Why have I decided to post about Latam companies? After speaking to a friend of mine, I have realized that many North American investors are not investing properly in emerging markets just because they are unfamiliar with the companies and the region overall. Thus, I could help by speaking of Latin American companies where I am located.
I have decided to start with a well-known company, Gol Linhas (GOL), but I am planning to dig deeper into less well-known companies (even with no ADRs):
Prices based on ADRs
Current price: $8.43
Average price of holding: $7.01
Target price (12 months based on DCF): $19.00
- This is the low cost airline of Brazil. It owns 157 airplanes.
- 95% of its revenues come from domestic flights.
- It just bought Webjet (still pending approval) giving Gol a 41% market share in Brazil (36% pre-Webjet) which is similar to Tam`s (TAM) 41% share.
- 5% of its revenues, 60% of its costs and 80% of its debt is USD denominated
- It has a frequent flyer program called Smiles (inherited from the acquisition of VRG), it has 8.2 million members. While it is not as mature as Tam`s Multiplus it is growing that way.
- No refinancing risk within 3 years. Policy of keeping one third of revenues in cash.
The airline industry in Brazil is in an attractive position right now for four main reasons:
- More and more Brazilians and migrating from the low income classes to mid-class which right now stands at 55% of the population. As more individuals enter this class, more people will become first time travelers increasing the number of passengers (a theme we have seen for years now).
- Poor train and road infrastructure in Brazil.
- World Cup and Olympics have led to airports to being taken private in concessions of 20-30 years and the government already has committed an additional 5bn commitment in airport infrastructure.
- Consolidation. The creation of LATAM (Chilean company Lan + Brazilian Tam) will introduce more rationality into the market. For those covering the industry from ground zero, have known for years that Tam is running its domestic operation at a loss subsidized by its profitable international operation. However, the Cueto family (controlling owner of Lan) are more interested in profitability than market share, therefore, we will see an increase in domestic ticket prices in Brazil.
- Attractive industry in Brazil
- A stoppage in the price war between Tam and Gol will help the industry overall in increasing yields. But as Gol is a more efficient and lower cost carrier than Tam, we prefer Gol.
- Yields will increase due to 1) the increase in prices and 2) keeping capacity constant (2012 guidance is an increase of 0% to 2% of capacity).
- Based on my DCF there is a considerable upside (see target prices above).
- Big currency mismatch, buying Gol is a short on the USD and a long on the BRL. (10c change in BRLUSD translates to 250 bps in margin).
- Oil prices, Gol has a policy to hedge 40%.
- The market does not act rationally (eg. Tam does not increase prices or Tam and Gol return to increase capacity).
I hope I put enough information to encourage some discussion; if you have comments, questions or just disagree with me, I will try to reply as soon as I can.