Grupo Aeroportuario del Centro Norte (NASDAQ:OMAB) is up 18.5% YTD and trades at a premium to historical averages across valuation metrics. A weaker peso and low oil prices are the reasons, causing airport traffic to grow much faster than expected. In the latest quarter, revenue increased 26% y/y and management raised guidance for full-year traffic growth. However the latest traffic data for the month of August disappointed investors. Total traffic increased 10.7% thanks to strong domestic growth (up 13%), but international traffic declined 5.6%. Shares are down 12% since the traffic report and while OMAB is still expensive based on historical metrics, we think the sell-off provides an opportunity for investors with a long-term focus.
OMAB scores high on our test of quality, which takes into account competitive advantages and profitability. The company has a regional monopoly as the sole authorized airport operator in the North Central region of Mexico, and faces no competition for passengers in some high traffic destinations. OMAB's wide moat allows the company to generate sustainable economic profits and convert a sizable portion of sales into cash flow. EBITDA and OCF have averaged roughly 50% and 40% of sales over the past three years, leaving more than enough cash to cover the company's massive infrastructure payments and dividends without leaning too heavily on debt. Due to high capital intensity and significant fixed costs in the capital structure, profits grow faster than revenues when traffic is growing, and this is why the expectation of higher traffic has pushed shares so much higher throughout the year.
Of course, fixed cost leverage works against OMAB when traffic declines, as it causes margins to contract. However, we don't see traffic declining anytime soon. OMAB is levered to the Mexican economy, and we are optimistic about the long-term outlook. The government has implemented structural reforms to increase competition and improve access to financing, which should lead to higher capital formation and productivity in the future. And unlike many countries, Mexico has been more responsible with its public finances. While many countries have increased borrowing to make up for the shortfall caused by weak oil prices, Mexico has slashed public spending. We believe Mexico will grow GDP at a 3% CAGR through 2020, roughly double the pace of the global average over the next five years.
The issue with OMAB therefore isn't whether traffic will decline, but when it will start to decelerate. The oil price and currency headwinds won't last forever, and OMAB won't be able to sustain double-digit traffic growth indefinitely. We believe that oil prices will stay around $50 through 2017, which should keep airline operating cost down and ticket prices affordable. The bigger risk in the short term stems from a weaker dollar. We don't think the Fed will raise interest rates much if at all during the next year, which will likely cause a lot of money to flow out of the dollar into other currencies (the reason the dollar has appreciated over the past few years has been the expectation of higher interest rates). A weaker dollar would weigh on tourist travel, but it wouldn't be a massive headwind for OMAB. OMAB has fewer tourist destinations than its Pacific coast rival Groupo Aeropuerto del Pacifico (NYSE:PAC), and domestic passengers account for 80% of OMAB's capacity (compared to 65% for PAC).
OMAB looks expensive, but we think the stock can go higher. Low oil prices will continue to drive travel demand over the next year, and profit margins should expand. OMAB's strong competitive position, Mexico's growing economy, and favorable long-term travel trends underpin the long-term thesis. After the latest sell-off OMAB offers a dividend yield of 4.5%, and the combination of yield and the potential for long-term capital appreciation makes OMAB a compelling choice. The dividend also reduces some of the risks associated with a weaker dollar should the Fed keep interest rates low, as investor will increasingly look outside the US for yield.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OMAB over the next 72 hours.
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