TAP - Short-haul
All,
Please find our updated analysis here.
As per original thesis, the restructuring has taken place behind the bonds, leaving investors untouched, safe for some covenant holidays. Moreover, RPK have returned more rapidly than we had dared to assume, which is lucky for us. From here, the outlook must take into account higher fuel prices, TAP’s hedging position, dynamics around long-haul flights and restrictions and the remaining aid approved by the EC.
Return in RPK:
- Long-haul flights, which are so important for TAP, have been among the worst hit during the pandemic, not least because the virus tends to rage at different times in one country vs. the other and each choses to close borders at a given time.
- The return of passenger revenue has, however, been faster than we had assumed, which bodes well for 2022 and beyond, if it can be maintained - grown further.
- Between Brazil and Portugal, many families and friends have been unable to visit each other for a significant amount of time and the pent-up demand that is expected for this segment is consistent with other areas that have been similarly impacted, like ferry traffic across the Moroccan strait - See our analysis of Naviera Armas.
- In a stable environment, a continuous organic projection of RPK and other metrics to approach 2019 levels by 2024 would allow TAP to fly without requiring additional cash.
Jet Fuel:
- Except fuel prices have risen sharply and TAP are only 50% hedged for H122 with 40% and 15% for Q322 and Q422 respectively. Our model assumes that TAP are rolling the current hedging profile forwards and further assumes that fuel prices remain static from there.
- TAP’s hedging position his is below the level seen at other airlines and makes TAP vulnerable to aggressive competition.
- We therefore model a lag in passing through the increased Jet Fuel Expenses to consumers, which could easily cost the airline some €250m in the interim.
- This effect on its own would still leave cash on the balance sheet.
Other effects:
- We expect further, but have not modelled, labour cost inflation as well as price rises in other areas. We are offsetting those with certain sand-bags where we are assuming higher marketing expenses to drive return of traffic for instance.
- We expect WC to show an outflow of some €400m in H122 to reflect a normalisation to a profile in line with pre-restructuring stats, but on a smaller scale. This assumption is included in all cases discussed above.
Liquidity:
- Including our calculation of rising jet fuel cost, the company would not run out of cash, but liquidity would begin to run low again and TAP would have no margin of error. In this industry the airline would invite even stronger challenges to its market if it were visible that TAP are travelling without a war chest.
- As part of the restructuring, the EC has allowed for a “buffer" injection by Portugal in 2022. This facility, we understand, was originally requested in the region of €500m. We have heard other accounts of €1bn, but consider that high.
- The buffer injection would have to be passed through Parliament, but given how far we are down the runway now, we cannot see the republic apply the brakes now.
Positioning:
- We remain long 4.5% of NAV the 24s with a view to being taken out in 2023 along with the Portuguese law bonds. The buffer injection should put TAP in a comfortable position, not only to conduct its operations, but also to refinance its debt. Given the bonds are only 1.5 years apart, we think chances are good enough that a refinancing will address both issues at once.
- Meanwhile we expect bonds to reflect their solid position by Q3, when we think we could see a pull to par in what has become a 100% government owned company (which traditionally comes with a government guarantee, although that trade has a chequered past and we are ignoring it here). We are therefore only in it for the short-haul and expect to exit our position some time in H222.
- We consider the downside to this position limited. Yes, another covid waive cannot be ruled out - is perhaps even likely. But the mechanism for dealing with it has now been laid out and the republic has made its position clear. For the small touristy country who’s only land connection to Europe is via Spain and who is so closely related to gigantic Brazil across the Atlantic, a domestic airline is crucial for its sovereignty.
Happy to discuss,
Wolfgang