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Gol's rationalisation and revenue management efforts pay off May 2014 Download PDF

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Amid Brazil’s prolonged economic slowdown, currency woes and World Cup challenges, Gol, Latin America’s leading LCC, has staged a surprisingly robust financial turnaround. But because the airline has had to dig itself out of a very deep hole, its operating margins are still in the low-to-mid single digits — a significant improvement from the negative 11.2% margin seen in 2012 but nowhere near satisfactory.

Gol’s problem is that there is no let-up from external challenges. Brazil is in its fourth consecutive year of modest GDP growth, with more of the same expected in 2015. The latest projection is for only 1.6% growth in 2014, followed by 2% in 2015 (a mid-May survey of some 100 financial institutions in Brazil). Inflation is on the rise, currently projected to be 6.4% in 2014.

In the past year the Brazilian Real has hovered in the 2.2-2.5 to the dollar range — a low level not seen since 2008. More weakening and volatility are on the cards for the second half of 2014, given likely changes to the US interest rate policy and Brazil’s general election in October. The Real at that level is keeping Gol’s fuel prices at record levels.

Gol, like its Brazilian peers, faces a challenging June-July period catering for a spike in low-yield demand because of the World Cup. It will be a financial negative for the airlines in the short term, because business travel is expected to be down sharply during the Cup.

And competitors are making bold moves. Azul, Brazil’s third largest carrier, recently announced plans to enter the Brazil-US market in early 2015, initially with six A330-200s and later with A350-900s. The planned daily nonstop, low-fare flights from Azul’s São Paulo Campinas hub (from where it serves 104 domestic destinations) to various US gateways could potentially undermine Gol’s strategy of operating one-stop flights to the US.

Gol’s main competitor TAM is now much stronger because it is part of the Latam Group. With Latam’s help and expertise, TAM has turned around its Brazil domestic operations, which are now profitable. Also, Latam has almost eliminated TAM’s balance sheet exposure to the Brazilian Real (see Aviation Strategy, April 2014).

Revenue-led turnaround

According to its Q1 presentation, Gol achieved the highest EBIT margin improvement among 15 international carriers in the 12 months ended March 31. Its margin rose by 13.4 percentage points, compared to runner-up IAG’s 10.6, Alaska’s 6.4 and Delta’s 4.5 point improvements.

The key reason was Gol’s outstanding unit revenue performance. Its RASK rose by 17.7%, compared to the 4% increase seen by the next-best carrier (Alaska). Gol has also seen strong yield and load factor improvements; in the first quarter, its load factor rose by nine points to 76.1%.

The dramatic RASK and load factor shifts were possible because Gol contracted in size and because capacity and pricing discipline has prevailed in the Brazilian airline industry since early/mid 2012 — at least at Gol and TAM, which still account for 75% of the domestic market.

Gol is now 14% smaller in terms of ASKs than two years ago (March quarter figures). It is unusual for an LCC to shrink like that, though Gol had boosted its size through two acquisitions — Varig in 2007 and Webjet in 2011. The Webjet integration definitely helped the latest restructuring efforts in 2012 and early 2013, because Gol opted to end Webjet’s operations and dispose of its 20 737-300s.

Better yield management and a new focus on more profitable routes have also contributed to Gol’s strong RASK trends. In early 2013 Gol implemented what it described as a “new route network”, which involved eliminating some routes, reducing night flights, strengthening São Paulo Guarulhos hub operations, improving connectivity with partners and increased focus on the corporate market.

Of course, the main benefit of the R$70m Webjet acquisition was that it strengthened Gol’s slot holdings at six key airports: Guarulhos, Brasilia, Galeao, Santos Dumont, Confins and Porto Alegre’s Salgado Filho.

Despite its sharp contraction (and because TAM also contracted), Gol actually improved its domestic market share (in RPKs) by 1.8 points in the past year, to 36.6% in Q1 2014. In that period TAM’s share fell by 3.1 points to 38.1%, Azul’s remained unchanged at 16.7% and Avianca Brazil’s increased by 1.2 points to 7.9%.

Gol’s revenue performance may also have benefited from the move more upmarket with JetBlue-style products like “GOL+Conforto”, which was first introduced on the 737-800s on the Rio-São Paulo shuttle late last year. The product features more comfortable seats, with extra legroom and more space between seats, in the first seven rows of the aircraft. The seats are offered free of charge to elite FFP members and sold from R$30 to other customers. Like JetBlue, Gol has found the strategy so successful that it is now expanding it to its entire domestic fleet, including 737-700s. By the end of May, 80% of Gol’s fleet will have those seats.

Gol can soon advertise that it offers the “largest number of category A seats” (an ANAC classification) in Brazil. There are efficiency benefits associated with having only one type of configuration for each aircraft model. And the move makes it easier to keep capacity in check this year.

So Gol has done a lot of work on the revenue side. Notably, a new leadership took over in June 2012, when Paulo Kakinoff, formerly Audi’s Brazil head and a Gol director, replaced founder Constantino de Oliveira Jr. as CEO.

Terrible cost headwinds

The 2012 restructuring included some promising cost cuts (notably from a 20% headcount reduction), which enabled Gol to keep its total unit costs flat in 2013, despite the ASK reduction. But recent months have seen terrible cost headwinds, as was illustrated by the 17% and 22% surges in Gol’s CASK and ex-fuel CASK in the March quarter.

The main culprit has been the Brazilian Real’s decline against the dollar (18% year-on-year in Q1). Because of that, Gol paid record fuel prices. Leasing costs per ASK surged by 36%, mainly because more aircraft were on operating leases but also because of the weaker currency. There were inflationary pressures in many cost categories, including labour.

In the non-operating categories, Gol incurred sharply higher interest expenses because of the Real’s decline. Gol had to pay income tax because of profits earned at its FFP unit Smiles. There were odd items such as a R$56m “interest hedge” expense. And Gol conservatively recognised a R$76m ($34m) loss from the devaluation of the Venezuelan bolivar against the dollar. (Gol had R$351m cash trapped in Venezuela at the end of March and will of course continue to fight to get the funds repatriated at the original exchange rates.)

Because of the cost headwinds, Gol achieved only a 3.9% adjusted operating margin in Q1. The reported operating profit of R$144m (5.8% of revenues) included a R$48m gain from a sale-leaseback transaction. The net loss for the quarter was R$96m.

Although Gol achieved a R$266m ($120m) operating profit in 2013, it has had net losses for three consecutive years, losing R$3bn ($1.4bn) in aggregate in 2011-2013.

A lot to Smile about

Smiles, the FFP that Gol listed publicly in April 2013 but still includes in its consolidated results (54.5% owned), has truly been a bright spot financially. In addition to helping Gol attract and retain passengers, Smiles is highly profitable. It earned net profits of R$208m and R$78m ($94m and $35m) in 2013 and Q1 2014, respectively, representing 36% and 42% of revenues.

The IPO raised R$1.1bn ($495m). In April Smiles’ board approved a R$1bn ($450m) “capital reduction” or a special dividend, which will be in addition to R$160.3m ($72m) of dividends paid for 2013. It will essentially mean a big chunk of cash redistributed to Gol from the Smiles/consolidated balance sheet and a modest increase in consolidated debt because Smiles is taking a R$700m ($315m) loan from a financial institution.

Smiles had 9.9m members and 218 commercial partners at the end of March. The membership grew by 10% in 2013 and by 7.4% in Q1 2014.

Airline partnerships

Gol is benefiting significantly from airline partnerships, especially since it has secured equity investments from two major global carriers — Delta and Air France-KLM. Gol was able to forge two such “exclusive” long-term strategic partnerships, because it had something really special to offer: long-term access to the huge Brazilian market.

Delta paid $100m for a 3% stake in Gol, a board seat, an exclusive codeshare agreement in the Brazil-US market and two 767s in December 2011. Codeshare cooperation now gives the airlines access to some 400 destinations in over 62 countries.

The February 2014 deal with Air France-KLM was modelled after the Delta agreement. It is exclusive in the Brazil-Europe market and will mean a joint reach of 318 destinations in 115 countries. The deal was also valued at $100m and includes a board seat, but there were some interesting differences. First, it comprised of two main parts: a $52m investment in Gol’s preferred shares (1.5% ownership stake) and $48m “for purposes of enhancing the effectiveness of the strategic commercial partnership”. Gol has not disclosed exactly what the $48m relates to, other than that $23m is for “commercial and synergies” and $15m is “due over two years as cash flow from the agreement”.

Second, AF-KLM paid a steep premium for the 1.5% stake (170% above the stock’s closing price that day). AF-KLM, which continues to report losses and is trying to restructure, evidently very badly wanted that foothold in Brazil. The deal gained timely regulatory approval from Brazil’s CADE in early May, enabling AF-KLM to take advantage of the World Cup-related demand surge (as well as obviously next year’s Olympics). AF began a new route to Brasilia in March and also plans Paris-São Paulo A380 flights.

The fact that Delta and AF-KLM are both members of SkyTeam may make it easier for Gol to coordinate its systems with AF-KLM, but Gol will not join SkyTeam. It remains committed to the “open architecture” type alliance strategy similar to those of JetBlue and WestJet.

Gol also has codeshare agreements in place with Iberia, Alitalia, Qatar, Aerolineas Argentinas and TAP. The TAP deal, announced on April 11, is interesting because TAP is the Europe-Brazil market leader, operating 74 weekly flights from Portugal to as many as 10 cities in Brazil.

International expansion

In early 2013 Gol announced a new international expansion drive that would serve two purposes: diversify revenue sources (given the sluggish demand in Brazil) and give it a natural exchange rate hedge (through an increase foreign currency denominated revenues).

Gol had just entered the Brazil-US market (December 2012) with daily São Paulo-Orlando and Rio-Miami flights, which are operated via Santo Domingo (Dominican Republic) because the 737-800s need a fuel stop. The flights are timed to arrive in Santo Domingo at about the same time, allowing passengers to switch.

In the Q1 call Gol’s management described the US services as “very, very successful”. The flights have enjoyed strong demand and are very important for Smiles. Gol will be adding São Paulo (Campinas)-Santo Domingo-Miami flights in July.

But what about the potential impact of Azul’s plans to operate nonstop to the US with larger, longer-range aircraft? In response to questions, Gol executives indicated in mid-May that the airline had not yet decided whether to grow the Santo Domingo operations, though there was “clear potential”. (The original plans envisaged SD as a potential hub for the carrier.)

Of course, the US is just one of 15 international markets for Gol. The airline is adding new routes to Chile and Argentina this summer (Guarulhos-Santiago and Fortaleza-Buenos Aires) and expects to announce more international expansion before the year-end. Gol is on track with the strategy to grow its international revenues from 8% to 17% of total revenues within three years; the current level is 12%.

Balance sheet considerations

Gol does not have any liquidity issues, because it has made it a policy to maintain strong cash reserves ever since it narrowly escaped a cash crunch after the Varig acquisition. Total cash at the end of March was R$2.8bn — a very healthy 30% of annual revenues.

Gol remains highly leveraged, though, with total debt of R$5.5bn ($2.5bn) and adjusted debt (including leases) of R$10.8bn ($4.9bn) as of March 31. But growth in EBITDAR has greatly improved debt ratios, and there are no major repayments due this year. Gol remains committed to reducing short-term obligations and keeping a strong cash position.

Even though Gol postponed many deliveries when it began cutting capacity, its aircraft capex remains sizable, at R$1.1-1.2bn ($495-540m) annually in 2015-2016. But the new aircraft will be for replacement, and the year-end 2015 and 2016 operational fleets will actually be smaller than what Gol had three years ago (though total seats will increase because Gol is receiving 737-800s and retiring 737-700s). The March 31 operational fleet comprised of 141 737-NGs (not including six aircraft that were being returned to lessors) and is expected to remain at 140 in 2015 and 2016. The total firm orderbook with Boeing is impressive: 133 aircraft, valued at R$34.1bn ($15.3bn).

Gol aims to be free cash flow (FCF) neutral this year but hopes that from 2015 better margins and continued capital discipline would lead to positive FCF. As long as EBITDAR margins remain high (17-18% in recent quarters), there will be no cash constraints or pressure to reduce capex.


The steady improvement trend in Gol’s operating profit in the past five quarters (see chart) offers much hope for the future. Even in this very difficult external environment, Gol has been able to improve its operating margins.

Gol is projecting a 3-6% operating margin for 2014. The forecast is based on realistic assumptions: Brazilian GDP expanding by 1.5-2%, the Real weakening further to R$/US$ 2.40-2.50 and fuel prices increasing from the Q1 level. Gol expects its domestic ASKs to decline by 1-3%, international ASKs to increase by 8%, RASK growth to exceed 10% and ex-fuel CASK to increase by 10% or less in 2014.

Although the forecast has some level of negative financial impact from the World Cup built in, that is one area of uncertainty. It is hard to predict how much business travel demand will decline in June-July and much will also depend on Gol’s pricing strategy.

Preparing for the World Cup has been one big hassle for Brazil’s airlines. They have been subjected to increased ANAC monitoring and are under the threat of penalties for delays, overpricing, “misuse of slots” and such-like during the Cup. And, of course, each airline wants to ``put its best foot forward'' for the throngs of foreign visitors that will be flying domestically in Brazil.

Gol has provided 974 extra flights or flight-time changes for the Cup. It has invested in a “new visual identity” at the 12 host airports and on its website and mobile platforms, which included adding three new languages. It has provided special training to employees, hired additional staff and reallocated personnel. Four of its aircraft have received special paint jobs.

Analysts say that if the financial impact of the Cup is not too bad, Gol could report a positive EBIT margin for the June quarter for the first time since 2010. But, because exchange rates are not cooperating, a net loss is expected for a fourth consecutive year. Of course, the long-term prospects for Brazil and Gol remain excellent.

By Heini Nuutinen

GOL'S Unit revenues and domestic capacity trends
GOL'S Unit revenues and domestic capacity trends Produced by GNUPLOT 4.6 patchlevel 3 10,500 11,000 11,500 12,000 12,500 13,000 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 -10% -5% 0% 5% 10% 15% 20% 25% 30% ASK m Year-on-year % change GOL'S Unit revenues and domestic capacity trends gnuplot_plot_1 gnuplot_plot_2 2011 2012 2013 2014 Domestic ASKs Unit revenues pct change -14.2%
GOL's Revenues and Operating Margins
GOL's Revenues and Operating Margins Produced by GNUPLOT 4.6 patchlevel 3 0 2,000 4,000 6,000 8,000 10,000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014* -10% 0% 10% 20% 30% R$m Gol's Revenues and Operating Margins gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 24% 29% 23% 18% 0% 7% 10% 3% 4% gnuplot_plot_5 -1% -3% -11% Operating margin Revenues

Note: * Mid-point of the 3-6% forecast Gol reaffirmed on May 15.

Gol's Revenues and Operating margins
Gol's Revenues and Operating margins Produced by GNUPLOT 4.6 patchlevel 3 -1,000 -500 0 500 Q1 Q2 Q3 Q4 Q1 -10% -5% 0% 5% R$m Steady improvement in Gol's EBIT gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 3.0% 3.3% gnuplot_plot_4 -10.1% -6.1% -3.0% EBIT Margin

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