ANALYSIS: Azul embarks on next phase of growth with IPO

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Brazil's third largest carrier Azul has filed for an initial public offering (IPO) with US regulators, taking a step towards the next phase for the growing carrier in Latin America's largest domestic market.

The low-cost carrier aims to raise about R$1 billion ($490 million) from the offering. It will use the proceeds to expand its fleet, fund capital expenditure to expand its network, repay debt as well as for other general corporate purposes, says the airline in its offering prospectus filed with the US Securities and Exchange Commission (SEC) on 27 May.

Azul will offer shares on the Sao Paulo stock exchange as well as in the USA in the form of American Depository Receipts as part of a global offering.

The IPO signals the next phase for the growing carrier, which began operations in December 2008 with a fleet of only five Embraer 190s and 195s, some of which were operated by New York's JetBlue Airways, which was also founded by Azul founder David Neeleman.

Azul has grown from strength to strength since then. Most notably in its recent history, it successfully acquired Brazilian carrier Trip in a merger that was approved by Brazilian anti-trust authorities this past March.

The Trip acquisition added another 46 cities to Azul's growing network. Together, the two carriers serve 103 destinations in Brazil, operating 232 routes and 799 departures every day. Azul says it holds a 29.3% share of the Brazilian aviation market in terms of departures.

From a fleet of only five aircraft in late 2008, Azul now operates 118 aircraft in its in-service fleet as of 31 March. It has 130 aircraft in total in its fleet. Of these, 72 are on operating leases while the remaining 58 are on finance leases. Azul operates the E-175, E-190, E-195 and the ATR 42 and 72 turboprops. The average age of its fleet is four years - younger than that of its rivals in Brazil.

Based at Campinas-Viracopos International airport in Sao Paulo state, Azul's strategy is to offer low-cost air transport for smaller, underserved domestic markets through a hub and spoke model. The carrier says it is the sole airline on 70.7% of its routes. "We believe we have created a robust network of profitable routes by stimulating demand through frequent and affordable air service. We select routes that we believe possess high demand and growth potential and are either not served or underserved by other airlines," says Azul. "We believe this model has enabled us to stimulate significant new demand to become the market leader in the majority of the markets we serve."

The use of smaller aircraft, unlike its competitors Gol and TAM, ensure that Azul can serve these markets profitably, it says. "We believe our main competitors, with their larger aircraft, are unable to generate sufficient demand to serve most of our markets profitably."

Much like JetBlue, Azul has sought to differentiate itself as a low-cost carrier focused on service. It offers LiveTV at every seat on its aircraft, a legroom pitch of 30 inches or more, as well as complimentary beverages and snacks and free bus transportation to key airports in its network.

The acquisition of Trip made Azul the largest carrier in Belo Horizonte, and helped it gain strategic slots at Sao Paulo Guarulhos and Rio de Janeiro Santos Dumont airports. Both airlines operated similar aircraft before the merger, which will help contribute to projected synergies of between R$200 million and R$300 million in 2013 and R$300 million to R$400 million in 2014.


Azul route map, May 2013

Source: Innovata Flightmaps Analytics

Azul reported a full-year operating profit of R$8.64 million in 2012, according to the prospectus it filed with the SEC. This was down more than 60% from the R$25.1 million operating profit it reported in 2011. Azul attributes the decline to the one-time expense of R$43.2 million, the majority of which was incurred as a result of the merger with Trip.

Azul posted operating revenues of R$2.72 billion and a net loss of R$171 million for 2012. It consolidated Trip into its financial statements from 30 November 2012, and says it would have posted an operating profit of R$51.8 million without the non-recurring expenses.

The carrier reported a 17.8% growth in passenger revenue per available seat kilometre (PRASK) in 2012 to 21.4 Brazilian cents. Yields were up 21.2% to 27.1 Brazilian cents during the year.

Azul posted an average load factor of 79% in 2012, which it says it had maintained in the first quarter of 2013.

As it files for an IPO, the airline says it aims to increase profitability by expanding its network, connecting more of its existing destinations, increasing flight frequencies, increasing ancillary revenue and boosting operating efficiency.

Azul cites its new Campo Grande-Rio de Janeiro route, launched in November 2012, as an example. It began offering flights on the route in response to demand for connections between its Campinas-Campo Grande and Campinas-Rio de Janeiro routes.

The airline also aims to begin flights to destinations dropped by other Brazilian carriers when they began operating larger aircraft, and boost the number of flights on its existing routes, says Azul.

On the ancillary revenue front, the carrier says it will focus on "deriving further value" from ancillary revenue streams including cargo services, passenger fees and sales of its extra legroom product and advertising space.

"We plan to expand our cargo business, building on our extensive route network and taking advantage of the fact that Campinas is the second largest cargo airport in Brazil by freight volume," says Azul. The airline will also aim to grow revenue from the sale of travel packages on its website.

Several upcoming developments in Brazil's aviation infrastructure will weigh in Azul's favour. These include planned investments of up to R$7.3 billion in regional aviation infrastructure unveiled in late 2012 by Brazil's government, which will expand the number of airports in the country to 270 from 129 in ten years. The investments include subsidies and airport fee exemptions for regional flights.

Azul's base at Campinas-Viracopos is set to be expanded after the airport was privatised in 2012. The works include a new runway by 2017 and a new passenger terminal to handle up to 14 million passengers a year by 2014. The airport will also get a new apron for 35 aircraft and 4,500 additional car parking spaces.

Belo Horizonte-Confins airport, which is Azul's second largest base, is also set to be privatised in 2013 - a move that the airline believes it will benefit from.