Azul: Add This Stock To Your Watchlist

Summary

• Following the stock's 55% drop in only six weeks, Azul continues to report very solid operational metrics.
• Domestic flights have not been impacted by the COVID-19 spread, but traffic growth could decelerate later in the winter season.
• Is now the right time to buy airline stocks? Probably not. But I believe AZUL should eventually reclaim previous highs.
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Given the current market rout that has been particularly damaging to companies in the travel and leisure industry, this may be the worst time to discuss airline stocks. But following Azul's (NYSE:AZUL) February traffic update, I find myself compelled to talk about this particular name, which has been down a mind-boggling 55% in less than six weeks.

Azul reported traffic numbers that impressed once again, despite growth in RPK (revenue passenger kilometers) and ASK (available seat kilometer) having decelerated since 4Q19. Occupancy improved minimally YOY in February, a feat that I don't believe any airline in the US has been able to pull off in the most recent month.

Credit: Flickr

Traffic remains robust

The COVID-19 spread had already been a hot topic of conversation since January 2019, but the negative business implications did not start to surface until the second week of February. Still, possibly due to the fact that (1) the disease did not spread to Brazil until February 25 and (2) roughly 75% of Azul's traffic is domestic, the Barueri-based company does not seem to have suffered the consequences of the virus's global proliferation.

The graphs below depict RPK and ASK trends at the total company level since the early 2017 IPO. Notice how growth in both cases has been decelerating since October 2019 still to an impressive 25% YOY in February.

However, the downward trend started to form well ahead of any breaking news on the COVID-19 and seems to be better explained by a natural correction that followed the initial (positive) impact of Azul's Rio-São Paulo route debut, in late August 2019. In fact, only the domestic segment has been experiencing traffic growth declines, while the international division continues to recover steadily from April 2019 lows - for now, at least.

Source: DM Martins Research, using data from company's traffic reports

It is likely that Azul's operational performance will eventually suffer a bit over the next few months. Flights from Brazil to Italy that make a connection in Portugal have already been impacted by the virus spread, as Azul has been offering international customers a full refund on this particular route.

However, I don't expect traffic growth to fall off a cliff. My checks in Brazil indicate that other of Azul's international routes have not yet been altered due to the health crisis, and that domestic flights continue to operate as scheduled. Because bookings tend to precede trips by at least a month or more, any potential impact from a falling Brazilian Real or from fears of an imminent global recession would likely not manifest itself until the southern hemisphere's late fall and early winter weeks.

Don't fire quite yet

Azul's golden days of 30%-plus traffic and capacity growth have certainly been left a few months behind. However, it does not look like the company has been or will be suffering much from the dreaded COVID-19 spread - at least not to the extent that the stock's 55% drop of the past month and a half seems to suggest, or unless the global health crisis escalates substantially.

Data by YCharts

The same factors that made me an AZUL bull a couple of years ago continue to be in place: (1) dominance in the highly profitable small-to-mid size market in Brazil, (2) the fleet upgrade that has been leading to more fuel efficiency and lower CASM-ex (i.e. per unit cost ex-fuel), and (3) the company's fast-growing loyalty program. It helps that the stock is now selling at a next-year earnings multiple of 8.3x that I find overly discounted.

But I can't ignore the fact that equity markets are still in the middle of the sharpest and fastest correction off an all-time peak in history. Things could get a lot uglier before they get better. In addition, it is still a bit premature to make a well-informed call on the long-term economic impact of the COVID-19 scare.

Therefore, I believe AZUL deserves a spot in the "stocks to buy on weakness" watchlist. In the end, and given enough time (maybe even a few years), AZUL should reclaim and eventually surpass its all-time highs of $44/ADS. But trying to time an entry when stocks remain stuck in the eye of the tornado can be a risky proposition. I would rather wait for signs of a broad market recovery before pulling the trigger on a volatile, pro-cyclical name like AZUL - even if I miss out on the first ten to fifteen percentage points of the upswing.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[seekfind123]

@DM Martinis. Very curious as to your current thinking on AZUL. If only 6 weeks after this report. AZUL is down 60% since this report and 80% since your original report of a year ago. I do not mean any disrespect. A lot has happened in the world.  

But now would seem one of those terrific binary moments. Either AZUL is a steal, or there’s gonna be a highly dilutive re-capitalization.

Any thoughts?

[DM Martins Research]

Good question... I will need to defer my answer until I can do a bit of homework on this again. To your point, a lot has changed in the whole world in 60-90 days.

Generally speaking, being involved with the airline industry today is very risky, let alone a company that generates most of its revenues (non-USD denominated, primarily) in an emerging country. Brazil has also been a bit behind the curve on the virus spread, so they may start to really feel the pinch in the near future. So generally speaking, caution is advised -- either by staying away or by sizing the bet properly.

That's all I have for now, I'll try to look at AZUL again soon... happy investing!

[InvestLT]

@D.M. Martins Research
Can you help me on the debt. Actual long term bonds o/s

[Catskills1]

@D.M. Martins Research Hello again. Thanks for continuing to track and write about AZUL. I am in total agreement on the strength of the company. The impact of the coronavirus on their flights remains to be seen--if Brazil follows other countries with expansion of cases, I would anticipate a sharp decline in bookings and a reduction in flights scheduled. I must say you are right and I commend you for not investing yet. I was nibbling in the upper 30s (ouch) anticipating another 10% up and down, to enter and exit for a small gain. As it has come down, I have bought small additions every $5 of drop. The only good thing I did was to buy larger amounts as price came down, to overweight the lower price in my holding. When it hit close to $20 yesterday I didn't even bite! But despite today's rally, my guess is we are going down into the teens, and I'll buy more. I'll make money on all these purchases eventually, but it's going to take time. Now, I'm not a complete idiot, because as the market was going up, I was selling stocks into strength, and even with a bunch of small purchases (mostly REITs, which have also dropped like rocks), I still have a good amount of dry powder, about 8% of my portfolio is in cash, and I am being patient (but not enough so, obviously). Good luck with your trades/investments!

[DM Martins Research]

Thanks, Catskills. I've never been particularly good at timing entries and exits consistently (who has?), but it seems to me a bit premature to go "all in" here. The averaging down approach makes sense to me.

Happy investing!