Monday, July 14, 2008

One day the Smogbirds will come back

"I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out."- Warren Buffett in Oct. 2003 talking with Wharton MBA students

The Position of the Month

Stock: Grupo Aeroportuario del Pacifico S.A.B de C.V. (Ticker: PAC)
Position: Long
Opening Price: Below $21.50
Expected Closing Price: Above $60

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 there 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. (Ticker: PAC) 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 are Ticker: ASR and Ticker: 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, Manzanillo.

With monopoly status, the fortunes of the company are directly indicated by the number passengers passing through their 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 in higher margin international passengers.

At the end of 2007 and early 2008, the company continued to believe traffic growth will continue at previous rates unabated. 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 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…

The LCCs are getting directly hit from oil and, as is prudent, abandoning the smaller airports 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 overall decrease in passenger traffic overall for GAP.

This trend is reflected in the GAP stock price. From Oct 2007, GAP has moved inverse to oil. With oil now at skyrocketing to $142 / barrel and continued stress in the energy markets for the foreseeable future, a major economic downturn in the US and particularly Southern California, the major question for GAP what will be the rock bottom price of GAP as the dust settles. Even if the downturn moderates the oil price, 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 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 So Cal 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 the 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 cash machine. Yet due to concerns over oil the company currently holds a market cap of $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 always a 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 addresses any economic risk, oil shock risk, or carrier risk 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 until their traditional margarita watering holes filled again with chattering about the 101, the 5, the 405 and the latest Hollywood gossip.§ion=REPORTES_ANUALES&tema=579&menu=INVERSIONISTAS&lang=eng

Transparency: The author bought a long position at $21/share.


Lockstep said...

The position started on October 6, 2008 at $21.5 / share.

Lockstep said...

Still long here. The recovery of the stock price has slowed due to the USD going higher, the stimulus peaking, and slow growth in Mexico, but I still expect a lot of upside in this stock and will continue to collect the 9% dividend until then.

Lockstep said...

Still long this position. The rebound of the USD has not helped the price. But the rebound of the Mexican economy due to the worldwide stimulus has greatly improved the outlook of all the Mexican airport operators and that is reflected in the stock price.

Lockstep said...

After such a large return, the dividend yield is low and the income growth is low compared to valuation. So I am selling this position and will look to return at a better price.

Sold at 56.96. Bought at 21.5. Total gain is 262% over 5 years.