On the Rebound: The Resurgence of Brazilian Aviation

Siddharth Desigan

Research Analyst

Economic Research and Analytics Group

Aerospace & Defense Industry

August 28, 2008

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Focus Points

Country Profile

Economic Overview

Industrial Policy

Industry Structure

Commercial Aviation Sector

Industry Overview

Airports Modernization

Space Sector

Industry Trends

Market Drivers & Restraints

Growth Opportunities

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Country Profile

• Largest democracy in Latin America.

• Pop. 187 million. Largely concentrated in the south and central regions.

• Head of State: President Luiz Ignacio “Lula” da Silva.

• Neo-liberal economic policy aimed at increasing growth and widening the manufacturing base.

• Re-election platform includes poverty alleviation and infrastructure modernization.

• Founding member of UN & MERCOSUR

• Major Trade Partners:

• EEC (26%)• US (24%)• LatAm/MERCOSUR (21%)• Asia (12%)

International Relations

Political Overview

• Defense Budget � $24 billion (Equipment Acquisition: $5.6 Billion)

• Brazilian Air Force � Largest in Latin America. Fleet size: 700+ Manned Aircraft.

• Government Aerospace Policy � Positive• Provision of Loans & Lines of Credit � Enhance export competitiveness• Compilation of Supplier Database � Expedite Exports• Privatization of State-held enterprises• Increased investment in aerospace-related research.

Government Stance on Aerospace

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Economic Overview

Favorable

Investment

Destination

Growth

• 5.1% GDP growth over 2007 ($1.84 Trillion).

• Projected growth rate of 4.1% over 2008-2012.

Growth

• 5.1% GDP growth over 2007 ($1.84 Trillion).

• Projected growth rate of 4.1% over 2008-2012.

FDI

• Robust FDI inflows into manufacturing sectors.

• Long-term FDI estimated at $193.8 billion in 2007

FDI

• Robust FDI inflows into manufacturing sectors.

• Long-term FDI estimated at $193.8 billion in 2007

Labor

• Estimated labor force of over 100 million.

• Aggregate labor costs estimated to be 80% lower than U.S levels.

Labor

• Estimated labor force of over 100 million.

• Aggregate labor costs estimated to be 80% lower than U.S levels.

Monetary Policy

• Floating exchange regime since 1999.

• Interest rates hiked to curb inflation and speculative borrowing.

Monetary Policy

• Floating exchange regime since 1999.

• Interest rates hiked to curb inflation and speculative borrowing.

Trade

• Strong external demand driving trade.

• Recorded first current account surplus in 2008

Trade

• Strong external demand driving trade.

• Recorded first current account surplus in 2008

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Economic Overview

2.7

5.7

3.1

3.7

5.1

4.5

4.1 4.0 3.9 3.9

1.21.3

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Years

Growth Rate (%)

GDP Growth Rate (2001-2012)

Growth Drivers:

• Low inflation driving consumption and growth.

• Global commodity boom driving long term FDI in key sectors.

• Economy gradually decoupling fromU.S, thus buffered from the impactof the sub-prime crisis.

Industrial Policy:

• Policy focused on improving export competitiveness of Brazilian firms due to appreciating Real.

• $12.7 Billion package to boost exports in targeted sectors of the economy.

• Assistance to private sector taking the form of soft loans & waiver in duties for import of capital goods.

Restraints:

• Appreciating Real is hampering export capability.

• Poor quality of infrastructure restricts long-term economic growth.

• Impending elections in 2009 could prompt government to adopt an expansionist agenda

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New Industry Policy and Impact on A&D

New Industrial Policy

Focus on key export-oriented Industries like Pharmaceuticals, Electronics and Aerospace

Deregulation of norms on opening and closing of firms

Soft loans for modernization of industry through the Brazilian Development Bank

Focus on BNDES Loans

• Loans for Modernization of Equipment to meet ABNIEE standards

• Program for Incorporation of locally manufactured capital goods – 36 month loans carrying a 3 percent interest rate and 3 month graceperiod

• Capital influx will offset the effects of appreciating Real and increase access to credit.

• Imports of equipment will drive product diversification and sophistication in the aerospace sector.

Impact On A&D Industry

Policy of gradual disinvestment and facilitation of private-public partnerships

Policy of gradual disinvestment and facilitation of private-public partnerships

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Industry Structure

Industry Regulator ANAC (National Civil Aviation Agency)

CarriersCarriers Manufacturers Manufacturers Maintenance, Repair and Overhaul (MRO)

Maintenance, Repair and Overhaul (MRO)

Big 2 Airline Operators

•TAM•GOL (recently acquired VARIG)

Big 2 Airline Operators

•TAM•GOL (recently acquired VARIG)

Outsourced/ ThirdParty MRO Facilities

• Varig E&M (VEM)• TAM• GE Celma

Outsourced/ ThirdParty MRO Facilities

• Varig E&M (VEM)• TAM• GE Celma

Airline Affiliates/ In house MRO

•Varig E&M (VEM)

•TAM

Airline Affiliates/ In house MRO

•Varig E&M (VEM)

•TAM

Traders andDistributors

Traders andDistributors

• Embraer

• Helibras

• Embraer

• Helibras

ResearchInstitutes

ResearchInstitutes

National Institute for Space Research

National Institute for Space Research

Airports(Infraero)

Airports(Infraero)

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Overview of Aerospace Industry and Commercial Aviation Sector

• Key industrial sector, employing 23000+ workers & turnovers of over $4.2 billion

• 90% of domestic production geared towards export market. Embraer 2nd largest Brazilian exporter.

• 80+ firms involved in aerospace related manufacturing and R&D.

• Total commercial fleet of over 600 aircraft � 21% of Latin America’s fleet.

• 9 private airline operators. TAM & GOL Aerolinhas major players � 90% combined market share.

• Embraer is the local airframe manufacturer. 3rd largest globally with specialization in smaller body regional jets (30-120 seats)

Industry Overview

Commercial Aviation

Export Promotion:$50 million program by Govt. & BNDES to assist small & medium sized suppliers compete effectively.

Export Promotion:$50 million program by Govt. & BNDES to assist small & medium sized suppliers compete effectively.

Research:Establishment of a $14 million research facility in Sao Paulo studying light structures, aircraft design & composite materials. Co-sponsors: BNDES, Embraer & Sao Paulo Inst. Of Tech.

Research:Establishment of a $14 million research facility in Sao Paulo studying light structures, aircraft design & composite materials. Co-sponsors: BNDES, Embraer & Sao Paulo Inst. Of Tech.

Privatization:BNDES/Govt. joint initiative to privatize airport operator Infraero. Sale of 49% stake expected to raise up to $3 billion. State to retain control of enterprise.

Privatization:BNDES/Govt. joint initiative to privatize airport operator Infraero. Sale of 49% stake expected to raise up to $3 billion. State to retain control of enterprise.

Government Initiatives in Aerospace

Government Initiatives in Aerospace

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Commercial Aviation Policy in Brazil

Deregulation

Industrial Organization

Price Controls

Fleet Acquisition

Partial regulation restored in aerospace sector after deregulation in 2001.

Partial regulation restored in aerospace sector after deregulation in 2001.

No macroeconomic interference in the form of price controls. Airlines have to register fares with ANAC.

No macroeconomic interference in the form of price controls. Airlines have to register fares with ANAC.

• Regional monopolies abolished, but policies favor established operators.

• Stimulus provided to new entrants based on performance.• Government policy to guard against over crowding and

excess capacity

• Regional monopolies abolished, but policies favor established operators.

• Stimulus provided to new entrants based on performance.• Government policy to guard against over crowding and

excess capacity

Fleet acquisition linked to profitability of carrier and infrastructural constraints like availability of landing slots

Fleet acquisition linked to profitability of carrier and infrastructural constraints like availability of landing slots

AirportsAll airports managed by state-owned entity Infraero, based under the Ministry of Defense. All ATC personnel are subordinated to the Brazilian Air Force.

All airports managed by state-owned entity Infraero, based under the Ministry of Defense. All ATC personnel are subordinated to the Brazilian Air Force.

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Trends and Opportunities in Commercial Aviation

Brazilian carriers expected to add 700 new aircraft over next 20 years. Majority in small jets segment.

Trends

OEMs, suppliers and MRO operatorsFleet Expansion

Current players Infraero & airline affiliates. Expected growth in demand and industry deregulation.

International MRO operators, small firms with MRO expertise.

MRO Operations

Large carriers (TAM, GOL) fly only limited number of routes. Service to North & Northwest regions sporadic

New entrants in low-cost segment.

Underserved Market

Year-on-year growth of 8.1% � commercial aviation & 5.1% � cargo (2000-2007). Tourism & Infrastructure revamp �create demand & add capacity.

Airline operators, manufacturers, in-flight services etc.

Growth Industry

Rising fuel prices � airline operators shifting to smaller fuel-efficient jets. Embraer market leader in this segment (Backlog orders � $14 billion +)

Embraer, firms in Embraer’s supply chain (R&D partners & 1000+ suppliers)

Manufacturing

Opportunities for

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Aerospace Industry – Drivers & Restraints

Rising demand for commercial aviation services

Competitive advantage in terms of start-up and labor costs.

Manufacturing competencies in areas of aircraft design, production, space technology & avionics.

Infrastructure revamp will ease congestion and create capacity. Opportunities for existing market players and new entrants. Will also create openings for firms engaged in infrastructure.

Market Drivers

Infrastructural ConstraintsCrowded facilities, lack of landing slots,

shortage of personnel

Lack of diversificationNation’s aerospace industry depends on

Embraer, which employs 80% of aerospace labor force.

Cyclical downturnsCyclical nature of aviation industry amplifies shocks caused by lack of

diversity in the market

Regulatory IssuesPolicies favor established players over

new entrants, creating entry barriers and establishing monopolies.

Market Restraints

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Airports

INFRAEROINFRAERO

Airports in Brazil managed by state-owned, Air Force staffed monopoly Infraero. Critical functions, including Air Traffic Control, performed by Air Force personnel.

67 Airports handling 97% of Brazilian air

traffic.

81 Air Navigation Stations & 32 Cargo Logistics Terminals.

Processing 96 million passengers & 1.3

million tons of Cargo annually.

• National airport infrastructure congested and over crowded. Lack of oversight and improper resource management widely blamed for aviation crisis of 2006-07.

• Passenger traffic expected to double during 2014 Football World Cup.

• Significant infrastructural inputs needed to cope with surge in demand.

Northeast

$80 (Million)

Southeast

$380(Million)

South

$11(Million)

Middle East

$140(Million)

North

$60 (Million)

Airport Infrastructure at Present

Airport Investments By Region (2003-2007)

Source: Infraero, 2008

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Airport Modernization in Brazil

Goainia

Estimated $122 million project to acquire baggage X-Rays, ATC & radar systems, metal detectors, elevators and

passenger bridges. Natal$50 million Greenfield airport project.

Macapa

Devt. of $39 million Greenfield airport in Macapa. Venture includes acquisition of X-Rays, elevators, passenger bridges and other equipment.

Santa CatarinaFlorianopolis Intl. Airport

$147 million project to modernize existing airport & construction of a new passenger terminal.

Sao PauloGaurulhos Intl AirportConstruction of a third passenger terminal; extension of tarmac and equipment purchases including access controls, mobile bridges, non-intrusive drug and explosive scanners and baggage handling equipment.

Rio de JaneiroJacarepagua Intl Airport:

A public bid will be opened to modernize the passenger terminal at Jacarepagua Airport.

• Slated $2.4 billion investment to revamp and modernize national airport facilities before the 2014 Football World Cup, (Brazil hosting)

• Expected completion of primary phase of modernization by 2010.

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Brazilian Space Sector

Program initiated in 1961 with the establishment of the National Institute of Space Research(INPE). Presently headed by the Brazilian Space Agency (AEB), (est. 1994) under the executive office of the President.

Program initiated in 1961 with the establishment of the National Institute of Space Research(INPE). Presently headed by the Brazilian Space Agency (AEB), (est. 1994) under the executive office of the President.

Areas of program implementation

• Satellites & Payload Systems• Ground Control Systems• Launching Vehicles & Sounding

Rockets• Aeronautical Training

Areas of program implementation

• Satellites & Payload Systems• Ground Control Systems• Launching Vehicles & Sounding

Rockets• Aeronautical Training

Program follows goals set by the National Policy on Development of Space Activities:

• Attaining autonomy in space exploration and research.

• Identify and implement aeronautical solutions to national problems.

• Enhance local manufacturing competitiveness in space related research and production.

Program follows goals set by the National Policy on Development of Space Activities:

• Attaining autonomy in space exploration and research.

• Identify and implement aeronautical solutions to national problems.

• Enhance local manufacturing competitiveness in space related research and production.

Key Firms:

• AVIBRAS (missiles and sounding rockets)• Aeroeletrifica (Avionics) • CENIC (Composite Materials)• Elebra/NORCAL (Electronics)• TECNASA (Air Navigation Support & Radar Countermeasures)

Key Firms:

• AVIBRAS (missiles and sounding rockets)• Aeroeletrifica (Avionics) • CENIC (Composite Materials)• Elebra/NORCAL (Electronics)• TECNASA (Air Navigation Support & Radar Countermeasures)

Drivers:

• Ideal Geography• Established technological base• Availability of skilled manpower• Lack of regional competitors

Drivers:

• Ideal Geography• Established technological base• Availability of skilled manpower• Lack of regional competitors

http://www.spacetoday.org/Rockets/Brazil/BrazilRockets.html

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Growth Opportunities in A&D

• MRO Operations

• In-flight Services

• Dry & Wet leasing of aircrafts

• Aircraft Manufacturing

• MRO Operations

• In-flight Services

• Dry & Wet leasing of aircrafts

• Aircraft Manufacturing

Commercial Aviation

Airport Modernization

• Airport Infrastructure & Retail

• ATC & ground control equipment

• Aviation specific training & education

• Security & baggage monitoring.

• Airport Infrastructure & Retail

• ATC & ground control equipment

• Aviation specific training & education

• Security & baggage monitoring.

Space & Defense

• Satellite launching & ground control

• Composite materials

• Guidance systems and avionics

• Radar, monitoring and early warning systems

• Satellite launching & ground control

• Composite materials

• Guidance systems and avionics

• Radar, monitoring and early warning systems

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