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We recently downgraded our recommendation on GOL Linhas Aereas (GOL - Analyst Report) to Underperform from Neutral.

The lowered rating was due to the significant international competition in the airlines industry, which may adversely affect the company’s market share. In addition, the proposed merger of Lan Airlines and Tam S.A. is anticipated to aggravate competition further.

However, during the second quarter, GOL was able to make more efficient use of its fleet, both in terms of increased productivity and higher occupancy rate, even on the backdrop of competitive air traffic market. Moreover, the recent rise in load factor for July 2011 appears encouraging and the company is able to foresee a better future demand growth.

The recent rise in fuel prices, appreciation of the Real against the U.S. dollar due to currency fluctuation are also anticipated to impact profitability going forward. However, the company’s cost reduction initiatives, consultancy programs for saving fuel and reducing gas emissions are anticipated to keep costs appropriate with its business model while maintaining profitability as well as commitment to safety and quality.

We remain on the sidelines on the stock driven by the risk of fall in customer demand for the product / service as well as dwindling demand for domestic and international route network, which could adversely impact expected revenues and earnings.

However, GOL’s long-term business strategy of focusing on differentiated service, launch of new international destinations and partnership with travel agencies to sell block seating on flights are expected to raise customer demand and increase sales in the coming quarters.

The company’s dependence on a few large customers as well as the risk of infrastructural crisis in Brazilian Airports still remains a matter of concern for the stock.

GOL Linhas is one of the most profitable low-cost airlines in the world connecting the cities of Brazil as well as those in Argentina, Bolivia, Chile, Paraguay, Peru and Uruguay. The company currently operates about 38% of Brazil's domestic flights and 12% of international flights. It competes directly with its peers, such as Copa Holdings SA (CPA - Snapshot Report), LAN Airlines S.A (LFL - Snapshot Report), and TAM S.A (TAM - Snapshot Report).

We currently provide a long-term Underperform recommendation on the stock. GOL Linhas has a Zacks #4 Rank, which translates into a short-term Sell rating (1-3 months).

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