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Tam Bonds Rally as Air Travel Offsets Rating Cuts

Tam SA’s relative borrowing costs are declining from a record high as the fastest growth in domestic air travel since at least 2006 offsets concern about fleet expansion at Brazil’s second-largest carrier.

Tam’s 9.5 percent bonds due in 2020 yielded 546 basis points more than Brazil’s government debt, down from 593 basis points on May 26, a day before Fitch Ratings joined Standard & Poor’s in cutting the Sao Paulo-based company’s credit grade by one level.

Brazilian air travel has jumped more than 20 percent for 10 straight months, the longest streak since the civil aviation agency began collecting the data four years ago. The nation’s economic expansion will bolster Tam’s revenue, increase utilization of the eight planes it added in the first quarter and shore up its debt-to-earnings ratio, according to CreditSights Inc.

“There’s much more flying going on, much more demand,” Roger King, an analyst at CreditSights who has covered airlines for 20 years, said in a telephone interview from Norwalk, Connecticut. “That’s a fundamental positive.”

Yields on Tam’s $300 million of bonds due 2020 have dropped 36 basis points from 10.76 percent on May 26, the highest since the securities were issued in October, as the price climbed 2.6 cents on the dollar to 94.6 cents at 5:13 p.m. New York time, according to Trace, the bond price-reporting system of the Financial Industry Regulatory Authority. The average yield on Brazilian corporate dollar debt dropped nine basis points, or 0.09 percentage point, to 6.61 percent during that time, according to JPMorgan Chase & Co.’s CEMBI index.

Tam-Gol Gap

The rally is a reversal of last month, when Tam bonds sank 5.75 cents, driving the yield up 95 basis points, following the S&P rating cut to B+, or four levels below investment grade, and on concern that Europe’s debt crisis would stunt global economic growth. Tam receives 41 percent of revenue from international travel, compared with 11 percent at Sao Paulo-based Gol Linhas Aereas Inteligentes SA, Brazil’s biggest airline by market value, according to April figures.

The difference in yield between Tam’s bonds due in 2017 and similar-maturity debt issued by Gol rose to a record 126 basis points last month before narrowing to 94 yesterday, according to data compiled by Bloomberg.

S&P said on May 12 that it lowered Tam’s rating in part because the company’s fleet expansion “will continue adding” to its debt and undercut aircraft utilization. Tam’s eight new planes boosted its fleet 6 percent to 140, according to the company’s first-quarter results.

‘Fierce’ Competition

“Fierce” price competition has eroded yields, or average fare per mile, S&P said in a statement. Fitch matched S&P’s downgrade two weeks later, citing a “deterioration” in Tam’s credit quality.

Tam had a ratio of net debt-to-earnings before interest, taxes, depreciation, amortization and rent of 7.1 at the end of the first quarter, compared with 3.9 at Gol, according to Itau Unibanco Holding SA. Excluding rent, Tam had an average debt-to-earnings ratio of 9.3, compared with an average of 5.4 at Latin American airlines, data compiled by Bloomberg show.

“Of course they have to reduce their leverage, but I don’t see any immediate liquidity problem,” said Marcelo Menusso, a corporate bond analyst for Deutsche Bank AG in New York.

Rebound in June

Brazil’s economy, Latin America’s biggest, expanded 9 percent in the first quarter, its fastest annual rate since 1995. Gross domestic product may grow 6.6 percent this year, the most since 1986, according to a central bank survey of about 100 financial institutions released yesterday. Tam earnings will improve this quarter after reporting a 54.5 million reais ($29 million) loss in the January-to-March period, according to Itau.

“April was weak, May was weak, but June was rebounding,” Libano Miranda Barroso, Chief Executive Officer of Tam, said in an interview in Berlin yesterday. “So what we see is that year over year it will be better.”

The Tam debt rally may stall because Europe’s most-indebted countries will curb demand for higher-yielding securities to finance budget deficits, said Ciro Matuo and Boanerges Pereira, corporate bond analysts at Itau in Sao Paulo.

The cost of protecting Brazil’s debt against non-payment for five years with credit-default swaps fell one basis point to 146, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Real Gains

The real gained 1.4 percent to 1.8543 per dollar, paring its decline this year to 5.9 percent. The yield on Brazil’s interest-rate futures contract due in January rose five basis points to 11.01 percent.

The extra yield investors demand to own Brazilian corporate dollar bonds instead of U.S. Treasuries jumped two basis points to 346, according to JPMorgan. The yield gap on Brazilian government dollar debt over Treasuries rose seven basis points to 251.

The yield difference between Tam’s 2017 bonds and Gol’s 2017 notes may narrow another 20 basis points to about 75 because Tam raised $383 million through an initial public offering of its frequent-flyer unit, Multiplus SA, in February and extended debt maturities with October’s $300 million bond sale, according to Menusso.

“On a relative basis, these bonds don’t look bad,” Menusso said.

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