OMAB - OMAB: Safe To BUY

2023-11-01 11:18:37 ET

Summary

• Mexican Government changes concession terms, increasing fees from 5% to 9% of gross revenue, impacting OMA's results.
• Changes to the formula for airport fees may lead to reduced growth estimates and capex/investment.
• OMA's stock price may be impacted, but the company still has ample EBITDA and free cash flow growth.
• New Price Target of US$82 +34% upside.

Summary

The Mexican Government changed the two key items to Grupo Aeroportuario del Centro Norte (OMAB) [OMA] concession terms, which will have a negative impact on the company's results. The first is an increase in the concession fee from 5% to 9% of gross revenue. The second is how the discount rate is calculated and applied to the MDP (Master Development Plan) which provides OMA with its regulated return on investment. Both items are more than priced according to my estimates, and OMA shares offer 34% upside to the YE24 price target of US$82.

Regulatory Changes

The most immediate impact is the move to change the concession fee from 5% to 9% of gross revenue, which still needs to be approved by the Mexican Senate. OMA confirmed that this would impact EBITDA margins by 4% but that the extra cost would be passed through in its next MDP plan to be implemented in 2026.

The next change is to the formula by which the regulator sets airport fees, called the TUA. Below are the main changes as illustrated in a JP Morgan report. The company said in its 3Q23 earnings call that it expects little change to the discount rate and its investment outlook. I found the return cap of 3% over estimated traffic a concern, but OMA stated that it added greater transparency and precision to MDPs.

In the past, the airports budgeted for 3% to 5% traffic growth and garnered excess returns since traffic growth has been over 6%. This cap means that airports will likely reduce growth estimates and capex/investment to better safeguard returns, i.e., more conservative given the lack of incentive.

Modeling Regulation

I incorporated the higher concession fee in YE24-25 estimates, which effectively reduced EBITDA margins from 75% to 71%. OMA stated it would continue to invest in non-airport business segments such as hotels and warehousing to reduce the concession cost impact. Currently, about 8% of revenue comes from these initiatives.

In 2026, I assume the TUA will increase 8%, which should recuperate the extra concession cost and provide at least a 10% real return on investment. However, I decreased traffic estimates from 8% to 6% long term.

Traffic Estimates

Due to the PW engine grounding, I also reduced traffic growth in the domestic market to 6% vs. 8%. Volaris (VLRS) and Viva, which make up 70% of the Mexican domestic market, have Airbus aircraft that are impacted by the recall. While Volaris expects to be able to offset much of this via extending leases and delivery of new airplanes, a reduction in growth is still likely.

Valuation

This episode should leave a mark on the stock's risk profile, at least until when Asur (ASR) completes its MDP by YE23. If things go relatively well the market may breathe a sigh of relief. Until then, it is prudent to incorporate greater risk in OMAs share valuation. I reduced the EV/EBITDA target multiple to 8.5x from 10x. This coincides with a higher beta in the WACC calculation. Thus, assuming lower results and cutting valuation, the new YE24 price target is MXN$184 or US$82 per ADR. Prior to the event, I had a US$108 price target.

Conclusion

BUY OMA, the worst seems to be more than incorporated into the share price. The regulatory changes will impact results through YE25, but still provide OMA with ample EBITDA and free cash flow growth to fund capex and payout generous dividends. The key test to the sector will be in December 2023 when Asur presents its MDP and if all goes well, we may get a significant relief rally.

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