Business restructuring: What could be LATAM Airlines strategic options going forward?

After 7 weeks of filing, it is good news to observe that LATAM Airlines has secured already US$2.2B (1.3B + 0.9M) for its restructuring process. As per filing, the airline had US$1.3B in cash on hand plus receivables and lines of credit on May 25th, 2020 from US$1.9B at the end of year 2019. Therefore, its filling was a very different one when compared to Avianca and Aeromexico not only because of the amount of cash on hand but also its lower leverage position. For Avianca and Aeromexico, their filing was purely associated with its high financial leverage position.

In my views, LATAM filing was a strategic management move as demand has collapsed. Besides, it needed to cut costs and rightsized quickly to stay afloat as unions and other factors might have made them a very painful and lengthier process. As it continues restructuring under bankruptcy protection, LATAM filing will allow the carrier to slash labor costs, make significant progress to reduce debt, cancel aircraft orders while divesting assets more swiftly.

But putting lackluster demand aside, LATAM was already facing cost pressures and revenues were deteriorating. For example, when looking at top line revenue from 2012 to 2019 it shows a CAGR of -2.9% while costs were reduced -3.7% as per figure below (Source: LATAM Airlines financial reports). Likewise, passenger revenue per ASK show a CAGR of -3.9% but what is most concerning is a CAGR of -5.4% in its domestic SSC operation (domestic passenger operations in Spanish speaking countries carried by the airline including Chile, Peru, Argentina, Ecuador and Colombia) but it have further deteriorated to -7.8% when compared 2018 vs. 2019. Having said that, it is true that GDP contractions, currency devaluations and inflation and a difficult LAN + TAM merger have played against the carrier as well. Furthermore, cargo revenues per ATK has also fallen to -5.1% CAGR in the 2012-2019 period but further deteriorated to -6.8% when compared 2018 vs. 2019.

In addition, 2012 to 2014 were the highest revenue years for the airline but after that it has plateau and is stagnated at US$10B. Although the airline has been profitable in the past 4 years, its long-term sustainability as a profitable has deteriorated over the years.   

Besides and at a high level, LATAM Airlines strengths include a valuable and well recognized brand in Latin America, one of the best cabin service in the region, world recognized equity partners (DL & QR) and strong loyalty program, among others. On the other hand, its weaknesses include perhaps over expansion to minimize the loss of domestic market share, 122 FTE p/aircraft (which should be below 100 FTE p/aircraft as partner DL. By using said benchmark and LATAM fleet count by YE2019, it is observed the carrier operates with an “extra layer” of 7,524 employees). Likewise and when compared to domestic/regional competitors including lower CASKs ULCC operators, it has a higher cost structure. Moreover and due to ULCC penetration in the region, the airline may have had to balance out domestic market losses with more Point-to-Point (“P2P”) premium revenue service to counter weakened domestic revenue environment as it must feed cross border traffic to its long-haul services.

Therefore and to be able to compete in a more cost balanced field, what could be LATAM strategic options going forward as it continues to restructure its business?

A)     Domestic and regional operation options:

1.      Exit unprofitable markets. LATAM has left domestic Argentina markets. Due to its small (when compared to other) market size Ecuador and Paraguay may follow. In a liquidity conservation environment vs. returns, these two markets could be a distraction for management unless they are highly profitable which in the case of Ecuador may not be the case. Besides, Peru domestic market size is 3x larger than Ecuador while Colombia is 5x.

2.      Eliminate the practice of balancing potential domestic market losses with P2P international services (previously launched to avoid revenue dilution and optimize revenue vs. through codeshare services)

3.      Focus on profitability before market share growth. Implement a rigorous seat capacity discipline network. Based on how cases are contained by government, border will close and open without much notice and it will negatively impact demand

4.      Maintain current business model but look for major cost-cutting initiatives. Achieve at least a 50% CASK reduction that will allow to compete head-on against ULCC. Agree on union concessions at least for the next 5 to 10 years. Examples: Payrates reduction, productivity improvements, benefits and perdiem reductions, etc.

5.      Evaluate a new mixed business model. Launch its own “budget” ULCC bare fare product as Copa Airlines did with Wingo. WestJet has Swoop. Lufthansa operates Eurowings, etc. Will the new mixed business model generate synergies is a good question to begin with. Can the airline operate with a dual management and branding strategies? Many airlines have tried in the past and failed. In the Wingo case, it is still brand but have not grown its fleet and route network much perhaps as it launched operations to counterattack an ULCC player in Colombia. Going forward and as liquidity is a concern, Copa Airlines might decide to concentrate on its core business and axe it. But if this is still a viable option for LATAM, it should focus on improving personnel productivity, unionized workforce, lowering pay rate and salary levels, lowest FTE p/aircraft (an international benchmark is 35 FTE p/aircraft), leanest processes, flatter structures and high usage of digitalization to reduce costs to name a few. In phase one, budget model to be flown in highly competitive domestic markets while regional markets to be evaluated based on competition penetration, CASK and markets price point on a one-on-one basis. Phase two and long-term strategy, budget model to be flown to be extended to regional markets.

6.      Seek out more codeshare partnerships (we have observed one with a competitor in Brazil already). Besides, look for tighter ties with competitors as the name of the game is to stay afloat.

7.      Evaluate low-cost operator feeding traffic model. It could be a good strategy if at a lower cost a competitor can feed regional and/or international traffic to mainline operation. Using a low-cost carrier instead could be a more cost-effective solution of bringing passengers to connecting hubs for long-haul flights. Besides and through it, LATAM could more easily fill their long-haul aircraft and even ensure marginal routes become profitable. This option might be preferred than launching its own ULCC operation. Besides, they can be a good way to become more profitable and leaner while returning higher dividends to investors. However, egos in the airline business and others such as agreed revenue sharing and terms, passenger/bags transfer complexities, flight cancelation liability, etc. have prevented this type of deals at a large scale though interlining between LCCs and FSCs is not new at least in Europe

8.      Buying a competitor. Unlikely but as airline valuations are at low historical levels, it could be an option on the table

9.      Others considered by management

B)     International market options:

1.      Expand P2P long and ultra long-haul international premium services to further optimize revenues 

2.      Explore new opportunities for connectivity with the US, Europe, Oceania, Asia-Pac and the Middle East with current equity partners but as well beyond them

3.      Evaluate new potential areas of cooperation with equity partners through a value-based approach (digitalization, joint procurement, MKT, airport facilities, maintenance, data analytics, etc.)

4.      Seek out new equity stake partners or increase participation (QR has expressed interest already). However, lower airline valuations at this time will prevent LATAM to benefit financially  

5.      Avoid price wars strategy with current and upcoming competitors such as United Airlines seat capacity push in Latin America. Instead focus on increasing product differentiation and benefits in premium cabins followed by innovation, offering unique product mix and selling travel experiences rather than a flight

6.      Others considered by management

As per this discussion, perhaps the need of LATAM to rethink its business thorough has become critical. As it's expected that ULCCs will continue to mushroom and become larger through consolidations (or organically) on a global scale including in Latin America, LATAM next moves related to growth might end up being one of the most strategic ones it has ever needed to make.