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Latin American Airlines: Buyers welcome

septiembre 2, 2016
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Foreign airlines and investors are plowing money into Latin American carriers, and more appears on the way. Why the strong appetite for the region’s airlines? The combination of market, industry and operator-specific factors make Latin America one of the safest bets in the global airline business.

As background, in recent months, China’s HNA Group acquired a 24% stake in Azul for USD455m, Qatar Airways bought 10% of LATAM for USD613m, and Irish fund Irelandia has increased its stake in Colombian LCC VivaColombia from 25% to 75%. Meanwhile, airlines from the US and elsewhere are reportedly eyeing long-term investments in Avianca, Gol, and others. This is in addition to existing airline equity holdings in the region’s airlines, such as Delta’s 9.5% stake in Gol and 4.1% stake in Aeromexico, or Air France’s 1.5% stake in Gol.

From a market perspective, despite the news about Brazil’s struggling economy, uncertain political situation and depressed commodity prices, there is a lot to celebrate: the return of pro-market government in Argentina; a new pro-business president in Peru; and a clear path to peace in Colombia. These are promising signs for a region with over 600 million inhabitants, about 40% of which are under 24, and which has seen poverty rates fall by 2/3, to under 6%, since 1990 according to the World Bank.

Hence, the political outlook in the region hasn’t looked this good in years, which bodes well for investors. As for Brazil, its economic fundamentals are strong and growth should resume once politicians can agree on needed structural reforms to lower the cost of doing business and spur productivity growth. Mexico, which has implemented long-needed reforms in recent years, is an example that change is possible. It’s a matter of when, not if, Brazil will recover. And when it does, its growth will benefit the entire region.

Looking at the airline industry structure, the situation is very attractive for three reasons:

• As a result of industry consolidation, competition from incumbents is limited. For instance, on international routes within Latin America, Copa, LATAM and Avianca combine for 70% of seats, and ¾ of the top 100 routes are served by 2 or fewer carriers. In the largest domestic market, Brazil, three carriers – LATAM, Gol and Azul – control 90% of seats. Competition on international routes will be further limited as a result of airline JVs such as the joint business agreement between LATAM, American and IAG.

• The threat of competition from other modes of transportation is nonexistent, given long distances between cities, poor highways and lack of both national and intercontinental rail networks.

• Despite an increasingly favorable regulatory environment governing commercial decision-making (fares and routes, JVs) and foreign ownership restrictions, highly constrained airports in key markets (e.g., Sao Paulo, Mexico City, Bogota, Lima, to name a few) act as a barrier to entry, making it difficult for new entrants to grow into threats.

Lastly, the operator-specific situation makes a very strong case for equity investment. Airline stocks are trading in the low end of their range: as of early August, Copa was trading at USD78 (down from USD150 in mid-2014); Avianca at USD6 (down from USD18 in early 2014); Gol – despite a reverse stock split – at USD18 (down from USD88 in 2012); and LATAM at under USD9 (down from USD29 in 2012). This results in some overly pessimistic valuations that do not accurately reflect the going-concern value of these companies. For instance, Avianca’s market cap of only USD262m is below book value of about USD950m; Gol’s market cap of USD362m is low when you consider its owned aircraft fleet alone is worth over USD3b; and Qatar’s investment in LATAM valued the airline at about USD6.1b vs. a current market cap of only USD4.9b.

There’s no denying that the region’s airlines are currently facing financial headwinds due to currency devaluation and soft demand, and have consequently piled on significant debt, but their balance sheets are reasonably strong, with sufficient liquidity to weather the crisis while they seek to raise fresh capital. The risks of bankruptcy are low (for instance, LATAM and Gol, the most indebted of the region’s publicly traded carriers, have interest coverage ratios of 2.2 and 1.8, respectively), whereas the medium-to-long term potential of these airlines is favorable.

Given these factors, it makes sense for foreign airlines and funds to bet on Latin America’s airlines, whether as minority shareholders seeking to make a return on undervalued stock, or as decision-makers if the airlines’ current owners are willing to give up management control. US airlines in particular can bring a lot of business transformation know-how, given their experience in successfully restructuring their own legacy airlines in recent years.

Expect the Latin American airline fire sale to intensify in the coming months…
Notes and disclosures. The above are my personal views, and do not represent those of ICF International. They should not be construed as a recommendation to buy or sell stock. I do not own any stock in the companies mentioned in this article.

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Fuente: By Carlos Ozores, Principal, ICF International / ALTA

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