In my search for stable companies with growing earnings and trading at a discount, I found Copa Holdings SA (CPA). The airline company has been steadily growing throughout the years. The value of the stock has been increasing along with the company’s growth until this year. There is now a disconnect between Copa’s growth and the movement of its stock. The stock is now down 10 percent year-to-date while its earnings are up 35.5 percent for the past twelve months. One thought is that the stock has outrun its earnings and was due for a pullback, but it is only trading at a P/E of 13.20. I decided to take a closer look at the company to see if its stock was worth buying.
Company Background
Copa is one of the main airline companies in Latin America providing airline passenger and cargo services. It is headquartered in Panama City, Panama. It operates with a spoke and hub strategy with the hub centrally located in Panama’s Tocumen International Airport.
Copa was first established in 1947. In 1998 Continental Airlines purchased a 49 percent stake in the company. In connection with the investment, the two companies entered into an extensive alliance agreement providing for code-sharing, joint marketing, technical exchanges, and other cooperative initiatives between the airlines. Since 1998, Copa has grown and modernized its fleet while improving customer service and reliability. The company has gone from having a fleet of 13 airplanes to fleet of 90 airplanes today. Continental began reducing their ownership in 2005 and sold off their remaining stake in 2008. 2005 is when Copa’s stock went public, and it has increased 484 percent since then. That same year the company also purchased AeroRepublica, the second largest carrier in Columbia. The company now has 69 destinations in 30 countries and is continuing to expand. Copa Airlines also provides passengers access to flights to more than 120 other destinations through their codeshare arrangements with United Continental.
The hub of Copa, Tocumen International Airport, is the only airport in Central America with two runways for use. It has also been going through stages of expansion and renovation throughout the past decade. The latest expansion plan to build a new south terminal is 38 percent complete and expected to be finished in 2016. There are currently 34 gates and the new terminal will add another 20 plus another runway. There are future plans to add an additional 10 gates. Of the gates at Tocumen, Copa controls over 80 percent of them. Panama has been the perfect hub with its central location to provide flights to 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.
Financial Strength
It would be difficult to find a company that is more solid when it comes to its financial statements. Copa ranks a 4/5 for Business Predictability, 9/10 for Financial Strength, and 10/10 for Profitability and Growth. The balance sheet is strong with enough cash to cover its long-term debt. As of the latest quarter, the balance of cash and cash equivalents was $1.132 billion and the long-term debt was $833 million. The debt is being used to further expand the company as they are looking to add 15 more Boeing 737-800’s to their fleet by 2016. Copa can be fully trusted with the debt to purchase new planes due to their high return on capital of 22 percent. The debt-to-equity ratio of 0.52 is low compared to most other airlines, and Copa has enough operating earnings to cover their interest payments 17.5 times. On the equity side, shares outstanding have been stable. There has been no change in share count for the past year and half and shares outstanding have only increased at an annual rate of 0.41 percent over the past five years. A stable share count alleviates the worry of share dilution.
It is hard to go wrong with a Profitability & Growth rating of 10/10, even with room for error. Revenue has been growing at an annual rate of 20.8 percent over the past five years and earnings have been growing at an annual rate of 14.4 percent. Earnings have jumped 35.5 percent in the past 12 months. It superior business plan has allowed Copa to maintain some of the highest margins in the industry. Its operating margin is at 19.84 percent; nearly quadruple the Global Airline industry median of 5 percent. The large margins have help maintain the high return on equity currently at 22.48 percent.
Management
Copa’s board of directors is made up of 11 members with three of them being independent. Six of the directors have been with the company throughout its rapid growth phase, including the Chairman and CEO. Pedro Heilbron has been the CEO of Copa Airlines since 1988. He has an M.B.A. from George Washington University and a B.A. from Holy Cross. The Chairman, Stanley Motta, has been a director of Copa since 1986. He is a director on six other boards and is a graduate of Tulane University. The current management has done an excellent job growing the company and will likely continue to do so in the future.
Valuation
What stands out with Copa is its consistent earnings power. The company has a 4-star rating for Business Predictability has been consistently increasing its earnings over the years. Earnings have grown annually 21 percent over the past 10 years, 14.4 percent over the past 5 years, and 35.5 percent over the past 12 months.
To be conservative I used the 5-year EPS growth rate of 14.4 percent with the GuruFocus DCF Calculator to receive a fair value of $189.41 with a 24 percent margin of safety. The price is currently $143.59.
Risks
Venezuela has been a large issue for all airlines flying there. The government has a mandates that Venezuelan flights originating in the country be paid in Bolivars. The government has been withholding the funds and not paying them back to the airlines. Airlines have been experiencing a year delay in repatriating the funds from Venezuela. Throughout the repatriating process, the government has been devaluing the currency for the transactions in order to pay back a smaller amount of U.S. dollars. Copa is still owed $509 million and have reduced their flights to the country by 40 percent. So far the flight reduction has had small impact on operating margins with less than a one percentage point impact. Most all other airlines have either drastically reduced or cancelled flights to Venezuela.
Direct flight competition and jet fuel prices can be a risk to Copa in the future. The airline has a very efficient spoke and hub model for the Latin American market with Panama being the hub. Consumers will likely want more direct flights, but at this time it is not economically feasible to maintain the routes. Copa is still experiencing high margins with their efficient model. Their main competitors, Avianca Holdings (AVH), and LATAM Airlines Group (LFL) have not been able to successfully maintain operations as efficiently as Copa. Avianca had an operating margin of 8.35 percent in 2013 and LATAM had an operating margin of 4.53 percent. Copa’s operating margin was a superior 19.84 percent.
Jet fuel prices have a large potential to be an issue in the future since it makes up 37.5 percent of the operating expenses. The company hedges about 20-30 percent of their fuel costs. According to the International Air Transport Association, jet fuel prices have only increased 3.9 percent for the past year as of June 13, 2014. Copa’s CEO, Pedro Heilbron, has said that the airline has been able to increase revenues enough to compensate for the increase in fuel prices.
Another risk is that the Class A voting shares for Copa Holdings are 100 percent held by CIASA, a company controlled by several Copa officers and their families. The shares that are for sale on the open market are non-voting shares. Other than the Class A shareholders, no one has any say in what will happen to the company.
Outlook
The earnings growth for Copa is expected to continue even with the complications from Venezuela. It has been able to successfully manage its fuel costs and has fleet of efficient jets at an average age of only 5.7 years. Any concerns about a slowdown can be monitored on the company’s website. The monthly traffic statistics are released every month, and May’s year-over-year passenger traffic was up 12.6 percent. Copa’s hub, Tocumen International Airport, will be completing a large expansion project within the next couple of years allowing it to capitalize on the increasing flight traffic within Latin America. Boeing has forecasted that Latin American flight traffic will have the second highest growth rate behind Middle East to Asia Pacific traffic through 2032.
The investing guru with the largest holding is Jeremy Grantham, co-founder and chief investment strategist for GMO LLC. He currently controls 1,281,061 shares of CPA, about 2.9 percent of the shares outstanding. You can follow him at GuruFocus to see how he manages his position.
