Hi Investors ,

The travel industry in Latin America has been very robust over the last few years. Copa Holdings is right in the middle of that growth and it has the ability to capitalize on the opportunities ahead.The business turns a profit very easily in an industry with a history filled with companies gone bust. Dividend investors will find this business very appealing as the business shows a promising path to more dividend increases.

Introduction

Here’s a quick question: How does one become a millionaire?

Simple – you become a billionaire and then invest in an airline company.

That’s a joke that have been in dozens of conversations amongst investors when they speak of the airline business. It seems as though the industry does not have the ability to compound its earnings and even worse, requires huge amounts of capital injection to keep itself afloat. After digging further into how ariline companies operate, I don’t blame them for framing the airline industry in this way.

Think about it: the fixed costs are usually extremely high to start with. Pricing power is almost absent in this arena as prices are susceptible to discounting and customers are very sensitive to price movements. Couple these challenges with an enormous debt load and a very volatile fuel price, it seems like buying an airline compnay is almost a death wish.

However, after Warren Buffett loaded up billions of dollars on airline companies, it got me thinking if my assumptions about the airline industry still holds true.

 Copa Holdings (NYSE: CPA) is a Latin American airline company that would surely add plenty of value to any portfolio. This Latin American airline company has a sustainable competitive advantage that competitors find it difficult to imitate. Located in Panama, this company has quite a few advantages that help it become successful. These include favourable location, cheap labour and a relatively low tax rate. 

With the recent fall in fuel prices, share prices for airline companies are on the rise. Investors who are looking for great value can add this company into their portfolios and sleep well at night.

Business Overview

Copa serves a total of 75 destinations across 31 countries. While Panama might be well known to tourists and travellers alike, it can sound quite foreign to most investors. With a free market, a moderate inflation level and a steady GDP growth, Panama may seem just like the perfect place to operate an airline company. As mentioned before, Copa is positioned in a very favourable position demographically, as it is within reach of almost every city in North America, South America, and the Caribbean. Panama also has the fastest growing economy in Latin America, and it is growing as a regional headquarters base for many multinational companies such as Caterpillar, Procter & Gamble, Unilever, BMW, Nestle, and many others.

This is a huge advantage for the company, as it has the ability to operate a standardized fleet which has relatively low maintenance compared to its peers.

Operating within Tocumen International Airport, Copa has a very extensive network of flight carriers that gives it an edge over competitors. The airport is situated within reach of almost every other American city which offers a higher frequency of flights.

Since Tocumen is operated by a corporation that is owned by the Panamanian government, Copa is charged a lower fee compared to its counterparts that operate in privatized airports. The master plan for the expansion of Tocumen International Airport is planned to increase capacity from 5.8 to 18 million passengers by 2022, thereby allowing the company to expand and grow.

There are two types of business models that airline companies use to operate. Copa manages its flights using a hub-and-spoke model.

Here’s how it works: The company aggregates passengers from a number of spoke origins to its central hub, who are then transported to the destination. For the type of market that Copa serves (it’s a very small one), it’s extremely difficult to operate using a low-cost model. By aggregating its customers or grouping them, it can better fill up its planes and thus negate the effects of having a situation whereby the plane isn’t optimally utilized.

Getting Ready for Take-Off

There is one problem that the company is facing and that is it’s close to Venezuela. These routes not only provide the business with a huge margin, but a stable one as well. The country is currently not in great shape, and it’s facing difficulties in meeting even the basic needs of the people. To add salt to the wound, Copa has a stash of cash (almost half a billion) which is stuck in Caracas, as the government has imposed restrictions on foreign companies repatriating money earned in bolivars.

Right now, Copa is making changes in the way it operates in Venezuela. Customers are required to pay in U.S. dollars, while the company is trying to shrink the amount of revenue from the country. The company has plans to reduce its revenue streams from Venezuela to less than 6% so as to reduce the effects of a depreciating bolivar on its profits. Perhaps, the rising share price of the company is a reflection of a strategy that has been well executed.

Evaluating Its’ Management

Executive officers in Copa Holdings own a meager 0.2% of the company’s class A shares. These shares are traded publicly, and they do not carry any voting rights. The class B shares are not traded publicly, carry voting rights and can only be owned by Panamanians. The board of the company is made up of individuals from three very wealthy families, and this means that outsiders will have a difficult time trying to exert their influence on the operations of the business.

If the company’s management acted in an incompetent manner, investors would immediately lose confidence in them and would very likely sell their shares. However, that has not been the case. Share dilution has been at a very minimal level, and the compensation for the executives is reasonable as well.

CEO Pedro Heilbron has been stewarding this business since 1988. From a small domestic carrier, the business has expanded into one of the most profitable airline companies. Unlike most of its debt-heavy peers, Copa’s balance sheet is very healthy. Lastly, the company has been returning cash to shareholders via a very generous amount of dividends (its current yield stands at 2.2% after the stock price has more than tripled since 2015). The company has announced in August a dividend increase by almost 50% which amounts to an annualised dividend of $3 per share. The board has taken advantage of the softness in the share price by authorizing a $250 million share repurchase program when it was at its bottom and the effects of it can also be seen in the share price.

Risks

Demand in the travel industry is a very fickle one. It is largely dependent on the spending power of the individual (disposable income) and the economic growth of a country. Over the long term, Latin America is expected to fuel Copa’s growth. The company has faced a number of challenges in the last few years as economies in Venezuela, Brazil and Columbia experienced currency devaluation. Coupled with soft demand from these key markets, it is no wonder the business tumbled back in 2014. While the situation may have improved for Copa now, we can never be certain that the past will not repeat itself again.

Investors ought to be prepared for political challenges that will come as well. Republicans are pushing for a boarder-adjustment tax in the US which will an import tax and export subsidy. If economists are right that this will push the US dollar higher relative to other currencies, Copa’s revenue and profits will be negatively impacted.

One other concern for Copa is that competition is starting to show up. Because of the way the company  it enjoys significant cost advantages compared to its larger peers. As Tocumen operates,Airport increases in its capacity to serve a bigger market, I won’t be surprised to see larger carriers enter the market. When that happens, I would like to see how Copa navigates around the bends with regard to pricing and the frequency of flights that it can offer toremain competitive, and more importantly, profitable.

Lastly, Copa has reported during its most recent quarter the impact that natural disasters have on its business. The company had to cancel more than 450 flights (approximately 1.5% of flights schedule) during the quarter due to disruptions it faced from the weather. While operating earnings took only a $12 million hit, investors need to be mindful that such events do impact businesses like Copa and hence, be able to stomach short-term losses in profits along the way.

Conclusion

To sum things up, Copa Holdings has plenty of competitive advantages that will keep competitors at bay while it maintains its top-dog position. This airline company is one of the most profitable carriers in the world, with a very conservative balance sheet and a long path way of growth ahead of it. From the looks of it, investors stand a very good chance to reap a handsome profit if they take up a position in Copa before it soars higher.

Marcus Ho
Research Analyst, Mind Kinesis Value Investing Academy

Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.

Click here for our Free Value Investing Guidebook :

Would you like to accelerate your training on investments? Click here to join our Free Value Investing Masterclass In Singapore :

Click here to hear what our graduates have to say about the value investing course in Singapore :