Description
Copa is the most profitable airline in the world yet trades at 5x earnings. The business is consistently profitable given a number of competitive advantages, such as low costs and strategic geographic position. This has enabled Copa to earn +20% ROICs, which the company has partially reinvested in growth, expanding the fleet and reinforcing the strength of the business. Given its high profitability, Copa has not incurred significant debt to finance this growth, so they have a clean balance sheet with less than 1x net leverage including leases. Shares are too cheap as the market has not recognized the quality of Copa, lumping it with the group of airlines, on top of that operating from a developing country. Over the next few years, Copa should keep executing and shares might jump 3-4x using realistic assumptions.
Copa is a privately owned Panamanian airline, controlled by one of the country´s wealthiest families through super voting shares. The airline serves the American continent, through its Panama hub, with connection to most of the important cities in the Americas. The company has been public for ~20 years; initially coming to markets because Continental Airlines wanted to sell their stake, not because they needed capital. Throughout this period, Copa has grown revenues at a 10% CAGR, from $600mm to $3.5bn, aircraft fleet from 30 to 110 and ASMs from 5.4mm to 30mm. This rapid growth has been entirely self-funded, with S/O remaining flat and no significant expansion in net debt.
Over the next five years, Copa expects to expand its fleet and RPMs by ~50%, primarily by incorporating close to 50 new 737 max. This seems to be a good investment as the company earns high ROICs and has the demand for these planes; they will mostly increase frequencies in existing routes.
Copa´s strategy is based on the hub and spoke model; all flights connect in Panama. If done correctly, the network and its appeal strengthens as it grows. Any given flight feeds from passengers connecting in Panama, coming from other destinations. This is similar to how LTL carriers like Old Dominion benefit from more volume going though their routes, as with more volume going through the distribution center, it is easier to fill the next truck. In a way, there are some network effects going on here that should strengthen going forward.Copa laso benefits from other airlines (e.g. European carriers), traveling to Panama and bringing passengers to Tocumen as a connection airport.
One of Copa´s advantages is the geographic position of the Tocumen Airport in Panama, their hub. This airport is located in the middle of the Americas, so basically the whole continent can be connected with direct flights using the 737 planes and Copa currently reaches 85 destinations. The airport is at sea level which helps during takeoff (Bogota is nearby but given the altitude, they have some disadvantages). Also, the weather is benign with some rains during winter months but tend to last just a few hours.
Copa historically has been quite disciplined, conservative and well-managed. They have taken their business plan seriously and focused on it; connecting the Americas. The focus for years has been on developing new routes within the continent, instead of expanding to Europe, Asia or other markets (CEO even jokes there is a case with a loaded gun that should be used if they decide to travel to Europe). This has been executed at a high level, without overexpanding or creating problems. The conservative culture helped during many volatile periods, including COVID as the airline was able to go through the pandemic without receiving any help from the government; they issued convertible debt at the bottom as a precaution, but already paid it back. This discipline is also reflected in the simplicity of their fleet which is composed only of 737s; this provides efficiencies in terms of maintenance, training staff, procedures, etc.
All these things show up in profitability levels that can´t be really compared to the rest of the industry. The company earns +20% operating margins and ROEs in a normal environment. This is not typical in airlines and might be explained by the cost advantages and benefits of its strategic position and the strength of the Panama Hub. I expect these advantages to continue to expand as they grow the network and reinforce the advantages of the model.
The company has also gotten more efficient over time, benefiting from its growing scale. For example, over the last few years, they have migrated most of their bookings to their own platform or direct. Previously, something like 70% of bookings were executed through a third party distributor, and that has flipped to most going through Copa, thus reducing costs. Also, the company has developed a team that provides maintenance to their own fleet and is capable of doing +90% of the work in keeping the planes flying. This maintenance is done in the Tocumen Airport, by locally trained mechanics. There are also benefits from growing revenues in a business that has a fixed cost base of administrative jobs. In numbers, the Company´s best metric might be cost per available seat mile excluding fuel; that number has gone down from 6.4 cents a decade ago to 5.8 cents, a 10% reduction. This has helped the company reach margins that would have been out of reach some years ago; this year they are expecting +21% operating margins, a bit lower than 2023 levels, but still quite good.
The plan for the following 5 years has already been presented to investors, and it is quite clear. This is good for investors as there is a clear path to grow earnings power and strengthen the business model. It is only a matter of executing, and so far it has paid to bet on this team.
If things go according to plan, by 2029 the Company should be doing close to $5.5bn in revenue, $1.2bn EBIT and $1bn in earnings. Assuming excess capital goes to dividends, Copa should be earning ~$25 per share in 5 years. In the past, Copa has reached a P/E of 15x for long periods of time and something around those levels might be appropriate given the qualities of this business. Let´s say Copa reaches 12x at some point close to 2029, shares should trade at $300 or +3x from current levels. On top of that, they should distribute $40 per share in dividends over this period. There is also some margin of safety as Copa currently trades for roughly 5x expected 2025 earnings, on top of a clean balance sheet.
Copa is being valued by Mr. Market as a regular airline with the common boom and bust cycle; a terrible business. This is very different from the truth; Copa is a good business in a difficult industry and region. Over time, I expect there will be a significant re-evaluation by the market as Copa proofs the strength of its model.
There are risks, but I think investors are being rewarded at these prices; in any case, let´s go over some of these. Copa does depend on the 737 program and any issues going forward will hurt. So far, the Company´s growth has been curtailed by the lack of deliveries; that is manageable. If things deteriorate further, that would take a toll. The company is an airline after all, with fixed costs, exposure to oil prices, catastrophe risks, etc. This airline operates in the LatAm region with risks related to currency devaluation, exposure to weak economies, political instability, etc. Finally, there is the constant risk of LCC competition and its consequences on pricing are relevant and should be paid attention to. All these issues are real, but I trust Copa will manage through them given the high quality management team and its low-cost position. For sure, there will be ups and downs, but Copa should do well over time.
v. 4.20
