Major Latin American Airlines Facing A Tough Year: Exclusive Interview

Fitch ratings recently published a “Latin American Airlines Dashboard” for the first half of 2015. According to the ratings firm, Latin American airlines face a challenging scenario for the rest of 2015. The benefits from lower fuel costs are being offset by declining yields, driven by weaker demand and
increased competition. Additional challenges include the devaluation of local currencies against the
US dollar and unfavorable fuel hedge positions. The difficult environment is expected to test companies’
market positions, competitive strength, management effectiveness, and capacity to balance business
growth and fleet renewal efforts against capital structure strength.
Finance Colombia had a conversation with Fitch Director José Vertiz to discuss the situation and gather insight on how this may affect airline revenues and market positions.

Finance Colombia: Even though fuel prices are very low right now it’s still a challenging year for airlines in Latin America, is that the case?

Jose Vertiz: There is a combination of factors we need to take in our analysis and we need to differentiate each player because market position and responses to competition and responses to foreign exchange effects are different for each case, but I will say there are factors that are playing in favor of the companies: they are paying the fuel costs at an international price. But on the other side they are facing a very challenging macroeconomic environment in general in the region, a slowdown in the economy is making the business travel segment weaker so because of that we also see yields of ticket price trending down so it’s a combination of factors. I will say that companies that have exposure in Brasíl are maybe the ones that are going to suffer more and companies like Copa andAvianca because of their market position and a smaller exposure to Brasíl could maybe be in a better position.

In general, the other factor is the fuel hedge strategy, how they are going to manage that during the year. In summary I will say it’s a very challenging year but the trend I’ve seen is that the market will see some improvement, but it will depend on the development of the macroeconomic environment in each market so I think it’s a combination of factors.

Finance Colombia: Colombia is doing relatively well financially but with stagnation in Brasíl, and obviously with troubles in Argentina and Venezuela, how is that affecting passenger traffic within South America?

Jose Vertiz: In general we see a trend in the last quarter in terms of traffic: I think the first point will be the growth in traffic has slowed down, it’s still positive, but we are not looking at the same traffic growth that we saw maybe two or three years ago. The growth is more moderate, I will say in single digits in general. But in addition, the business segment has been weakened, so because of that we are watching that negative trend in yields.

I will say that the oil sector is also a very important segment for the for the travel business so I think it’s going to affect all of the countries. Maybe more in Brasíl, but I think that is also going to be the case in Colombia or in other countries, but I think in general we see this weak or soft demand affecting all of them and the exposure to Brasíl is maybe making that tendency more important. So we see traffic in general is still growing in the single digits, but we need take into consideration that it is not just the traffic figures, but we need to see the composition. I think the business segment is weakened and because of that, yields are going down and that is affecting all the players; but maybe those who have exposure to Brasíl are that ones that are suffering more.

Finance Colombia:We see budget airlines growing in Latin America. Is that putting significant pressure on the traditional players? For example, there’s Fast Colombia, which operates as Viva Colombia, they’re flying to Panama, they’re flying within Colombia, I think they’re flying into Ecuador. Are the traditional airlines like LAN and Avianca and Copa facing significant pressure from these low cost carriers, or is that still too small of a market segment to really affect their models?

Fitch Director Jose Vertiz

Jose Vertiz: I think there is some pressure from these small players in general, but what the big players like Avianca, Copa, LAN, can offer in general is that they have regular flights for many different routes, they can offer more alternatives to their customers, especially the business travel customers, so I think that is still something that adds an advantage for the big players; and things that are still going to play in favor of them but it’s clear that there are smaller players that want to grow, they are going to continue and are going to still be adding some pressure, adding capacity or putting negative pressure in terms of the yield, but I will say in general, the leadinging players still have a strong market position. I don’t see that there is going to be a big change in the next, let’s say, one year, two years; but it’s still a negative for them, having these smaller players trying to gain market share.

Finance Colombia:We see big deals. Copa just signed almost a seven billion dollar deal for 61 aircraft, Avianca just took delivery of their 787s. How are these major deals that they’re announcing going to affect their capital structure? I know that you guys at Fitch have, I think, Avianca as BBB-, but how do these big deals—are they kind of in line with what’s normal for these airlines? Is this reflecting any kind of growth or change in their capital position? These are major announcements. I think the Copa deal was a record announcement for an airline of that size.

Jose Vertiz: Yes, to answer your question on this topic is to make a comparison in general during the last 3 years of the Latin American airlines versus for example the US airlines, Latin American airlines have been more focused on growth and I don’t see that they are going to change too much during the next 3 years. Maybe, the only exception is GOL, because there is more pressure on them, but if you see the other players like Copa, Avianca or LAN, all of them have very strong capital plans. So from a strategic point of view that is positive in the medium term, but in the short term I think that is going to put a limit in terms of that leverage or capacity to deleverage the business for these companies and in some ways that is a negative. I think you have to take into consideration that Copa really has a very low leverage business; they are something like 2.5 gross a year true leverage, which is very strong for the industry.

But the other players, I think Avianca Holdings Colombia or LAN, I think they both have true leverage of six times, and I think this effort, or this target of continual fleet renewal is really going to make it difficult for them to reduce those high leverages in the medium, in the short term, let’s say the next 24 months. So I think these two companies are giving more priority to growth and maybe not to much priority versus growth in the business, to the capital structure right now. So we see limited reasons that the leverage for these two companies, Avianca and LAN, and I think for GOL, I think that they have been very consistent over the last 3 years. And for Copa I think it’s something that they can manage. They have been very consistent in focusing on their market, which is around Panama, and having a network around that airport.

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