The Trump presidency casts a long shadow over a tentative recovery in Latin America
After battling dismal economic conditions for the past two years, Latin America is poised to begin pulling itself out of fiscal decay in 2017. Near the end of 2016, forecasts tilted toward a return of modest GDP growth between 1.5% and 2% for 2017 after the region endured an economic recession for the prior two years.
But the emerging optimism was significantly clouded when the US selected Donald Trump as its next president in Nov-2016. An already weak Mexican peso (MXN) plunged against the US dollar (USD) on fears of a Trump Administration abolishing NAFTA, engaging in mass deportation and following through on plans to erect a wall on the US-Mexico border. Economists have already issued revisions to Mexico’s projected economic growth for 2017, and the benefits of a new liberalised bilateral between the two countries are in jeopardy as airlines have to adjust their growth prospects to reflect a potential new era of protectionism.
Broader implications of Mr Trump’s presidency on Latin America will emerge over time; hopefully they will not be as sombre as the politicking noises might suggest.
But even so the current cloud of continuing uncertainty ushered in by his election could become an impediment to recovering economies and air traffic flows within, and to and from the region – just as demand was starting a tepid recovery near the end of 2016. Any downward revision to Latin America’s economic forecast for 2017 places airlines operating in the region in a precarious position.
LCC capacity share (%) of total seats: 2007 to 2016 Jan-Dec*
Country share of Latin America % of seats as of early Dec-2016
Latin America projected delivery dates for aircraft as at 12-Dec-2016
Throughout the last two years economic conditions have forced Latin American airlines to strike a balance of adjusting their business to the current climate and forging strategies to compete over the long term in a region with significant and inherent untapped potential.
As Brazil’s recession created a downward economic spiral in Latin America beginning in late 2014, pricing traction collapsed. Even with markedly lower fuel costs, many Latin American airlines faced significant pressure on their financial results in 2015. Although Copa remained profitable, its net income in 2015 fell nearly 49%. LATAM Airlines Group posted a USD109 million loss for the year and Avianca Holdings’ losses in 2015 reached USD139.5 million. Brazilian airline Gol, which is almost exclusively a domestic operator, posted a USD1.2 billion loss in 2015, and was forced to undertake a significant debt restructuring as access to credit for Brazilian companies vaporised.
In late 2015 and continuing through 2016, Avianca, Copa, LATAM and Gol all slashed their fleet forecast to adjust to the new short term economic reality in Latin America. Over that time period, LATAM reduced its fleet commitments by USD5 billion. Avianca has pushed back the deliveries of 28 Airbus aircraft from 2016 to 2019, slashing its capital expenditures by USD2.4 billion for that time period. Copa’s fleet is growing by just one aircraft in 2017 for a year-end total fleet of 100. During 2016, Latin American airlines accepted delivery of just 20 aircraft, according to the CAPA Fleet Database. Deliveries pick up in 2017 as production of new generation Airbus and Boeing narrowbodies ramps up.
Beginning in late 2Q2016 some Latin American airlines began to see signs that anaemic operating conditions were reaching an inflection point, and their optimism gained momentum in 3Q2016.
Copa turned a corner in its unit revenue performance in 3Q2016, posting positive results after deep year-on-year decreases. Although yields remain depressed, company executives concluded: “In terms of the demand environment, we believe the worst is already behind us.” Copa’s operating margin for 2016 fell between 11% and 13%, which is below the airline’s historical highs. But Copa believes it can restore its margins to the high teens during the next two years.
Avianca also exhibited optimism about the changing tides in Latin America’s economic environment as 2016 drew to a close driven by stabilisation in exchange rates and healthy load factors, particularly in long haul markets. The company welcomed the start of a rebound in Brazil, which is both Latin America’s largest economy and aviation market.
Brazil’s largest domestic airline measured by seat deployment, Gol, posted a BRL1.1 billion profit for the nine months ending Sep-2016. The company also recorded positive unit revenue and yield growth for that time frame.
The government of Brazil forecasts positive GDP growth of 1.5% for 2017. However, Gol understandably is taking a careful approach to assessing the market going forward. “In terms of outlook, I think this is a time to be cautious”, Gol CEO Paulo Kakinoff declared in late 2016. He concluded Brazil’s domestic industry was growing its ASKs ahead of GDP. “We have seen significant competitive capacity adds in markets that we serve, and it is increased competition that is diluting revenue on routes that we also serve.”
Data from Brazil’s ANAC show for the nine months ending Sep-2016 both RPKs and ASKs in Brazil’s domestic market fell approximately 6% year-on-year. LATAM Airlines Brazil’s capacity fell 12% and Gol’s ASKs declined 6%. Azul, which engaged in rapid growth prior to and in the beginning of Brazil’s recession, posted a 5% drop in its capacity for that time period. Avianca Brazil has continued its capacity expansion during Brazil’s economic decline, posting a 13.5% year-on-year increase in ASKs for the first nine months of 2016.
As Brazil’s third and fourth largest domestic airlines measured by market share, Azul and Avianca Brazil remain in growth mode in a market that still holds promise once economic conditions improve. Brazil’s trips per capita in 2014 were 0.56 compared with 2.68 for the US and 3.73 for the UK. For the nine months ending Sep-2016 Avianca Brazil’s market share jumped 2 ppts from 9% to 11%, and Azul’s share held steady at 17%. Prior to Brazil’s recession, Azul had a stated goal of reaching a 20% domestic market share by the end of 2012.
LATAM Airlines Brazil is also striking a cautious tone about prospects for the Brazilian domestic market. The airline recently concluded after 14 months of a consistent drop in traffic, the decreases are decelerating; however, “we still don’t see a pick-up in demand”, the company declared in late 2016. “We’re still looking forward very cautiously in terms of capacity in the market.”
Brazil logged just 0.3% domestic passenger growth in 2015, and still weak conditions in 2016 pointed to similar growth levels for that time period. Brazil represents the lion’s share of Latin America’s seats at 43%. The full onset of an economic recovery in Brazil is crucial for Latin America to restart sustained economic growth.
Near the end of 2016, most of Latin America’s largest airlines were remaining cautious about capacity growth for 2017. The only airline to provide a definitive forecast was Copa, which plans a 5% increase in capacity year-on-year compared with 1.5% growth in 2016. The company’s 2017 forecast is driven by increased utilisation and the annualisation of new routes launched in 2016.
As Brazil embarks on a slow economic recovery, Mexico’s prospects quickly and drastically changed after the US presidential election in Nov-2016. An already weak MXN plummeted 15% against the USD, and some forecasters subsequently cut Mexico’s economic growth prospects for 2017 to 1.7% from previous projections of 2% growth. Mexico’s GDP grew roughly 2% in 2016.
Mr Trump’s threats of abolishing NAFTA, engaging in mass deportations and erecting a border wall have triggered massive uncertainty for Mexico. The US is Mexico’s largest trading partner, representing approximately 81% of its exports. The international airline market is also the largest in the world.
The election of Mr Trump with an (apparently) protectionist agenda occurred just as a new liberalised bilateral between Mexico and the US was taking full force. Restrictions on the number of airlines operating on certain transborder routes were completely lifted, and Mexico’s three largest airlines Aeromexico, Interjet and Volaris were all taking advantage of the freedom to operate in any transborder market. Those airlines are now likely re-examining those expansion plans after the currency plunge and downward revisions to Mexico’s economic forecast.
Mexico’s domestic market has also been a growth machine during the last several years, with passenger levels jumping 13% in 2015 and 12% from Jan-2016 to Sep-2016. But with dimming economic prospects and continued currency pressure, Mexican airlines could face weakening demand in the country’s domestic market in 2017 until Mr Trump’s intentions on trade and immigration become more crystallised.
Despite the economic downturn and uncertainty over the effects of Mr Trump assuming the US presidency, changes are afoot in Latin America’s aviation landscape. The region is one of the most ripe for LCC penetration; its three largest markets – Brazil, Mexico and Colombia – are the only countries with significant low cost penetration.
But those dynamics are changing in 2017. The Viva franchise is spreading to Peru after establishing VivaAerobus in Mexico and VivaColombia in Colombia. Mexican ULCC Volaris launched a subsidiary in Costa Rica in Nov-2016. With a new government adopting a more liberalised mindset, Argentina is drawing attention of start up airlines. Avianca’s major shareholder Synergy plans to launch a new domestic airline in the country, and in the past Viva has also cited Argentina as a potential target.
Latin America’s existing airlines are watching the moves of new LCCs closely, and are devising strategies to compete once new dynamics take hold. Copa is transitioning its Colombian operation to a low cost model, and the rebranded Wingo made its debut in late 2016.
LATAM Airlines Group is adding a new low fare pricing tier into its South American domestic markets in order to compete effectively with new and potential low cost competitors. Chile’s second largest operator, Sky Airline, has also transitioned to a low cost model in an effort to ward off would be competitors from entering Chile, which is one of the most liberalised markets in Latin America.
Despite Latin America’s formidable short term challenges, the region’s growth potential has not gone unnoticed by foreign investors. During the last year HNA Group has taken a 24% stake in Azul, joining United as an investor in the fast growing Brazilian airline. United has assumed a 5% stake in Azul, and along with Delta, placed a bid offer, in Dec-2016, for a strategic partnership for Avianca. Qatar is taking a 10% stake in fellow oneworld partner LATAM Airlines Group, and Synergy is attempting to carve out a place in Mexico’s market with a stake in regional airline Aeromar.
LATAM is also attempting to forge an immunised joint venture with fellow oneworld members European airline group IAG and American Airlines. However, Latin America’s largest airline group has met some resistance in its pursuit of those tie-ups as governments have expressed concerns about their competitive implications. Following the liberalised bilateral between the US and Mexico, SkyTeam partners Aeromexico and Delta aimed to forge a transborder joint venture, but the US government has required the airlines to relinquish 24 slot pairs at Mexico City Juarez and four at New York JFK.
Smaller airlines have become vocal opponents of the concentration of flights enjoyed by members of joint ventures on US trans-Atlantic routes, and their voices gained some traction with the Obama Administration. If Mr Trump’s protectionist tones permeate the aviation industry, LATAM’s aspirations to forge joint ventures could meet further resistance.
Even with Latin America’s promising growth prospects, the long standing challenge of heavy taxation of the region’s airlines remains stubbornly intact. Sky Airline’s CEO Holger Paulmann has concluded high taxes in the southern cone of South America create difficulty in maintaining the low cost model, offering the example of USD105 in taxes on a regional flight from Santiago to Cordoba, which is a similar amount paid on long haul service to Paris and London.
LATAM Airlines Group CEO Enrique Cueto has concluded government charges are rising too fast for him to hold an optimistic view. Earlier in 2016, the Viva Group abandoned plans to create a Costa Rican low cost airline, concluding taxes and airport fees were too high to create price points favourable for passenger stimulation.
Latin American airlines are operating on diametrical different paths, adjusting their business strategy for what appears to be a slow economic recovery while positioning themselves to compete effectively in order to capitalise on the region’s still vast potential.
The region’s countries still boast a burgeoning middle class whose propensity for travel will strengthen as economic stability continues to grow. However, one of the region’s most long standing challenges for airlines remains the most formidable, high taxes imposed by governments thwarting the full benefits of Latin America’s passenger growth potential.