Description

Grupo Aeroportuario del Sureste (ASR-US) is a publicly traded manager of airports in Mexico, Puerto Rico and Columbia. Passengers through the Cancun, Mexico airport represented 46% of all terminal passengers in 2019. Puerto Rico and Columbia represented and additional 17% and 22% of 2019 passengers, respectively. Together these three airports account for 85% of the company’s total passenger traffic in 2019 thus making shares in ASR a bet on a gradual recovery in air traffic primarily through these destinations. The remaining 15% of traffic is through smaller airports in Southeast Mexico.

The Cancun airport, though it is 46% of passengers, carries greater weight in terms of the company-wide financial results. In 2019, Cancun generated 52% of revenues and 56% of EBITDA. This Cancun skew also weights ASR more towards leisure travel than many travel recovery ideas. Arguably, leisure travel should return earlier and reach its previous peak faster when compared to business travel.

I also believe ASR offers a somewhat lower risk play on a return of global air travel compared to an airline. First, unlike an airline an airport manager’s revenue per passenger is regulated and does not change due to competition (of which there is none in their markets). Second, costs are not impacted by the ever-changing cost of jet fuel and thus are more predictable.  Finally, ASR is more lightly levered than the typical airline. Recently I wrote up peer Mexican airport manager, Grupo Aeroportuario del Pacifico (PAC-US). That report offers some additional background on the Mexican airport business and the progression of pandemic in the country.

Currently I am modeling ASR passenger traffic to return to 94% of 2019 levels by 2023 and to slightly exceed 2019 levels in 2024. Should those numbers be met I believe fair value for ASR’s U.S. ADS shares is approximately $172 or about 48% above today’s closing price of $116. I am using a 12x EV/EBITDA multiple which is at the low end of the trading range of 11x to 15x of the past few years, but which is in-line with 2019. All my financials and calculations are in Mexican pesos. I am converting market cap from USD to pesos using a 22:1 MXN/USD ratio.

I believe an investor may see upside to my fair value by virtue of a faster return to air travel and/or a strengthening of the peso. One or both of these events, I believe, have a material chance of occurring. First, there is a point at which travel, particularly leisure, will begin to rebound as we get beyond pandemic. It’s hard to believe people aren’t ready for a vacation in a warm place with a sandy beach and a cool beverage. I argue that a visit to a beach in Mexico is a somewhat covid-safer vacation during the coming winter high season when compared to holing up in covidphobic mountain ski chalet. Beaches, a large portion of dining, hotel lobbies, even hotel hallways are often (but not always) open air to some degree. Even the air surrounding you is warm and, according to the covid authorities, less dangerous.

The world, however, is clearly not at the point at which the average traveler, much less the marginal traveler, are ready to get on a plane. Even someone willing to sit on a beach may not be willing, yet, to get on a plane. Still, I believe the worst of covid will soon be behind us as the fall and winter outbreaks prove to be much more about rising cases and less about hospitalizations and deaths. As potential flyers realize that covid is receding increasing numbers of them will become actual flyers, at least for a vacation.

I believe that when the bow on travel hesitancy breaks it may break quickly and with little notice. Owning shares in ASR allows one to have a placeholder on this potential upside, but with a company that is liquid enough to wait out the pandemic. This investment provides an embedded option on a sudden change in attitude toward travel to the positive.

Regarding potential upside due to an improving peso, the currency made a new local low (which is to say strengthening) against the dollar at just under 21 recently before bouncing back to 22+ (currently 22.10). As Mexico comes through pandemic, which it seems to be, and the economy improves, perhaps the peso will strengthen too. The price of a barrel of oil staying stable (or ideally improving) is relevant to peso strength, too, given the importance of oil revenue to the sovereign budget. While I hardly see oil is poised for a historic bull run, I do believe a return of mobility and travel increases the likelihood that oil finds a more sustainable floor.

ASR passenger traffic bottomed in April at down -96.3 yoy across all their airports and as of August was at -63.1% of 2019 traffic. Mexican domestic traffic was the positive standout at down “only” 50.6%. Puerto Rico gets an honorable mention with traffic down a mere 60.1%. Cancun was down in line with the company average at -62.2%, but encouragingly domestic Cancun traffic was down only 39.8% compared to a drop of 77.1% in international traffic. The return of international vacationers traveling to Cancun from the U.S. and Canada is a key driver to the story.

Columbia air travel was down 99.6% as air travel in the country, both domestic and international was completely shut down until September 21. Even a 30% bounce back in Columbia traffic (from zero traffic to down 70% compared to 2019) would add back 5% of ASR’s 2019 traffic given that Columbia was 17% of traffic last year. This potential, and I think likely gain, should begin to be realized when Columbia airports are open for a full month in October and I suspect this modest gain is likely achieved in full by Dec.

My view forward is as follows. I believe the next two months to be reported, September and October, are going to lackluster and potentially with some decrease in international travel during the lull leading up to Cancun high season. The recent covid outbreaks in cold weather climates are likely to peak in another month or so, but as this portion of the covid story plays out I don’t anticipate any material improvement in ASR traffic and believe some minor backsliding is possible. However, any near-term backsliding in the already open airports (all but Columbia as of August) may be offset by the opening of Columbia (Sept 21). In any case, the September and October reports, which will be released the first weeks of October and November, respectively, could be disappointing and may keep the stock pinned down until the next upticks in traffic materialize.

I currently believe that when Cancun high season begins in November that traffic should begin making incremental improvements again. I suspect this will be true for Cancun international travel as well as domestic travel through the system, in particular Mexico based. The U.S. should be getting beyond the fall outbreak and, I believe, realizing that it was not the huge wave of death everyone expected it to be and that whatever covid still is, it is no longer what it was in March and April, 2020 and never will be. Mexico itself may be showing signs of putting covid in the rearview mirror altogether.

Personally, I’m not excited about having a rushed, half-baked vaccine stuck in me and I suspect I am not alone in this. However, judging from the liberals in my Facebook feed many of them seem to be super into it. By end of the year we may have news of a big beautiful vaccine and though it may take quite a while for before it gets injected into the average traveler, if it is credible enough it may cause the stocks to take off in advance of leisure travel’s actual return.

As for covid, the anticipated and much dreaded U.S. cool weather, fall outbreak has already begun. So far it is mostly casedemic; that is, lots of cases but with far less in the way of hospitalization and death. Every time an outbreak starts, the cases peak in about four or five weeks and deaths peak in about five or six. This was true in China, Italy, NYC and the U.S. south. The exact same pattern held true during the Spanish Flu. By early November we’ll understand the size of wave two. I think the world will then understand that covid is much more manageable that it was when it was new and unknown.

Regarding Mexico, the effort to fight covid played out very differently than in the developed world. While some level of lock down was implemented, it was limited. Since most people are poor and need to work to eat, and work generally can’t be done remotely, the population needed to end the lockdowns fast (regardless of what the government said) and that is exactly what happened. Cases and deaths rose with no curve ever being flattened as one would expect if there was no true lockdown. (See charts below.)

Cases peaked in late July. Since then the country has only opened-up further. Even as we open up more cases have continued in their downward trajectory. I suspect the trajectory downward will at some point be interrupted with some upticks. (If I had to guess, any uptick will most likely impact Mexicans that could afford to isolate. As a group they have less immunity built up and as they emerge from lockdown they may be impacted by the virus (which is most definitely in Mexico… read my PAC report).

Mexico covid CASES through Sep 29, 2020:

Cases in a downward trajectory in spite of the economy opening up.

Mexico covid DEATHS through Sep 29, 2020:

Deaths still high, but will necessarily follow cases downward should cases continue in that direction.

Compared to 2019 peak passenger traffic, I am budgeting ASR passenger related revenues down 50% in 2020, down 23% in 2021, down 15% in 2022 and down 6.5% in 2023. I then value off 2023. Again, these numbers are all based off 2019. They are not year over year over year. I have 2024 revenues up 2.9% compared to 2019.

ASR’s 5-year master plan with Mexico extends through 2023 and will soon need to be renegotiated for the five years thereafter. I do not anticipate any problems. I am assume all anticipated master plan capex continues per agreement and management has indicated they expect that to be the case. Master plan capex is weighted to 2020 and 2021 and drops off significantly in 2022. It means more pain now, but the balance sheet can handle it.

The company exited Q2 2020 with 7.2B pesos in cash and 15.3B pesos in debt. Debt is up from pre-pandemic primarily due to peso weakness impacting the dollar denominated debt on the Puerto Rico airport as well as a USD$10M drawdown on a working capital line for the Puerto Rico airport.

Debt is denominated in pesos, dollars and Columbian pesos and matched to their respective airports. Debt/EBITDA at the end of 2019 was 1.3. I expect that to bottom in Q1 2021 at 5.6x Debt/TTM EBITDA. However, it will then begin to improve rapidly ending 2021 back at around 2.0. I am certain to be adjusting these numbers many times, but I am comfortable with them directionally. What is most important is ASR did not start with high leverage.

I expect cash to bottom at the end of 2020 at $3.3B and for free cash flow to return to break even or slightly better in Q1 2020. This assumes Q1 passenger related revenues are still down 37% compared to Q1 of 2019. I’m projecting that the second half of high season will begin to see an uptick in visitors as everyone learns to both live with covid and to realize that covid itself is burning out and realize it’s time for a long overdue vacation.

Low season in Cancun begins in May. If covid continues to recede then I expect low season to see pent up demand that it might not normally experience as those who have deferred vacations decide to make the leap. I’m still estimating 2021 passengers down in the high teens compared to 2019, but there should be some benefit from more low season traffic. I live in Puerto Vallarta and I have noticed in the past few years that there is more and more business in low season. Also, low season for North American travelers happens to be high season for Mexican nationals to visit Cancun, PV and Cabo.

Domestic travel to Cancun is already improving ahead of International. In August 2020, Domestic travel (intra-Mexico) to Cancun was only down 39.8%. Mexicans are quickly becoming done with covid and life is moving on. Next summer I am confident that Mexicans will be back at the resorts in stronger numbers.

Using 12x EV/EBITDA off of my 2023 estimates I get a fair value of ~USD$172, or about 48% upside from a recent price of $116. Though the stock has traded in recent years well above 12x EV/EBITDA, in the most recent year prior to pandemic it settle around +/-12.

Risks:

The unprecedented decline in air travel does not begin to improve from current levels as we enter 2021. Though I am still expecting 2021 air travel to these airports to be down a significant 23% in 2021 compared to the 2019 peak, perhaps this is too aggressive.

Also, this is an investment in Mexico. Now that I live in this country I know that anything that can go wrong has a decent chance of doing just that.

Catalyst

A gradual return to air travel to Cancun as well as Southest Mexico, Puerto Rico and Columbia.