Copa Airlines - Fast Growing Airline Selling At Big Discount

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Dec 12, 2014
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Copa Holdings SA or "Copa" (CPA, Financial) is a Panama-based airline company operating through its two subsidiaries, Copa Airlines and Copa Colombia. Copa came to my attention recently when I was screening for high growth stocks with at least 10 years of financial history and selling at low P/E multiples.

Copa is an airline operating out of Panama's Tocumen International Airport. Tocumen is being developed as a hub airport by Copa in Central America connecting North and South America. Its prime location has given Copa a narrow moat as it dominates Tocumen, owning 80% of the gates. Panama has a great strategic location as evidenced by the Panama Canal. The airline is taking advantage of its geographical advantage and the rapidly developing economies of Central and South America. Copa's stock had plunged this year because Venezuela has prevented the repatriation of cash (amounting to over $500 million) as it copes with a rapidly deteriorating economy. On the positive side, the company is currently experiencing solid tailwinds due to plunge in fuel prices, which eats up 30% of revenue. Copa's dividend yield of 4% certainly looks attractive. The dividend is well covered by earnings (36% payout ratio) and cash flow and has being growing rapidly. The company has a strong balance sheet with Cash to Debt Ratio of 0.78, Equity to Asset ratio of 0.52 and Interest Coverage of 17.15. The following chart shows Copa's long term price chart (green line). The blue line shows Copa's price at median P/E indicating undervaluation. The red line shows Copa's price at median Price/ Operational cash flow indicating significant undervaluation. The light blue line shows price at median Price / Sales ratio also showing a small undervaluation. As you can see an investment is Copa has quadrupled in the last 10 years.

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Figure 1 (above): Copa is undervalued on median earnings, operational cash flow and sales basis.

Growth

Annualized Per share growth rates are given below. (Source: Gurufocus.com)

Annual Rates (per share) 10 yrs 5 yrs 12 months
Revenue Growth (%) 20.00 20.80 9.50
EBITDA Growth (%) 19.90 17.40 7.60
Book Value Growth (%) 29.70 20.40 16.40

Financial Statements

The following charts show Copa's financial statements in a graphical format. Financial metrics are very strong. Looking at the balance sheet, most assets are Property, plants and Equipment. Debt is under control with the bulk of financing is coming from retained earnings. Both net-income and free cash flow are robust.

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Economic Value Analysis

I have conducted an Economic Value Analysis of COPA. Copa has been consistently creating economic value over and above its cost of capital. This demonstrates to me that it is a good operator.

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Price Earnings Ratio and Return on Equity

Copa meets my criteria of a low P/E, high ROE stock. My favorite stocks have a ROE of over 20% and a P/E of below 15. Copa meets this criteria.

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Dividend Analysis

The following figure shows Copa's earnings and dividend per share. Copa is only paying 36% of its earnings as dividends. Clearly there is lots of room to grow.

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If we are to assume that Copa can grow its dividend 10% per year, the discounted cash flow from dividends alone would indicate that shares have a good margin of safety. This analysis assumes that dividend growth stops after 10 years and then dividend amount remains stable to perpetuity. The discount rate I have used is 2.4% (similar to a 10 year treasury).

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Source: Gurufocus.com

Risks

Apart from the obvious cyclical airline industry risk and exposure to oil prices, Copa is exposed to a number of important risks which should be appreciated. Copa is based in a developing country and is subject to high currency, political, and economic risk. Copa could also be disrupted by deep discount airlines similar to Ryan Air and Spirit Airlines. Copa has two classes of shares Class-A are non-voting shares which are traded on the NYSE and voting Class B shares which are traded only in Panama. Class B shares can only be held by Panamanian nationals and are effectively the controlling shares. Class A shares are entitled by dividends and have some ownership rights but self-serving or destructive action by Class B shareholders could effectively render them valueless. However, Panama is a small country heavily dependent on trade. It is in its interest to treat international investors with respect. Therefore, considering the above an investment in Copa should be considered to be a relatively medium risk investment and only a small portion of one's portfolio should be invested in CPA Class A shares.

Conclusion

Overall, my analysis shows that Copa Holdings is an attractive medium risk / high return investment. Copa appears to be an efficient operator with a narrow moat due to its geographical location in Panama. The Venezuelan cash repatriation issue appears to be priced in and the company appears to be benefiting from the falling fuel prices which should give it a short term boost. The margin of safety seems to be reasonable at this time. S&P Capital IQ rates the stock as 5-star with 12 month target of $147, implying a 50% upside. With rapid economic development taking place in Central and South America, a small investment in Copa should prove to be profitable in both the short and the medium-term.