ASR - Grupo Aeroportuario del Sureste: Moving To Hold Amid Significant Growth Slowdown

2023-05-18 09:09:32 ET

Summary

• Sureste reported a mere 3% traffic growth in April, which is a sharp deceleration both from its own recent results and that of peer Mexican airport operators.
• The primary fault lies in the Colombian market, where Sureste's airports saw an 18% year-over-year decline in traffic.
• Even putting Colombia aside, Sureste's tourism-driven Mexican airports are less attractive than the reshoring-driven industrial airports that other operators control.
• As such, I am moving from a buy to a hold rating on Sureste until the current challenges start to abate.

I have been bullish on the Mexican airport operators, including Grupo Aeroportuario del Sureste (ASR), over the past couple of years, seeing them as a good way to prosper from the rebound in the global travel industry. That's been a successful call; ASR stock is up approximately 60% since my coverage of the company in late 2021, for example.

With the stock having now exceeded my price target at that point, it's time for an update. While I remain upbeat on the Mexican airport operators, including Sureste, as a long-term growth story, valuations are no longer quite as compelling. And the bullish thesis for Sureste in particular has developed some cracks, at least on a near-term basis. As such, I'm moving to a hold rating on ASR stock. Here's why.

Cancun Concerns Are Starting To Play Out

Read my past coverage for more details on the business and properties. That said, as a quick reminder, Sureste's primary assets are its collection of airports in Southern Mexico.

Cancun is far and away the company's most valuable property, serving 30.3 million passengers in 2022. Sureste's next busiest airport, Medellin (Colombia), handled less than half that. And Sureste's #2 airport within Mexico, Merida, is at just 3 million passengers a year. As far as its Mexican operations go, Cancun is the overwhelming majority of the pie.

I've previously argued that there are natural limits to growth in Cancun. Like most tourist destinations, it eventually gets overbuilt and starts to lose its natural charm. Crime rises. Pollution becomes a problem. Decades ago, Acapulco was Mexico's busiest beach resort. After being overrun with crime, hardly any foreigners go to Acapulco anymore.

I don't see anything that drastic happening to Cancun anytime soon. That said, environmental problems are becoming a major problem. In particular, lack of sufficient plumbing and wastewater capacity has led to significant pollution issues at local beaches. As a recent Guardian article noted about Cancun and nearby Tulum:

Algal blooms have also plagued the coast of the Riviera Maya, a phenomenon scientists have linked to warming sea temperatures. The beachfront along the coast is frequentlylined with mounds of rotting black seaweed. In Tulum, the seaweed is often stacked high in piles with workers shovelling it on to wheelbarrows on the shore and hotel owners despairing over where to put it all.

Speaking of Tulum, a new international airport is set to open there in 2024 which will siphon off some (though probably not a lot of) travelers from Cancun.

Also weighing on the Cancun airport growth thesis, crime has been mounting. Americans have been the targets of several attacks over the past year and the Mexican government has had to take measures to try to tamp down the growing issue there. This is in contrast to Mexico as a whole, where crime statistics have generally improved in recent years.

Colombia Has Gone From Strength To Weakness

I originally invested in Sureste in 2017 at the time it announced a deal to buy the operating leases for 12 Colombian airports (it ultimately got regulatory approval for half of those). Prior to the Colombia deal, I viewed Sureste as relatively undiversified, as it relied nearly entirely on Cancun and the struggling San Juan (Puerto Rico) airports for its business.

With the addition of the Colombia airports, including the crown jewel of Medellin's international airport, I saw a much more intriguing and resilient airport operator.

And for the past few years, the Colombian airports have done well. Sureste put some much-needed money into renovations and modernization at Medellin and other Colombian airports, helping to boost non-aeronautical revenues considerably. Additionally, the construction of South America's largest road tunnel cut commute times from the city of Medellin to the previously distant airport by more than half.

On top of that -- and here's where today's problems start -- Colombia had previously had almost no discount carriers, leaving expensive legacy airlines to run the market. This, naturally, limited passenger growth.

In the late 2010s, however, new entrants such as Viva Air enjoyed tremendous growth, making air travel available at a reasonable price to millions of Colombians who couldn't afford to fly with Avianca. Viva saw rapid growth and best of all for Sureste, Viva was based out of the Medellin airport. This meant that most of the new associated air fees were going to ASR from the burgeoning Colombian discount carrier industry.

Fast forward to today and amid a sharp currency devaluation and worsening political situation, the discount carriers ran into intense problems. Facing financial strain, Viva attempted to merge, but was unable to get regulators to approve a deal. It ultimately suspended operations entirely and shut down. Just a month later, the other Colombian discount carrier of significance, Ultra, also folded .

This has massively reduced the number of seats in the Colombian market, especially so at ASR's Medellin airport. Legacy carrier Avianca now controls nearly 50% of the market since the discount carriers went under. Needless to say, this is a poor situation for the local airport operators, including Sureste. If you look back to the airport display screen at the top of the article, half of those airlines are no longer with us.

This brings us to the April passenger traffic figures, where Sureste's Colombian traffic plunged more than 18% year-over-year. This had the net result of making Sureste's overall results be just +3% for the month, which was light years short of the double-digit growth figures that the other two Mexican airport operators are reporting .

Ultimately, is this a thesis-breaker for Sureste? No, it's not. The second-largest air carrier went bust in Mexico in 2010 and it only took 24 months or so for all those lost seats to come back with other carriers; the airport operators didn't see too material of a hit to their business.

That said, Sureste is going to be reporting negative comps in Colombia for quite a while, and that's certainly not good for the valuation, at least compared to the other two Mexican airport operators. Additionally, I'd note that the Colombian political situation has markedly deteriorated over the past month, and investors may be nervous to put up funds for new air capacity in the country for the time being.

ASR Stock Verdict

Sureste has always been my smallest investment position of the three Mexican airport operators. I prefer the more industry and large city-based airport portfolios at Centro Norte Airports (OMAB) and Pacifico Airports (PAC), respectively.

Especially as the focus in Mexico moves from post-COVID tourism to new factories and industry, Cancun slips in appeal compared to airports like Monterrey and Guadalajara which are controlled by the rival airport groups. I'm also not a huge fan of Sureste's San Juan asset, given the structural problems and population decline that the island of Puerto Rico is facing.

Colombia was the intriguing factor that gave Sureste more excitement. The Medellin airport was rapidly ramping up operations, seeing heavy investment, and appeared set to become a major hub toward all of South America. With the failure of the Colombian airlines and the sharp deterioration in Colombian politics, however, the growth of the Medellin airport will be dramatically limited for the next several years.

As such, I believe Sureste stock should trade at a meaningful discount to Pacifico and Centro Norte. On an EV/EBITDA basis, the three always trade in close proportion to each other:

Centro Norte has now expanded to the highest multiple of the bunch -- which is understandable as it has the airports most tied to industrialization and manufacturing. Centro Norte has had the fastest traffic growth and earnings growth, and thus it has outperformed. That said, Pacifico is equally cheap to Sureste and has the more attractive airport portfolio of the two for current economic conditions.

On a P/E basis, Sureste is now the cheapest, which is a change, as traditionally Centro Norte was the lowest valued one:

Still, I'd argue this is not quite enough of a gap to get excited about, given that Sureste could be reporting negative year-over-year traffic growth later in 2023 whereas the other two airport groups are reporting double-digit growth.

I'm not selling my Sureste shares, to be clear. This will be a far larger business in five or ten years than it is today. And my cost basis is much below the current price; I'm in no mood to liquidate it and pay taxes.

That said, on a 24-month outlook, Pacifico and Centro Norte are both levered to highly favorable Mexican investment trends whereas Sureste will be stuck treading water in Cancun and facing a challenging (to put it politely) operating environment in Colombia.

Sureste is one to hold for now and revisit in 2024 or if the share price corrects considerably.

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