Market Watch (November 2010 - Ano II/ No 2)

A NEW LATIN AMERICAThe four best net profit results of the Americas in 2009; one of the best CASK measures in the world; the three best EBITDAR in the Americas; the fourth largest fleet of ERJ 145 aircraft in the world; the third largest regional company (except USA) in cities served; the highest daily use in the world of regular commercial aviation. Yes, these are some of the impressive results achieved by airline companies in Latin America.

Behind this success is the sustained growth of the economy and the domestic demand of Latin American countries. Sub-regions such as the Andean Community and Mercosul have been driving regional growth, with average rates of 6.7 and 5.9 times the average growth of GDP of the European Union (from 2005 to 2009), for example.

The capacity for recovery from the economic crisis was similarly shown to be positive and along with this, the confidence of investors grew, as demonstrated by the gradual growth of foreign investments and the best risk classifications given to Latin American countries by specialized banks.

Together the economic growth and social policies implemented, the countries achieved relative success in the gradual reduction of poverty rates. Between the years 2000 and 2008, Latin America saw a total of almost 35 million people cross the poverty line, with Brazil responsible for 40% of this gain. The improved social conditions were responsible for part of the growth in domestic demand in the Latin American countries, which contributed to the increase in demand for air travel.

In Brazil, for example, it is estimated that about 9 million new passengers will fly for the first time in the next 12 months.

Asia-Pacific North America Latin America Middle East Africa Europe

Net Profits By Region

US$

bill

ion

40

30

20

10

0

Mill

ions

of

Peop

leou

t of

the

Pov

erty

Zon

e

Brazil Venezuela Peru Mexico Colombia Chile Others

Market Watch2

Sources: ECLAC and The Economist (Apr. 2010)

Source: IATA (Sep. 2010)

A NEW LATIN AMERICAIn line with the growth of the region, the Latin American airlines have taken advantage of market opportunities and achieved higher levels of operational and financial efficiency. High occupation rates and financial earnings exceeding those of their North American equivalents are some of the signs of this success. Latin America is the only region of the world to show net profits in both 2009 and 2010. As an example of profitability, the profit obtained by the publicly traded airlines of the region in 2009 corresponds to the equivalent of 80% of all net profit obtained by these companies in the United States and Latin America.

The region has stood out in recent years as the one with the highest rates of growth in the air travel sector. With an average growth of approximately 8% in passenger demand in the region since 2005, this sector is estimated to grow by more than 10% in 2010, achieving an accumulated rate of more than 70% since 2004. Tracing the rise in demand, the aircraft fleet has also been growing consistently and has risen by of 35% since 2004.

1000

500

0

TAM

GOL

CopaLAN

AirTran

Southwest

SkywestJet Blue

Republic

U.S. Airw

ays

Continental

United Airlines

Delta Air Lines

AMR Corporation

-500

-1000

-1500

-2000

LatAm vs. US CarriersNet Income - 2009

US$

mill

ion

Intra-LatAm DemandMillion of Passengers Transported

9385

2004 2005 2006 2007 2008 2009 2010F

104118112

123136

Improved economic and social conditions of region helped generating three significant results:

Result 1: sustained growth of air travel demand.

Result 2: significantly positive perspective for future financial earnings for airlines of the region.

Result 3: higher profits and capitalization of airlines.

3

Sources: SABRE and ALTA (May 2010)

Sources: Thompson One and NASDAQ (May 2010)

POINTS WORTHY OFATTENTIONThe high concentration of air travel in a small number of airports and the congestion in some of the main airports of the region (e.g. Mexico City, Guarulhos, Congonhas and Aeroparque) are factors that still need much attention. Currently, only 15 airports in Latin America concentrate more than 60% of the seats offered by scheduled airlines. Regional integration is another factor worthy of attention. The vision of Latin America as a united region without borders has been advancing by working towards the implementation of air traffic agreements between countries, but this situation needs to make faster progresses. Some efforts in this regard can be highlighted:

The growth of the sector has also led to a gradual warming of the competitive environment, involving both established airlines and new competitors. More than six new companies have begun operations in the last two years in the region. The increase in internal rivalry can be seen by the reduction of concentration in some domestic markets,

which although still far from being close to that seen in the US market, for example, has seen a reduction in most Latin American countries. In an environment of greater competition, the airlines will have to formulate their strategies to ensure competitive advantages in the long term. Part of these efforts are the adoption of strategies related to Mergers & Acquisitions, for example of the COPA, Synergy Group, GOL and LATAM groups. It is estimated that these consolidations will strengthen the groups and create internal synergies.

Fuentes: Páginas web de CAN, ANAC y CLAC (jun 2010)

ColombiaEcuador

PeruBolivia

Bolivia

ParaguayChile Uruguay

Argentina

PeruBrazil

Fortaleza Agreement

5th Air Freedom ConcessionLiberalization of all international airports incountry membersLiberalization of capacity, frequencies andaircraft type

Policies addressed towards therelaxation of Bilateral Agreements

Decision no. 582: Air Transportation inAndean Community3rd , 4th and 5th Air FreedomConcessions

Comisión Latinoamericana de Aviación Civil Decision 582 of the Andean Community which establishes Air Freedom Concessions among member countries; The Fortaleza Agreement;

The policies conducted by CLAC, the Latin American Civil Aviation Commission.

AeroGal

LatAm

Market Watch4

Sources: CAN, ANAC and CLAC (Jun. 2010)

Source: Embraer and Airlines

Another very significant factor is the age of the fleet. Newer aircraft mean lower operating costs, due to reduced fuel consumption and maintenance, for example. The average age of the Latin American fleet fell significantly, especially since 2005, with the region ceasing to use a high number of used aircraft. However the region continues to use aircraft of an age 18% above that of the world. Besides this, there is a considerable excess of new and used narrow bodies flying routes that are not eligible to their capacity.

As a consequence of the excessive number of narrow bodies, many cities have lost flights or lack an adequate number of daily flights. This role is normally fulfilled by smaller jets, of which there are not enough in the region. If we compare with the United States and Canada, Latin America has ten times fewer jets of 30 to 120 seats per million inhabitants.

In the first half-year of 2010, for example, the United States and Canada had approximately 30% of their total fleet in regional jets, whilst Latin America had just 14%.

The potential for growth is high and should continue to be exploited.

Jet 91-120Old Generation

BETTER

WORST

Repl

acem

ent

Eval

uati

on Z

one

Avg.

Pro

duct

ivity

(avg

. ann

ual f

light

hou

rs)

Avg. Age (years)*Scheduled airlines, all passenger configuration, active in service aircraft

0

500

1000

1500

2000

2500

3000

3500

4000

5

Jet 91-120New Generation

Jet >210Jet 176-210

Jet 146-175

Jet 121-145

Jet 30-60

Jet 61-90

10 15 20 25

179 66

8581

267245

46

146

Number of Jets (30-120 seats) per million people

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00

USA & Canada

Latin America

5

Source: OAG and ACAS (Sep. 2010)

Source: OAG (Jun. 2010)

6 Market Watch

TOWARDS EFFICIENCY AND COMPETITIVENESSMarkets of medium and low densities, of up to 300 PDEW (Passenger Daily Each Way), represent the largest segment in Latin America, corresponding to 82% of the Origin-Destination markets. Strategies that aim to capture this market must consider the supply of flights with aircraft suitable for this profile of demand. The use of appropriate equipment allows airlines to maximize their operational efficiency, generating the best cost:revenue ratio.

The profile of flight frequencies in Latin America shows significant potential for growth and a better service for the routes currently served : 48% of the routes with demand between 25 and 300 PDEWs have a frequency of less than one. Higher flight frequencies would mean better schedules and better meeting the needs of passengers which together stimulate and strengthen the growth rate of passenger demand.

These medium density markets are not only the majority in Latin America but also have some quite important characteristics to be exploited:

Better Yield: medium density markets have typically higher yields than higher density, which means higher average revenue per enplanned passenger.

Less Competition: many of the medium-sized markets are as yet little exploited in Latin America. This means they have a lower level of internal competition. The opening up of flights allows, for example, companies to establish themselves by strategic positioning and taking advantage of higher stimuli in local demand.

Better Opportunities, Higher Growth: the supply of flights on less exploited markets offer higher rates of growth, in part due to higher levels of stimulus of demand by the inclusion of flights in markets not served and by the growth of flight frequencies in those markets that are poorly served. In some cases, many growth opportunities have been exploited by the establishment of regional hubs, allowing greater decentralization of traffic and better meeting the needs of local demand.

82%

18%

Num

ber

of M

arke

ts

O & D Demand Profile

Passengers Daily Each Way (PDEW)

0

20

180

253

149

18

79

44

26-5051-100

101-200

201-300

301-400

4001-500

501-600

601-700

701-800

801-900

901-1000

1001-1100

1101-1200

1201-1300>1300

17 179 8 6 5 5 5

15

50

75

100

125

150

175

200

225

250

275

Source: Sabre (2009)

7

TOWARDS EFFICIENCY AND COMPETITIVENESSIt is also important to note that 68% of flights made on aircraft with more than 120 seats take off with a total of just 40 to 110 passengers. As a direct consequence, due to the excess of narrowbody aircraft in the region, the number of seats offered is not in accordance with demand, resulting in low occupation rates and unnecessary expenses for an equal level of revenue. We can therefore conclude that the majority of flights in Latin America have a demand more appropriate for aircraft of 70 to 120 seats in capacity.

But it is not just demand that is favorable to aircraft with 70-120 seats, but also profitability per flight. In the example above we simulate a route of 600mn, at an average fare of US$ 100, considering the Latin America environment. The result obtained shows that for a flight of between 55 and 95 passengers, the best option would be for an aircraft of 100 seats, where the profit per flight is up to three times higher than for a narrowbody of 180 seats. Furthermore, this same narrowbody will only reach the point of equilibrium with 71 passengers on board, that is, 16 more passengers would be necessary with the 100 seater aircraft to achieve the same result. Another example: for a flight of 80 passengers with the same conditions as above, a 100 seat aircraft would make a profit of approximately US$ 2,000. To obtain the same result, a 180 seat narrowbody would have to charge 17% more than a 100 seater aircraft.

The lower cost per journey, the allocation of the right size of aircraft for markets compatible with their capacity and the revenue management are the principal elements which, when taken together, make up a more efficient and profitable operation.

68%

Passengersper Departure

Intra - LatAm Flights (>120 Seats Aircraft Only)

Loads Appropriate for70-120 Seat Aircraft

1-19

2%1%

4%

7%

9%

13%

11% 11%10%

7%6% 6%

4% 4%5%

20-3

9

30-3

9

40-4

9

50-5

9

60-6

9

70-7

9

80-8

9

90-9

9

100-

109

110-

119

120-

129

130-

139

140-

149

>=

150

Cont

ribu

tion

to

prof

it p

er f

light

(USD

)

CONTRIBUTION TO PROFIT PER FLIGHT (USD)

40

($1,000)

$1,000

$2,000

$3,000

$4,000

$5,000

$0

($2,000)

($3,000)

($4,000)

45 55 60 70 75 80 85 90 95 100 105 110 115 120 125 130 135 14050 65

61-75 76-90 90-105

100-SEATER NB 180

Place:Medium Segment:Average Tariff:Price of Fuel:

LatAm600 nmUSD 100USD 0,69/l

Passenger demand per flight

Sources: Sabre and OAG Back

Source: Embraer

SUMMARY CONTACTS

Market Watch8

Latin America has been growing at quite promising rates. The airlines of the region have a wide range of opportunities and have been working to take advantage of them. There are many examples of profitability, but there is still room for market growth and financial returns. The strategic plans taken towards the strengthening of the company results as well as sustaining competitive advantage in the long term involve arrangements such as:

Meeting the passenger needs; Offering direct flights; Fares at reasonable prices and compatible with the market; Appropriate schedules; Greater comfort; Increased market presence: • Increased flight frequencies; • Opening up of new medium-sized markets with direct flights; Higher operational efficiency and higher profitability: • Aircraft capacity fitted to the market size; • Maximization of “Revenue Management” and cost efficiency.

Latin America & Caribbean Marketing & Sales – Commercial Aviation Market Analysis & Strategy Department

Tel.: + 55 12 3927 3059E-mail: [email protected]

Find other examples in:http://www.embraercommercialjets.com/inservice/index.htmhttp://www.embraercommercialjets.com.br