Investing in foreign markets can be scary. You have to deal with geopolitical issues, currency fluctuations and a general lack of available information.
Fortunately for investors, some fast-growing emerging markets are much better than others. This includes Latin America's largest economy, Brazil.
Although it's still the prize of South America, the country has yet to live up its true growth potential. As a result, the Brazilian economy is expected to grow by close to 3% in 2014, with unemployment remaining below 6%. (Two of my colleagues are split on the country's prospects: Andy Obermueller, Chief Investment Strategist of Game-Changing Stocks, is bullish on Brazil. My colleague Joseph Hogue, on the other hand, thinks the country may be headed for bankruptcy.)
What the country needs is a catalyst. Enter next year's World Cup, which is expected to bring more than 600,000 tourists to Brazil, with another 3 million Brazilians traveling around the country for the monthlong tournament.
With all this activity, Brazil is expected to become the world's fourth-largest aviation market in 2014, with more than 100 million passengers. That growth is poised to continue with the Summer Olympics coming in 2016.
Gol Linhas Aereas Inteligentes (NYSE: GOL) is one of the best pure plays on the Brazilian airspace, with close to 150 aircraft and 90% of its capacity in the country. But the past three years have been punishing for investors: The stock is down some 75%, and Gol carries one of the largest debt loads in the industry.
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However, the current valuation appears to be pricing in the absolute worst case, and Gol's balance sheet is overshadowing its growth opportunities.
Last year was a "realization year" for Gol, which began a period of right-sizing, starting with capacity. Its capacity changes will involve focusing on more profitable and stable routes. Part of this includes the grounding of old planes. During 2012, Gol reduced domestic capacity by 5.4% from the previous year.
As far as 2014, the company expects revenue to grow with the help of a 5% to 8% increase in international market supply. As well, Gol has been looking to some non-recurring activities to help boost revenue, which includes subleasing planes to the likes of Dutch carrier Transavia.
|Brazil is expected to become the world's fourth-largest aviation market in 2014, with more than 100 million passengers. That growth is poised to continue with the Summer Olympics coming in 2016.|
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In any case, investors are already seeing some of the benefits from its improved operational efficiency. Gol was named the most punctual airline in the Brazilian market for the first nine months of 2013, with 94.4% on-time performance. In October, yield and load factor growth led to a 21% increase in Gol's passenger revenue per available seat kilometer.
Gol's improvements have been overshadowed this year by oil volatility and depreciation in the Brazilian real, which fell from 2 reals to the U.S. dollar in the first quarter to 2.4 reals per dollar at the end of the third quarter. Increased oil volatility placed even more pressure on margins, but amid an 8.3% year-over-year increase in average fuel prices in the third quarter, Gol managed to reduce its fuel consumption per seat.
Gol is shooting for a 1% to 3% margin on earnings before interest and taxes (EBIT) for full-year 2013, with a target of 7.5% in 2015. Compare this with 2009, when Gol churned out a 10% operating margin; before 2007, 20%-plus operating margins were not uncommon.
Gol is also getting help from the Brazilian Association of Airlines, which is working with Brazil's government on the industry's needs. The association has a goal for doubling the number of tickets sold in Brazil, to 200 million, by 2020. To that end, the association and a consortium of Brazilian airlines recently asked Brazil's civil aviation authority for help in regaining profitability. Among the requests were reductions in the state value-added taxes on fuel prices, tax subsidies on jet fuel, and the suspension of landing fees for several months. If approved, these subsidies could further boost Gol's margins.
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However, as mentioned, Gol is one of the most indebted airlines in the business. To accelerate its deleveraging, Gol recently completed the IPO of its Smiles frequent-flier program. The IPO not only helped Gol raise proceeds for debt reduction, it also helps the company refocus on its core operations.
The other thing that worked against Gol over the past year, effectively ballooning its debt load, was the weakening Brazilian real. Three-quarters of Gol's debt is denominated in U.S. dollars, so an expected stabilizing of the real against the dollar should be a big positive.
Risks to Consider: Gol's debt level remains a chief concern for investors. The company has $2.7 billion in debt, compared with a $1.2 billion market cap. Any missteps in generating cash flow could put pressure on the company's ability to make debt payments. On the other hand, the company does boast nearly $1.3 billion in cash, which is over $4.50 per share. As well, most of of its debt doesn't come due until after 2017. Only 2% is due next year.
Action to Take --> Buy Gol for a potential doubling of its stock price. Gol trades at an enterprise value-to-sales ratio of a mere 0.6. Compare this with major Latin American peers LATAM Airlines Group at 1.25 and Copa Airlines at 2.8. With expected 2014 sales of $3.9 billion and an EV/sales multiple of 1, the upside could be a share price of $8.50.