Stock Market Information

Recommendation Summary

We have revised our 2018E T.P. for LATAM Airlines to CLP 10.600/sh with an overweight recommendation, corresponding to a total expected return (including dividends) of 11.1% for the next 12M. We have revised Ebitdar margin recovery slightly upwards amid improved macro prospects in Brazil and the region, as well as greater cost efficiencies and passenger capacity (ASK) growth in the Brazil and International business units.

Investment Thesis

At a consolidated level, we expect a more favorable macroeconomic climate in countries where LATAM Airlines operates, providing a boost for the Domestic Brazil and International segments primarily. This is consistent with greater dynamism in consumption and more favorable GDP growth projections, providing momentum in ASK for the industry and thus for the company. This, in addition to the greater occupancy rate LATAM airlines has reached in the passenger business and strengthening of local currencies against the dollar, will translate to a positive impact in passenger traffic and to a lesser extent, the cargo business. Meanwhile, strong competition from new low-cost players will continue to pose one of the main risks to the company, in terms of sustainable cash flow generation exerting pressures on margins and preventing significant ASK growth in SSS (Spanish Speaking Countries). Furthermore, the price of oil will be a factor to monitor closely, representing close to 25% of consolidated costs, partially offset by efficiency improvements and driven primarily by reduced SG&A/Revenues and CASK, which we estimate will continue through 2018 and 2019. We estimate an average load factor of 84.7% during 2018-2019, accompanied by ASK growth of 3.5% YoY in 2018 and 3.0% YoY in 2019, consistent with revenues of US$10.680 (+5.1%) and US$11.234 (+5.2%) million, for the same period (Figure 1).


• Our medium and long-term revenue projections contemplate the International business unit as the main driver of operating expansion. We highlight the robust increase in passenger capacity (ASK) achieving positive levels of profitability during 2017, a trend that would continue in 2018-2019. In addition, we project 2.5% YoY yields expansion, translating into higher profitability in this segment. We expect a 2.0% YoY increase in PRASK for 2018 and 2.6% YoY in 2019, as a result of an improved macro scenario, greater demand and a commercial strategy focused on boosting long-haul flights, highlighting routes to Europe and the US, mainly from Brazil. Along with this, the materialization of JBAs (Joint Business Agreement) would provide greater leverage for this segment in the long term.
• Against this backdrop, our forecast for the International passengers business contemplates a 4.7% YoY and 3.7% YoY ASK growth and a 6.8% YoY and 6.4% YoY revenue growth during 2018 and 2019, respectively. It is important to emphasize the conservative character of our projections, below corporate guidance (6% - 8% in ASK 2018E).
• Domestic Brazil operations show a change in trend amid increasingly favorable macroeconomic conditions. Towards the end of 2017, passenger capacity (ASK) cuts decreased, displaying slight growth towards 4Q17 (0.9% YoY) along with a favorable occupancy rate (84.7%). This trend continues at the beginning of 2018 and we estimate it will endure throughout the year, reaching 1.6% YoY growth (Figure 2). Meanwhile, the strengthening of the Brazilian real against the USD has translated into better yields, measured in USD. This, together with a favorable occupancy rate, would allow for a 3.3% YoY expansion in revenue in 2018 for the Domestic Brazil passenger business.

• While our projections for SSC contemplate a capacity increase in the passenger business, this would merely reach 2.7% during 2018, below the industry’s aggregated potential. The latter contemplates a persistently high competitive scenario as a working assumption, given the effects from the incorporation of new low-cost players. Furthermore, it is worth noting restrictions on tariff flexibility in Argentina and tight infrastructure of regional airports. Our forecast contemplates a slight nominal expansion in Yields. Overall, we estimate a minor revenue expansion of 2.8% YoY and 2.6% YoY during 2018 and 2019, respectively.
• Finally, we estimate a consolidated operating margin of 8.5% for 2018 and 10.3% for 2019, an evolution reflecting a path of gradual recovery consistent with levels closer to the industry average (Figure 3). The latter would derive mainly from higher revenues and efficiency improvements. Particularly, we estimate the company would reach ratios of 125 employees per aircraft by year-end 2019, more favorable levels than at present (137 employees/aircraft) which we estimate will converge to the average industry range. For its part, the price of fuel and depreciation of the Brazilian real against the USD will continue to play a major role in cost volatility. In regards to fuel, we estimate a greater cost per gallon during 2018 situated at ~USD 2.2, converging to USD 2.15 by year-end 2019.

• Focus on a more efficient use of resources is reflected in the restructuring of the investment plan, which contemplates a lower intensity of Capex/Assets expansion when compared to 2016. During 2017, there were 308 operating aircraft while the 2018 plan contemplates 312 aircraft, thus reflecting a deceleration with respect to Capex/Assets levels observed in 2016. Additionally, we estimate the company will close 2019 with 318 operating aircraft, representing a Capex of US$715mn, US$1,177mn and US$1,202mn, respectively. The previous Capex incorporates both maintenance and new acquisitions of aircraft under three modalities; cash, financial lease and operating lease, with its corresponding arrangement. To this end, a structure consisting of a 12-year financial lease and a 7-year average operating lease were taken as working assumptions. Overall, the company’s strategy of improving operational efficiency accompanied by a recovery in ASK and a lower level of Capex/Assets expansion, would allow for a gradual deleveraging process, reflected in a downward trend in NFD*/EBITDAR reaching 3.5x in 2019 (Figure 4).

• EV/EBITDAR forward 2018 is trading at 7.7x, reflecting the company’s positive operating expansion. Furthermore, our conservative projections contemplate a more moderate growth in ASK in the long-term and greater stability in margins. The above is consistent with our Overweight recommendation and a T.P. of CLP 10,600/sh, determined through the DCF model.

Risks

(-) Slower than expected macroeconomic recovery in Brazil and the region.

(+/-) Appreciation/Depreciation of currencies against the US dollar.

(+/-) Presidential elections in the region, particularly Brazil, given the relevant impact of its operations on company results.

(+/-)Fuel price shocks.

(+/-)Strategic alliances and JBAs, both for LATAM Airlines and competitors.

(-) Increased competition and entry of new players, exerting pressure on prices and market share.

Fernando Domeyko

[email protected]

Operational estimates (CLP mn)

Company Description

LATAM Airlines Group is the leading airline in Latin America, offering regional flights within the continent and long-ranging services to the United States, Europe and Oceania.