The Mexican airline sector has been transformed by the privatisation of the country's two flag carriers and the launch of several low-cost start-ups. Is there space for everyone, or is it inevitable that there will be casualties along the way?
Mexico's airline industry has undergone a revolution in the past couple of years. The country's two flag carriers, Aeromexico and Mexicana, have been privatised and a crop of low-cost start-ups has sprung up to challenge the status quo. But is there enough room for everyone or is consolidation on the cards? And how will Mexico's more established carriers respond to this invasion of their turf and wrestle back the market share they have lost?
Aeromexico chief executive Andrés Conesa is confident that the carrier's long-awaited sale to a consortium led by Citibank-owned Banamex in October 2007 - almost two years after the Mexican government sold rival Mexicana to hotel chain operator Grupo Posadas - will provide Aeromexico with the capital it needs to compete effectively. "For us it makes a big difference to run a firm with a sound capital base," says Conesa. "[Mexican state-owned bank] IPAB by law was forbidden from putting money into the firm. Competing with our hands tied was very difficult, but we did very well under these conditions."
IPAB and other government agencies sold their 62% stake in Aeromexico to the Banamex consortium for $249 million, following a bidding war with Mexico's Saba family which saw the value of the carrier more than double in the space of one month. Banamex already owned publicly traded shares in Aeromexico, and Conesa says the new owner's commitment to invest an extra $250 million in the carrier will boost its stake to more than 90%, which will allow it to de-list the company. "You need to have more than a 90% stake to be de-listed from the stock exchange and the idea is to de-list and then re-list in two to three years," he explains.
One party that was not happy with the sale of Aeromexico to Banamex was Mexicana parent Grupo Posadas. It had planned to acquire its rival and merge it with Mexicana to form one large, united Mexican flag carrier, but was blocked from doing so by the country's competition authorities. Mexicana chairman Gastón Azcárraga describes this decision as "a big disappointment".
"We respect the decision but we disagree with it," he says. "In Mexico, this industry is going to need consolidation. There are 14 carriers and entry barriers are low, so consolidating the two legacies would have been good for everyone." However, the acquisition of Mexicana alone was not without its challenges and Azcárraga has his hands full transforming the carrier into a more efficient competitor. "It has been a challenging experience," he admits. "The airline industry is very complex and has its own problems - in Mexico more than in the rest of the world. We've been very busy trying to develop strategies that will allow us to become an efficient legacy carrier."
Azcárraga admits that when Grupo Posadas acquired Mexicana in late 2005, the carrier "was not ready to compete" with the wave of new low-cost entrants. "We hired consultants that told us where Mexicana was competitive and we're still working on that," he says. "We dedicated the first 18 months to cost reduction and we're making lots of progress. The new low-cost carriers had a different cost structure so we really had to look at everything." Mexicana is now "slightly over halfway through" its cost reduction programme, under which it is looking to achieve "north of $300 million of savings a year".
Conesa has also overseen a cost-cutting programme at Aeromexico, which he says was made possible by the entrance of low-cost start-ups into its market: "The low-cost carriers make us better. If they hadn't appeared, we would not have been able to cut our labour costs." But Conesa's praise for these new market entrants ends there. He agrees with Azcárraga that consolidation is necessary because there are too many airlines in the market.
"The number of airlines in Mexico doubled in one year - nowhere else in the world has this happened," says Conesa. "There is already significant overcapacity and the reflection of that overcapacity is declining yields. The process of airlines going bankrupt and going out of business is very slow, but mergers are one way to consolidate the industry faster." He predicts that the number of airlines in Mexico will dwindle from the mid-teens to "a single digit figure" within five years. "There is definitely space for a low-cost carrier in Mexico, but not for seven."
The demise of Azteca last March left six low-cost carriers in the Mexican market and about an equal number of full-service scheduled passenger carriers. While Mexico's two flag carriers believe the market is oversaturated, the view from the low-cost entrants is markedly different. Enrique Beltranena, chief executive of Volaris - which launched low-cost operations a little under two years ago from Toluca near Mexico City - is adamantly opposed to any talk of oversaturation. "I am totally against the view that the market is oversaturated. There is the potential for 56 million passengers a year," he says, although he does point out that there is a significant amount of unprofitable capacity.
"As fares were reduced the market went into a spiral rather than putting the price at the right level, so the pricing level is not real," says Beltranena. "The problem is not capacity, it is the cost of capacity. Carriers that don't have the right costs will say there is too much capacity." He believes a certain amount of consolidation is needed to eliminate unprofitable capacity from the market.
Mike Szucs, chief executive of one-year-old Monterrey-based budget carrier VivaAeroBus, shares Beltranena's view that the Mexican market has not reached saturation. "A market is saturated when you can't fill aircraft, but our seats are filling," says Szucs. "There is no sense of saturation for our model - the problem is for those without a low-cost model." Szucs points to the fact that only a small percentage of Mexico's population of 108 million uses air transport, and says he is much more focused on tapping into that potential than on thinking about consolidation: "In 2006, only 5% of the Mexican population flew, so there is a long way to go before we get to saturation. I'm sure a number of airlines in Mexico are genuinely struggling, but will there be consolidation? Perhaps there will be, but it's not something I'm focused on."
Guillermo Heredia, chief executive of low fares operator ALMA - which launched regional jet services from its Guadalajara base a year-and-a-half ago - agrees that there is a "significant opportunity considering that only 3-5% of the Mexican population flies". He adds: "About 25 million passengers a year fly domestically and another 25 million fly internationally. But two billion a year go by bus and 100 million of those pay the same fare by bus as by plane. The challenge is to get them to use air transport and to do this we have to be an easy company to do business with."
Mexico's new low-cost carriers are following a variety of strategies as they continue their march on the domestic market, and most are also now looking north and south of the border as they plan to take the battle with the country's incumbent carriers into international markets. On the domestic front, VivaAeroBus has steered clear of competing head-on with the incumbents, preferring instead to focus on less congested routes.
"Volaris and Interjet have slightly different ambitions from us - they entered the thick routes and they are doing a great market share grab from Aeromexico and Mexicana," says Szucs. "But we're not interested in grabbing market share. We're not sitting on any of the top 10 routes in Mexico we are looking for new routes. Carriers will eventually start overlapping on routes, but the lowest cost will win." VivaAeroBus plans to expand domestically with the opening of more bases to complement its existing base in Monterrey.
ALMA has taken a similar tack, following a strategy of operating underserved routes which avoid transiting congested Mexico City. "In Mexico, we felt the low-cost model was going to be significantly challenged, not only because of the entrenched legacy carriers but also because nine to 10 city pairs account for 50-60% of traffic and are centralised to Mexico City," explains Heredia. "It is very easy to saturate city pairs so we decided to explore a model which will complement the low-cost structure and the requirements of the country. A significant portion of our routes had not been flown before."
Like VivaAeroBus, ALMA also plans to open more bases, says the carrier's executive commercial director Jorge de Lara. "We are trying to develop three regional centres. We want one in the north and one in the south," says de Lara. The carrier's existing base, Guadalajara, is located in central Mexico. For its northern base, ALMA is considering Culiacan, Hermosillo and Monterrey, while cities under consideration in the south include Merida, Tuxtla and Villahermosa.
ALMA and VivaAeroBus also have their sights firmly set on the US market and both carriers are on the verge of launching transborder services. VivaAeroBus in March will launch flights from Monterrey and Cancun to Austin in Texas, where a new low-cost terminal is under construction. "There are masses of potential between Mexico and the USA and this is something we're exploring," says Szucs. "There are lots of opportunities to link Mexico with the Hispanic population in the USA. The two principle states are Texas and California - these are two attractive markets which are ideal in terms of sector lengths."
ALMA is in the process of applying for US FAA and Department of Transportation certification to begin transborder services. Once authorisation has been secured, Heredia says the carrier "will find the right time to move across the northern border and operate to southern US cities from San Antonio to San Jose". Volaris is also planning to branch into international services, although Beltranena is less forthcoming on which destinations are on the carrier's radar screen: "We are all domestic at the moment, but eventually we will go international, and this will happen in the next year," he says. "This could be to anywhere short-haul, including North America, the Caribbean and Central America."
Toluca-based Interjet, which launched services just over two years ago, recently began its first international service to Guatemala City. In November, the carrier began serving the Guatemalan capital from Toluca and Cancun. South-of-the-border expansion could also be on the cards for VivaAeroBus in the future. "At some point our international expansion will reach south of Mexico, but this is not in our immediate plans," says Szucs.
With the low-cost carriers seemingly attacking from all angles, what are Mexico's established carriers doing to fight back? And how much of an impact has the low-cost onslaught had on their market share and operations? Aeromexico's Conesa says the combined market share of Aeromexico and Mexicana used to stand at around 65%, before low-cost competition entered the market, but this has now gone down to 55%. Mexicana's Azcárraga gives a similar figure but goes back further in time. "In the early 1990s, Aeromexico and Mexicana had a 95% domestic market share, which came down to 84% in 2000, but since then both companies have held close to 50% of the market," he says, adding that Mexicana alone currently holds just under a quarter of the domestic market share.
Newly privatised Aeromexico is in the process of drawing up a new business plan, which is expected to be finalised in the first quarter of 2008. Conesa says the new plan will likely continue the carrier's ambitions to strengthen its international network while giving regional subsidiary Aeromexico Connect a stronger role in its domestic operations. Aeromexico launched flights to Barcelona in December, and will add Rome and Shanghai to its network in March. "We are repositioning more strongly outside Mexico and we are covering the domestic market with Aeromexico Connect," he says, adding that handing domestic routes to the regional carrier "means there are fewer seats but more frequencies, which has helped us to keep market share". Aeromexico Connect will also be used to operate certain US services, such as to Austin and San Antonio.
Meanwhile, Mexicana will continue its expansion throughout the Americas, but is also looking further afield. "Mexicana is a north-south airline - we operate from Canada to Buenos Aires and the idea is to cover as much of the Americas as possible. But we are also evaluating Asia and Europe," says Azcárraga.
Mexicana is also expanding its low-cost subsidiary, Click Mexicana, which Azcárraga describes as a "positive performer". Click will take delivery of eight additional Fokker 100s over the next six months, representing around a 50% growth. Long-haul fleet renewal is also on the cards, and both the Airbus A350 XWB and the Boeing 787 are being considered.
Financially, the impact of low-cost competition on Mexico's flag carriers can be more clearly seen. Mexicana will end 2007 in the red, although Azcárraga says: "Our target is to get back to profitability as soon as possible. Our financial situation is pretty good we have no net debt so the balance sheet looks pretty good." Over at Aeromexico, Conesa says Banamex aims to make the carrier profitable within 12-18 months. Aeromexico incurred a full-year net loss of Ps512 million ($47.4 million) in 2006. Its revenues reached Ps21.1 billion.
Not to be overlooked are Mexico's smaller, well-established carriers such as Aviacsa, which launched operations in 1990. The carrier's director of planning, Manuel Cung, gives a bleak outlook for the Mexican market, but says Aviacsa is in a good position to weather the storm. "2008 will be a very tough year for all Mexican carriers," says Cung. "The Aeromexico privatisation could make it harder for other airlines but the first impact will be on Mexicana - there will be a fight between them in the short-term. But Aviacsa is in the best of both worlds. We own our aircraft so we're pretty flexible to ground aircraft if we see a lot of competition."
Volaris' Beltranena is bracing himself for a tough year, but says the rapid entrance of new carriers is unlikely to continue: "The changes in the market over the next six to eight months will be so big that we will have to be very flexible in what we plan to do. But the market is not going to grow at the same rate over the next few years."
Emiliano Zapata was a leading figure in the real Mexican Revolution which broke out in 1910
Infrastructure plays catch-up
Air traffic in Mexico has experienced spectacular growth over the past couple of years as a number of low-cost start-ups have entered the market, but many in the industry are concerned that the country's airport infrastructure has not been keeping pace with this level of growth.
Guillermo Heredia, chief executive of Guadalajara-based regional operator ALMA, believes every airport in Mexico needs to undergo some kind of expansion or improvement over the coming years to keep abreast of explosive growth in the air transport sector. "All airports need to expand. There is not one single airport in the whole country that can operate in the next five years without major enhancement," he says. "Not only do they need to grow capacity, they need to improve the quality of infrastructure."
Manuel Cung, director of planning at Aviacsa, agrees: "There is a huge opportunity to improve infrastructure in Mexico - airports are doing their job but passenger growth is much higher than airport expansion. The government will need to accelerate infrastructure projects." Cung adds that airports such as Mexico City, Cancun and Guadalajara are becoming saturated, which he sees as a "huge problem".
But Volaris chief executive Enrique Beltranena is optimistic that airport infrastructure will eventually catch up with airline growth. "It's a matter of time - it will happen while we are all growing and developing," he says. "The problem the airport companies have is that the market didn't develop in 10 years, and an investor that has a business that doesn't grow is not going to invest in making that business grow. What happened is absolutely natural."
What the Mexican market does need, according to VivaAeroBus chief executive Mike Szucs, is additional airport capacity that is not accompanied by a high price tag. "This is mass transportation. Airports need to provide additional capacity but at low costs," says Szucs. "Look at Monterrey [VivaAeroBus' base], it only took three months to construct at a very low cost." He adds that Monterrey airport operator OMA will construct another facility for the carrier at the end of 2008.
However, Szucs does not believe the capacity situation is as pressing as others think. "Mexico does need investment in infrastructure but there are loads of airports. Terminals still have a bit more capacity that can go into them," he says, although he does point out that investment in aircraft navigation aids to reduce the impact of inclement weather on operations is needed.
Guillermo Heredia, chief executive of Guadalajara-based regional operator ALMA