TAP - of tides and boats
All,
Please find our updated analysis here.
Management cases are there to be discounted. But in the case of TAP, except for fuel prices, everything has gone to plan and has certainly beat our expectations. That said, fuel prices do weigh heavily on profitability, hedges are substandard and TAP have racked up over €1bn of liabilities from unused tickets. With the final injection coming next month, and the 24s yielding 8%, should we sell now, or should we wait? By HY standards, this yield is not particularly juicy anymore, but the bonds still benefit from positive event risk and momentum.
Liquidity and Cash Flows:
- Liquidity is impressive and will be even more so once the final sum of government aid comes in at the end of this year. TAP will be sitting on a cash pile of perhaps €1.7bn - theoretically resulting in net cash of €200m if we ignore all leases.
- We expect TAP, however, to have an €800m WC outflow, of which perhaps half could come before year-end as the company flies off the unused tickets for which it still has not returned the money.
- EBITDA and operating cashflow look flat over the next 18 months.
- CapEx and other investments look like they’ll account for €250-300m outflow.
- The 23s mature mid-year and present another €200m outflow.
- To pay down the 24s therefore and to retain sufficient liquidity thereafter, we conclude that TAP should raise some new debt from Portuguese banks. Portuguese banks could be roped in, but we don’t think that will be necessary as otherwise, the airline will be flying almost debt free.
- Our projections rely on key assumptions surrounding ticket price growth, passenger volume and costs, which are put under stress in the current inflationary environment and from fuel costs in particular. Please take a look. However, we are comforted by the fact that even though TAP is marginally sub-scale, its fleet is modern and its Emergency CLA aggressive (by Portuguese standards anyway). So if a tide lifts all boats, it should lift TAP as well.
Q3:
- TAP continue to achieve higher RPK than we had forecast, but are also managing to do so at a better load factor, which keeps Costs/ASK down compared to pre-covid.
- Ticket price development was largely as anticipated, which together with the above improvement in RPK already resulted in higher revenues in H1. We have therefore lifted our revenue forecast, which now also reflects a higher inflation rate.
- Along with higher RPK however, also went higher ASK (even if less so as load factors improved). Accordingly, Traffic Operating Costs and Employee Costs are also rising faster.
- While all else is going to plan, Fuel Costs are the killer. Our forecast has worked well, but the faster return of ASK has been driving this cost further.
- Based on the current cost structure, TAP need to raise their revenues 3% faster than their cost if the airline is to remain profitable on a stand-alone basis. The Portuguese government’s comments around TAP needing a partner to remain viable illustrate the challenge in that task.
Flight Path:
- December should see the Portuguese government inject the final €990m of equity into TAP.
- Armed with the fresh cash, TAP are planning to buy back bonds at a discount - most likely the 24s.
- A number of Airlines have recently signalled their interest in TAP. However, we think that Lufthansa - already connected via their Star Alliance - are in pole position.
- Lisbon is a geographically attractive airport to control over 50% of traffic in. Portugal is ideally positioned to compete with Madrid as a hub for South American routes, it also lies attractively on the way from North America to Southern Europe (where Alitalia still needs a solution).
Positioning:
- We continue to hold just under 5% in the NY Law 24s, which have been trading up into the mid-90s. From here they yield a mere 8% to maturity, but we see:
- a) a chance that we’ll be taken out early, either as a result of the government’s cash injection, or another event
- b) news leaking from a string of positive eligible suitors making their advances and paying their respects to the Portuguese government.
- For the time being, therefore we are holding on to the position, but we may give it up for more lucrative paper when we need to make space.
Happy to discuss,
Wolfgang
W1A 1AN, UK
+44 203 744 7003