Grupo Aeroportuario del Pacifico: Attractive at What Price?

Sometimes it actually rains in Southern California, or just becomes overcast during January and February every year. During that time the depressed residents of this area enjoy nothing more than a trip to balmy climates just south of the border where their dollar goes a little further and the SPF 50 cocoa butter is plentiful off season. Grupo Aeroportuario del Pacifico S.A.B de C.V. (PAC) [GAP] is a company that welcomes the Smog Birds of Southern California to their airports on their way to the vacation resort of their choice.

GAP is one of three airport operators [the other two being Grupo Aeroportuario del Sureste (ASR) and Grupo Aeroportuario del Centro Nort (OMAB)] concessions in Mexico created in 2005 with the privatization of the airport management entity. It has 12 airports under management in the Western part of the country including Guadalajara (third biggest in Mexico), Puerto Vallerta, Los Cabos, Tijuana and smaller locations Mexicali, Hermosillo, Agaucalientes, Bajio, Morelia, La Paz and Manzanillo.

With monopoly status, the fortunes of the company are directly indicated by the number passengers passing through its airports. The 2007 annual report for the company reported passenger growth at Guadalajara over a three year period and Los Cabos over a five year period of 11% and 14% respectively. At Los Cabos, 75% of the increase consisted of higher margin international passengers.

At the end of 2007 and early 2008, the company continued to believe traffic growth would continue unabated at previous rates. As such, the company has been investing in capital expansion projects in Guadalajara, Los Cabos, Puerto Vallarta and Tijuana airports with the intent of capturing new commercial revenues. Overall passenger growth and commercial growth were estimated at under 10% and 13-16% respectively. Customer traffic has been increasing to GAP airports due to increased international exposure of Mexico’s resort destinations and explosion of the Low Cost Carrier [LCC] industry in Mexico over the last few years. LCC traffic represented 30% of all domestic passenger traffic in Mexico at the beginning of 2007 and over 43% by the end of 2007. Given this, management entered 2008 optimistic.

But the best laid plans of mice and men often go awry. The spike in oil has caused a severe pullback in airline carrier operations at GAP airports that directly effects the amount of passenger traffic.

Airport and carriers which either ceased or significantly reduced operations at this location include:

• Tijuana (Aviacsa, Aeromexico, Mexicana, Avolar and Aerocalifornia)
• Mexicali – (Aviacsa)
• La Paz – (Avolar and Aeromexico)
• Guanjuato – (Volaris, Aviacsa)

 and there are more...

• [source]
• [source]

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The LCCs are getting directly hit from oil and, as is prudent, abandoning the smaller airports and retreating to the hubs and where their cost advantages serve them well. The discontinuation of routes and operations at smaller GAP airports due to jet fuel prices make the routes unprofitable, especially for the LCCs. Even though GAP continues to see increases in traffic at its four biggest airports from this LCC consolidation trend, the net effect is an overall decrease in passenger traffic for GAP.

This trend is reflected in GAP's stock price. Since October 2007, GAP has moved inverse to oil. With oil skyrocketing to $142/barrel and continued stress in the energy markets for the foreseeable future, coupled with a major economic downturn in the US and particularly Southern California, the major question for GAP is what will be its rock bottom price as the dust settles? Even if the downturn moderates the price of oil, even $80/barrel is a cruel and unusual punishment for well funded international carriers and low margin LCCs. Additional discontinuation of routes and failures due to elevated energy costs will cause significant disruptions in passenger traffic in GAP locations. For example, the American Airlines “no fly” episode cost GAP a bundle due to the fact that AA flights make up 14% of total passenger traffic at Los Cabos airport alone.

There is no better example of the future prospects of GAP than the Smog Birds of Southern California. The company also manages the second most important international route in Mexico, the Guadalajara-Los Angeles route. The broader context of a US recession aside, focused stress in the Southern California economy is bound to particularly hit GAP in terms of international passengers to resort destinations but also as SoCal residents with family ties to Mexico are impacted by decreased economic prospects.

GAP, as a monopoly, is what Warren Buffett would describe as having a “wide moat”. Strictly from a balance sheet perspective, GAP boasts assets including airport concessions and land valued at over $1.5B. In 2007 it improved operating margins 3.4% to 45%. The company has completed capital projects that support expansion sure to come in future years. The company earned $161m last year on $320m in revenue, a veritable cash machine. Yet due to concerns over oil, the company currently holds a market cap of just $1.4B. In June GAP sunk below its IPO share price of $31/share and now stands at $26/share.

I am expecting a prolonged period of pain for GAP due to oil and a US consumer-led recession, and thus my recommended purchase price is below my estimated market value for the company. Despite the energy markets run up, the company will still easily meet dividend commitments which are $2.01/share for ADRs, which make the company a definite buy, but at a particular price.

I recommend accumulating GAP at $21.50/share (1.15B market cap) will provide a 9.3% yield. At this price, an investor can stay defensive long enough to address any economic risks, oil shocks or carrier risks that could occur if events similar to the 1970s energy debacle are repeated. While you wait, the grittiest of Smog Birds will continue their annual migration route into their traditional margarita watering holes chattering about the 101, the 5, the 405 and the latest Hollywood gossip.

Disclosure: None

Comments

[whenwillitstop:]

Great article and good research. One thing that I wonder is how much the junk cars and tall weeds in our front yard will pull down our neighbors property value. There's already a lot less money flowing down to Mexico because of the housing downturn since the migrant labor is not sending money home. Now that the housing downturn, criminal hedge fund managers, and inflation is eating into the US economy, will Mexicans on the whole have to cut back even more. If so, then your stats on international travel will become a lot more important.

2008 Jul 14 11:09 PM