
1Q2016 15.4% decrease 13.9% decrease
2Q2016 14% decrease 7.7% decease
3Q2016 7.8% decrease 1.8% increase

The company’s positive unit revenue performance was underpinned by an 8ppt increase in load factor year-on-year to 84%. Yields were still depressed but the decreases slowed to single digits in 3Q2016, which again is a significant improvement over Copa’s yield performance during the first half of the year.

Copa CEO Pedro Heilbron recently noted that yields remain soft; however, demand in Latin America is improving, and currencies are gaining some traction against the USD. (Note: this assessment was offered just after Donald Trump won the US Presidential election.)

The positive unit revenue trends are continuing for Copa in 4Q2016 as it expects further year-on-year improvement in those metrics. Mr Heilbron has stated: “In terms of the demand environment, we believe the worst is already behind us”.

Two markets where Copa has experienced challenges – Colombia and Brazil – are showing signs of improvement. The airline has advised that Colombia has been showing improvement year-on-year, and quarterly sequential improvement in both yields and passenger unit revenues.

Copa executives have remarked that yields in Brazil were up slightly on a year-on-year basis. Generally, the airline's position is that there continues to be upside in yields in South America. The region is in a second consecutive year of economic contraction, which means the yield recovery is beginning from a low base.

See related reports:

Copa works to restore its margins to historical levels during the next couple of years

Copa’s improving outlook has resulted in the airline issuing slight revisions to its operating margin forecast. The company now expects an 12% to 13% operating margin for 2016, versus a prior projection of 11% to 13%.

Economic weakness in Latin America during the past couple of years has dampened Copa’s historical margin performance. Its 11.8% operating margin in 2015 was a 9.2ppt drop from the 21% performance achieved in 2011.

Copa Airlines operating margin: 2011 to 2015

2011 21%
2012 17.9%
2013 19.8%
2014 19.3%
2015 11.8%

Copa has declared that it will return to operating margins in the high teens during the next year or two.

A number of factors are driving Copa’s margin performance back to historical levels including the rolling-off of fuel hedges that have cost the company USD200 million during the past couple of years. It estimates that the effects of unraveling negative fuel hedges should create 4ppt of positive operating margins in 2017. Copa is also undertaking a focus on ancillary revenues that should contribute 2ppt to 3ppt of positive margin in the 2018-2019 period.

Other elements of Copa’s plan to bolster operating margins include cost-cutting and the effects of recovering economies in the region.

The company’s preliminary operating margin for 2017 is 15% to 17%, which at the upper end falls into Copa’s goals of posting margins in the high teens. After growth in ASMs of just 1.5% in 2016, Copa’s preliminary capacity guidance for 2017 is 5% growth. But the airline stresses most of the increase is driven by increased aircraft utilisation and new routes launched in 2016 – including services from its Panama Cit Tocumen hub to Holguín, Cuba; Chiclayo, Peru; and Rosario, Argentina.

Copa plans to add one net aircraft to its fleet in 2017, for a total of 100 aircraft. It is taking delivery of two new Boeing 737 narrowbodies during the year.

Copa Holdings fleet summary as of 11-Nov-2016

Aircraft In Service Inactive On Order*
Total: 99 0 69
Boeing 737 MAX 0 0 65
Boeing 737-700 14 0 0
Boeing 737-800 64 0 4
Embraer ERJ190-100IGW(AR) 15 0 0
Embraer ERJ190-100LR 6 0 0

Copa is making a significant change in its Colombian operations in late 2016 by shifting its business model to a low cost operation – Wingo – which is utilising Copa Colombia’s operating certificate.

Wingo is designed to make Copa more competitive in the Colombian domestic market and on certain international routes from the country. Copa Colombia has fallen into the background within Colombia as the low cost airline VivaColombia has built up market share, and as LATAM Airlines Colombia has expanded operations.

Copa Colombia’s market share in the Colombian domestic market has dropped to 1% for the 8M ending Aug-2016 – from 12% in 1H2012.

See related report: Copa Airlines: branching out with its new LCC Wingo to regain lost ground in Colombia

Wingo is operating four of Copa’s Boeing 737-700s configured with 142 seats, taking over some of Copa Colombia’s routes and entering new markets.

Mr Heilbron stressed that Wingo is a low risk exercise; the LCC is assuming 95% of Copa Colombia’s routes. “We’re introducing a different model to a network we’re already operating,” he has said. “We’re, in a way, serving them [the routes] with a high cost product and a high cost operation in what are mostly low-yield leisure markets.”

With Wingo Copa is converting its Colombian operations into a more cost-effective structure, said Mr Heilbron. Copa has always focused on low cost, but it is a full service airline with a hub network. Wingo is a point-to-point airline operating the pure low cost model.

Another important element of Wingo’s operation is unlike the low cost arms of other airlines: there are no restrictions from labour. “We have full flexibility to do whatever we want with Wingo”, Mr Heilbron has stated.

Copa believes Wingo should make a positive contribution to its bottom line by 2H2017. By that time trends should also emerge showing the effects of Wingo on its fellow Colombian competitors – VivaAerobus, LATAM Airlines Colombia and market leader Avianca.

Copa begins to emerge from Latin America's recession and takes an LCC bet in Colombia

Copa’s positive unit revenue performance is a welcome sign that positive momentum is beginning to gain strength in Latin America after airlines operating in, to, and from the region have struggled with sagging demand during the past couple of years as the region’s economy has contracted. Copa’s growing confidence is reflected in its declaration of regaining its historical margin performance in the short term.

The transition to an LCC model in Colombia is a low risk way for Copa to restore its relevance in the country’s domestic market, which remains one of the fastest growing in Latin America.

Over the course of the next year Wingo hopes to prove that the market can sustain two low cost airlines.

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