CPA - Is Copa Airlines Still A Top Growth Stock With Big Potential?

2023-10-18 13:46:46 ET

Summary

• Copa Holdings stock has declined since July, in line with other airline stocks.
• The company redeemed its 4.50% Convertible Senior Notes due 2025, resulting in minimal dilution for existing shareholders.
• Despite concerns about unit revenues and oil prices, Copa Holdings is still considered a strong buy with significant upside potential.

In June 2022, I covered Copa Holdings (CPA) and marked shares a buy, and that has worked out well with a 19.5% return to date and a total return of 22.7% compared to a gain of "only" 4.5% for the broader markets. With airlines and aerospace names, I'm looking for returns that lie significantly above the market return and for airlines that are related to the added risk and volatility that should yield a premium in case one does decide to invest. Since July many airline stocks have started to decline in value and Copa Holding is no exception. In this report, I will discuss whether Copa Holdings is still the top growth stock to buy.

Copa Holdings Stock Declines

Copa Holdings stock declined in line with its peers since July. So, there was not a particular element in the earnings posted in August that contributed to the decline. Unit revenues were up modestly by 2.7% showing that there no longer is double-digit growth in unit revenues but that also was not expected. Unit costs decreased by 17% but were only 1% lower when considering only the non-fuel cost components. Capacity expansion was around 14% demonstrating that capacity expansions currently are mostly servicing as offsets for inflated costs, but this is an industry phenomenon.

Dilution For Copa Airlines Shareholders

Probably the most interesting thing was that Copa Airlines decided to redeem its 4.50% Convertible Senior Notes due 2025 with a $350 million principal amount according to the net share method by September this year. The company will be paying or has already paid $350 million in cash and any unpaid interest would be settled by the issuance of shares.

I went through the terms of the convertible notes and the dilution of existing shareholders is minimal as the principal amount will be settled in cash and unpaid accrued interest will be settled with the issuance of shares. The conversion rate is set at 20.1603 shares for each $1,000 outstanding in unpaid interest or $49.60 per share.

In case parties wait until the redemption date, the redemption will be driven by a 40-day trading price for CPA stock which would equate to a price of $104.17 per share. So, there has been no reason for the noteholders to wait until the redemption date as they would get 2.1x times the number of shares if they convert. Overall, the dilution from conversion of unpaid interest to shares is rather small, yet we saw the number of shares outstanding increase from 39.05 million to 42.711 million currently. The company ended the second quarter with more than $281 million in cash and equivalents and over $833.5 million in short-term investments. A $350 million principal payment in cash would reduce cash and marketable securities by a little over 30%. While Copa did pay the principal amount in cash, it likely issued shares to raise the $350 million from shareholders to pay the noteholders.

Is Copa Airlines Still A Buy?

The big question is whether Copa Airlines stock is still a buy and I think that is most definitely the case. The company's quarterly reports regarding cash flows are somewhat limited providing a more difficult assessment of the stock, but with the balance sheet data and forward projections in place as well as an assumption of growing dividends according to the company's dividend policy of paying 40% of adjusted earnings I do believe that Copa Holdings is a strong buy. Not only is the upside around 114% with a price target of $179 per share but the company is currently also trading at an EV/EBITDA of 7.7x which is lower than the industry median but it also usually trades at elevated EV/EBITDA levels which gives me some confidence that a trading level in line with peers is justified as an absolute minimum.

Conclusion: Copa Airlines Has Significant Upside

Copa Holdings has shown strong results during the second quarter. I deem it likely that there's some dilution to shares as the company issued shares to pay the principal amount for the Notes due 2025 that were redeemed earlier at the convenience of Copa triggering conversions from noteholders. From an operational perspective, we don't see major growth in unit revenues so that provides a bit of pressure as oil prices are increasing and there are general concerns about the strength of the airfares going forward for the industry as a whole. That's keeping the stock down currently and provides a forward risk, but it also should be noted that airline stocks, in general, have seen significant pressure on the back of fears of airfares softening but those fares have stayed strong throughout with few exceptions. The direction of oil prices is of course a watch item, but in an environment where jet makers cannot deliver jets fast enough, there remains strength for airlines to prudently manage yields.

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