Traffic growth of 31% YOY – let that number sink in for a moment.

On October 8, Brazilian airline Azul Linhas Aéreas (AZUL) disclosed its September operating metrics. The headline numbers impressed, as I expected would be the case about one month ago. Shares of the company lacked traction during Tuesday’s trading session, however, despite the broad Brazilian market (EWZ) having gained as much as 1.3% intraday.

Credit: The Points Guy

In September, Azul broke records (see graphs below):

  1. Highest capacity and traffic growth rates ever – measured respectively by YOY increase in ASK, or available seat kilometers, and in RSK, or revenue seat kilometers.
  2. Best off-season and shoulder month of domestic traffic, in absolute numbers – and third best ever, topping even most peak summer months.
  3. Highest occupancy rate for a September month, aided mostly by a high load factor on the international side of the business.

These numbers deserve some unpacking. For starters, Azul must have benefited significantly from its late August entry into the busy Rio-São Paulo market. The timing of the route expansion couldn’t have been better, since Rio’s Santos Dumond airport has been partially closed for renovations, which has favored Azul and its smaller fleet. I calculated last month that this premium route alone would add about three percentage points of growth to the airline’s domestic capacity, starting in September.

Source: DM Martins Research, using data from multiple monthly traffic reports

But even if inorganic growth is discounted, Azul’s month still looked very robust. Assuming I am correct about my Rio-São Paulo estimates, the airline would have still managed to deliver all-time best capacity and traffic growth of around 28.5% without the network expansion, per my calculations. Not only that, but the total company load factor expansion of 10 bps suggests that, despite a sharp increase in available seats, demand for air travel in Brazil (at least for Azul’s services) has been keeping up with capacity growth.

Lastly, it was encouraging to see the international segment (representing only 22% of total traffic in September) regain its footing, to some extent. Travel outside the home country has been suffering from a number of negative factors, including (1) a weak Brazilian economy, (2) continued devaluation of the local currency, especially against the U.S. dollar, and (3) the softening global economy, particularly in Europe.

In September, international traffic grew by nearly 19% against comps that should become progressively easier over the next six months. Load factor of 87.7% expanded by 270 bps YoY in the most recent month, the second best occupancy growth rate since January 2015. It is worth mentioning that travel to the U.S. may have been impacted by hurricane Dorian in the first week of the month – Fort Lauderdale, in Florida, is Azul’s key international hub.

Source: DM Martins Research, using data from multiple monthly traffic reports

Still a high-conviction buy

I maintain my $50/ADS price target on AZUL, considering the company’s top and bottom line growth prospects. Traffic increase in the domestic market and improvement over easy comps internationally only begin to tell the story. Azul’s ongoing fleet upgrade to more fuel-efficient equipment is still expected to support margin expansion over the coming years – which bodes very well for long-term earnings growth that, in my view, analysts have been underestimating at only 10% (see orange line below).

ChartData by YCharts

Despite the usual risks associated with investing in the airline sector and in emerging markets, Azul continues to be one of my favorite growth stories within my stock coverage universe. Should I be right about my 12 to-18-month price target, I believe the implied 35% upside justifies the downside exposure.

Although I own AZUL, I also believe that I can create superior risk-adjusted returns in the long run using a different strategy. To dig deeper into how I have built a risk-diversified portfolio designed and back-tested to generate market-like returns with lower risk, join my Storm-Resistant Growth group. Take advantage of the 14-day free trial, read all the content written to date and get immediate access to the community.

Disclosure: I am/we are long AZUL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-10-08