Aeromexico Bolsters Stock Gains by Winning Air-Fare War

Grupo Aeromexico SAB got pushed around by low-cost airlines in 2012 and much of 2013. Now Mexico’s largest carrier is proving that bigger is better.

After losing market share to discounters Volaris, Interjet and VivaAerobus, Aeromexico is clawing its way back by cutting some of its own ticket prices at home and withstanding the pressure on profits with lucrative international flights.

That’s boosting the airline to an 18 percent gain this year, positioning it to beat the benchmark IPC index on an annual basis for the first time since it sold shares in 2011. An 11 percent advance in revenue from international passengers during the first quarter helped Aeromexico emerge as the “clear winner” of a price war with Volaris, according to Bernardo Velez, a Corporativo GBM SAB analyst.

“Aeromexico is getting bigger traffic increases than Volaris with smaller fare cuts in the domestic market, and the international segment is its secret weapon,” Velez, who has the equivalent of a hold recommendation on Aeromexico, said in a telephone interview from Mexico City. “Volaris went too far in cutting prices and got hurt more by the price war.”

Following its first-quarter performance, Aeromexico won a vote of confidence from an affiliate of Atlanta-based Delta Air Lines Inc. when a Delta pension trust purchased exposure to 2.2 percent of the Mexican company’s shares through a derivative agreement with a financial institution that bought the stock. Aeromexico has authorized the Delta trust to acquire a stake of as much as 4.9 percent via derivatives.

Delta Stake

Delta already holds a seat on Aeromexico’s board and bought 4.2 percent of the Mexican carrier’s shares in 2012 for $65 million. The U.S. carrier is working with Aeromexico and others to become the “preferred carrier” for travelers to and from Latin America, it said in an e-mailed statement.

Aeromexico, based in Mexico City, has climbed this year as quarterly results have improved, international sales have advanced and domestic market share has climbed, Chief Executive Officer Andres Conesa said.

“What Delta has shown since the initial investment, which is reinforced by this transaction, is a greater confidence in our outlook,” Conesa said in a telephone interview. “There’s no one better than someone who knows aviation really well, as they do, to say, ‘Hey, I see a good future here.’”

Aeromexico’s emphasis on international routes echoes the strategy of Delta and other U.S. legacy airlines. The Mexican carrier earned 71 percent of 2013 operating profit on flights to Western Hemisphere destinations such as New York, Houston and Sao Paulo, while those routes accounted for 39 percent of sales, according to a report with the Mexican stock exchange.

Domestic flights in Mexico generated 17 percent of operating income and 49 percent of revenue.

International Profit

Conesa’s company carried 39 percent of passengers in its home market during the first three months of the year from 36 percent a year earlier, while Volaris was little-changed at 23 percent, according to data compiled by the Communications and Transportation Ministry. Interjet fell to 23 percent from 24 percent and VivaAerobus dropped to 11 percent from 13 percent.

Aeromexico’s international profits and larger size helped it beat Controladora Vuela Cia. de Aviacion SAB, otherwise known as Volaris, in their price war in western and northwestern Mexico, according to Helane Becker, an analyst with Cowen & Co.

“They’re significantly bigger than Volaris, they have an enormous international operation,” Becker, who has the equivalent of a buy recommendation on Volaris and doesn’t rate Aeromexico, said in a telephone interview from New York. “They have a different business model and they can spare a half a percentage point of margin. For Volaris, it’s been a few margin points.”

Volaris Rebound

Flights outside Mexico accounted for a little more than half of Aeromexico’s sales last year. Total traffic in this year’s first four months rose 22 percent, almost twice the increase for Volaris. Aeromexico also retained more pricing power with a drop of 13 percent in average fare for each kilometer flown in the first quarter, compared with 21 percent for Volaris.

For airline investors, Volaris may now be poised for bigger gains than Aeromexico. Both airlines are trimming planned capacity growth while Volaris is also shifting flights to less-competitive routes, adding more international service and boosting non-ticket revenue. Its first-quarter loss widened more than fivefold to 370 million pesos ($28.6 million), it said April 28.

Craig Hodges, CEO of Hodges Capital Management in Dallas, bought 50,000 Volaris shares last week after exiting a position of 1 million earlier this year. Volaris posted a record 10 percent gain last week after hitting an all-time closing low on May 2. The stock has tumbled 44 percent this year.

Bottomed Out

“It’s a little down and out, it may have seen a bottom here,” Hodges, whose firm has about $2 billion under management, said in a telephone interview.

Volaris’s American depositary receipts have an implied potential gain of 25 percent from yesterday’s close of $7.93, according to six analyst estimates compiled by Bloomberg. The implied increase for Aeromexico is 6.3 percent. Interjet and VivaAerobus, which delayed a $226 million IPO in February, are closely held.

The effort to lure some customers back will help Aeromexico as an accelerating Mexican economy brings more travelers onto its planes even without additional fare reductions, according to Velez, the GBM analyst.

“The environment for everyone is going to be a lot better in the second half because an expected increase in consumption should help boost demand without price cuts,” he said. “We’ll still see some pressure on yields as capacity expands and the big plane orders arrive, but we won’t see as much as in the recent price war.”

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