Small- and mid-cap airlines are mainly low-fare airlines. This gives us an interesting space to cover given that performance of budget airlines is a solid indicator of actual levels of discretionary consumer spending in the economy. This is why, historically, budget airlines have performed well in recessionary times.
Let’s have a look at some of them:
Earnings preview and outlook
Copa Holdings, S.A. (NYSE:CPA) is expected to announce its earnings on Aug 8. The Street expects the company to announce an EPS of $1.77. Discussions on the investor conference call will likely focus on the company’s updated 2013 guidance as well as its capital deployment strategy going forward. The company has the potential to increase its payout ratio to 40% in 2014E from 30% currently, based on its target 30% cash to trailing-12 months revenue ratio.
This $6-billion company had an important catalyst on July 8. On that date, after the market closed, the company reported June and full second-quarter operating statistics. Consolidated traffic was up an encouraging 19.5% in June and up 20.4% for the quarter, outpacing the traffic estimate of 15.4% growth for 2Q. Importantly, demand growth outpaced supply growth, which was up only 14.4% in June and up 17.7% in the second quarter. As a result, load factors climbed 342 bps to 76.9% in June and closed out the quarter at 75.3%.
Although international demand remains the key driver of growth, up 21.7% in June and up 21.9% (year-over-year) in the second quarter, the domestic traffic lagged — down 20.1% in June. However, Copa Holdings, S.A. (NYSE:CPA) continues to limit its reliance on domestic demand, with domestic available seat miles (ASMs) representing only 3.4% of its total network capacity in June, down from 4.8% a year ago.
Another Latin American airline
Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL) was the first Brazilian low-fare airline. The stock for this company is down almost 45% since the start of the year. However, still the Street is bearish on the stock (despite such a fall in the price). The company might have experienced a larger-than-anticipated loss in the second quarter.
Earnings-per-share estimates have fallen 43% over the past few weeks as the company provided updated 2013 guidance, revising its ASM and BRL/USD exchange-rate guidance range. Given the easier setup into the quarter, investors’ attention will likely be focused on the company’s updated thoughts on the current demand environment in the domestic market (Brazil) amidst the recent geopolitical uncertainty.
One of the factors that has greatly upset investors has been the company’s weak balance sheet. Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL) has a thin equity base, with equity to total assets of just 20% versus 35% for the Latin American peers. The strengthening of its balance sheet should remain a top priority for Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL) over the next few years. GOL’s balance sheet will remain bogged down by an excessive debt load, with an adjusted net debt to EBITDA of 6.5x for 2013E, in contrast to many of the leading low-cost carries that have more modest levels of leverage. Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL)’s fleet strategy, which relies heavily on leases, creates significant off-balance sheet liability.
A Chile player
LATAM Airlines Group SA (ADR) (NYSE:LFL) is a major provider of domestic and international passenger and cargo services in Brazil. The company shares a similar story to Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL) in the context of a feeble balance sheet. Both LATAM Airlines Group SA (ADR) (NYSE:LFL) and Gol Linhas Aereas Inteligentes SA (ADR) (NYSE:GOL) are debt laden and need to bolster their balance sheets. LATAM Airlines Group SA (ADR) (NYSE:LFL) has already announced plans to issue up to $1 billion in a secondary issuance. There are a confluence of factors that keeps the Street grounded about this company: (1) uncertainty over the magnitude of dilution from its announced planned rights offering; (2) ongoing integration challenges; and (3) the near-term passenger (pax) and cargo traffic recovery looks uneven.
Those who are not aware of what integration means here should know that LATAM Airlines Group SA (ADR) (NYSE:LFL) is actually a product of merger between two Chile airlines that are Lan Airlines and TAM airlines. Both combined their business back in June 2012 and went on to form LATAM Airlines Group SA (ADR) (NYSE:LFL), which would provide its customers access to 150 destinations in 22 countries.
The stock is down 40% in the last six months. However, there are a few positives that can help to neutralize the bearish outlook on the company: (1) The Street sees earnings approaching an inflection point; (2) LATAM Airlines Group SA (ADR) (NYSE:LFL) is a leading carrier in oligopolistic markets in the region; and (3) there is a secular growth opportunity in the under-penetrated aviation market.
Final word
Copa Holdings, S.A. (NYSE:CPA) seems to be the best investment of the lot given its solid balance sheet, which will not only help to expand its operations but also increase its payout and eventually improve its modest 1.6% dividend yield.
The article One Latin American Airline to Buy, Two to Hold originally appeared on Fool.com and is written by Zain Abbas.
Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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