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Planes, Trains and Automobiles

Authors:
Farid Abasov (Equity Analyst, Latin America & EM EMEA Equities)
Rebecca McVittie (Investment Director, Emerging Markets)

Up, Up and Away - Mexican air travel in a post-COVID world

Mexican airports have been among the most affected industries by COVID as domestic and international airlines withdrew capacity very sharply. Recent signs of economic recovery and the vaccine rollout promise to bring benefits for airlines and airports. Pent-up travel demand should support an initial recovery, while societal changes and shifting consumer preferences should drive industry expansion over the medium to long-term.

Secular growth punctuated by the pandemic

Whilst we envisage some ‘turbulence’ in the Mexican airline industry, airports should initially benefit from pent-up travel demand as economies begin normalising, and then gradually return to the path indicated by their solid long-term fundamentals. We envisage sustainable traffic growth could translate into earnings growth given the high degree of operating leverage in the sector.

For a decade prior to the outbreak of Covid-19, Mexican airports enjoyed growth in air traffic of about 8% per annum and growth in domestic air travel was approximately three times higher than Mexican GDP growth. But the pandemic caused a major dent in that trend.

Mexican air traffic over the last decade - mn passengers versus growth yoy

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Source:  Goldman Sachs, Fidelity Research notes December 2020.

At the peak of the outbreak, air traffic was down approximately 90% YoY. In Q3, there were green shoots as an inflection point looked like it had been reached with airports exposed to domestic travel reporting improving data and traffic was down by a relatively better 50% YoY. International leisure travel also showed signs of improvement, albeit demand was still running at -70% YoY.

Whilst these signs of recovery were encouraging, we acknowledge that the industry as not been without strife. In the midst of the pandemic low cost carrier Interjet went bust. From a crisis, winners can emerge, their key competitor, Volaris showed that domestic travel was down just 4% YoY due in part to market share gains derived from Interjet’s demise.  By December, Volaris’ main hubs of Tijuana (the largest urban metropolis of North-western Mexico, neighbouring San Diego, California) and Guadalajara (Western Mexico) had recovered to 100% and 69% of pre-pandemic traffic levels respectively.¹

For Mexican airport operator ASUR, which relied on the well-known international tourist destination of Cancun for 55% of its group revenues pre-COVID, the recovery was lagging. But once vaccines are rolled out more widely, we anticipate a strong rebound as pent-up demand for air travel is unleashed.

Mexico’s progressive vaccination program could spur air travel recovery

While containment measures were lacklustre in Latin America, the Mexican government has wisely secured vaccines from multiple manufacturers. Mexico, along with Argentina and Chile, have reached deals that could enable them to protect more than 70% of their populations and spur normalisation.   

COVID-19 vaccines across the LatAM region by YE21 (% population)

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Source: Morgan Stanley, Bloomberg, various media sources, Morgan Stanley EM Fixed Income Research 26 January 2021.

Travel volumes for visiting friends and relatives (‘VFR’) should recover first, aided by higher remittances. Money sent home - primarily by Mexicans living in the US - during the first 11 months of last year reached a record breaking $36.9 billion, exceeding the previous high set in 2019 by 11%, potentially providing funding for trips.²

With no high-speed rail network and bus journeys accounting for % of travel,³ rising penetration will come from the migration of bus travel to air. Together with favourable demographics - a young and growing population - and the expansion of the middle classes, incomes should rise, affording the Mexican consumer more options for travel. And the cost and time savings of air travel will be hard for them to ignore.

Emerging Mexican Middle class continues to expand - Mexican Middle Class as % of population

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Source:  CONAPO, SCT and bus market information 2019.

Today, air travel accounts for only 39% of passenger traffic compared to more than 65% in in Brazil,⁴  which has similar GDP per capita, indicating the level of untapped growth in Mexico. The rapid growth of low-cost carriers is inevitable given their lower charge than bus fares and significantly shorter travel times.

Cheaper and faster travel options - Air versus bus

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Source: Volaris Company Presentation, January 2021.

The defensive profile of Mexican airports

Mexican airports have done an admirable job of navigating the crisis. Despite being among the most affected industries by Covid-19, Mexican airports haven’t added much incremental leverage to their healthy capital structure. This is thanks to the regulated nature of the aeronautical industry.

At the peak of the crisis, airport operators managed to almost break-even at the cash cost level, and in Q3, despite still markedly lower traffic on a YoY basis, profitability improved. Mexican operators enjoy a favourable and ‘compassionate’ regulatory system, which allowed operators to take advantage of the force majeure clause in concession contracts triggered by more than 5% drop in Mexican GDP. These airports were able to adjust tariffs upwards while lowering or delaying capex.

Airline sector well positioned as Mexico enters recovery phase

It’s no secret that the airline industry all over the world has been badly hurt by Covid-19 with people unable to travel amid lockdowns. But in Mexico at least, this gloom could lift sooner than elsewhere.

Mexico’s recovering economy and its governments’ prudent approach to securing vaccines, positions airlines to tap into pent-up travel demand. With growth in remittances helping to fund trips and poor alternatives offered by trains and buses, air travel could be set to benefit, translating into strong earnings growth underpinned by operating leverage for airlines and airport operators.

In the longer term, the secular dynamics of the airline industry remain in place: incomes are rising, demographics are supportive and air travel penetration rates are relatively low. This could see the Mexican air industry resume its ascent.

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¹ Fidelity Research notes, December 2020. Data extracted from monthly traffic data reported by airports and Credit Suisse, Goldman Sachs Research.
² pymnts.com and various media sources
³ Fidelity Research notes, December 2020.
⁴ Fidelity Research notes, December 2020, Volaris and JP Morgan Research.

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