Slowing economies, engine issues with major airlines, and longer-term worries about government policies have impacted all of Mexico’s publicly-traded airport operators to varying degrees, but Grupo Aeroportuario del Sureste (NYSE:ASR) has stood out from its peers over the last year and since my last update on the strength of its tourist-driven business to Cancun, its stronger non-aero revenue base, and its more diverse operations.
While Sureste doesn’t offer the same leverage as peers Grupo Aeroportuario del Centro Norte (OMAB) (“OMA”) and Grupo Aeroportuario del Pacifico (PAC) to near-shoring, the strength of its tourist business is a meaningful compensating factor, as is the fact that this operator should have less risk to its tariff structure in the next few years. Up nearly 80% since that last article, Sureste shares may not yet be overvalued, as both discounted cash flow and multiples-based valuation approaches suggest as much as 30% upside.
Diversification, Timing, And Strong Non-Aero Help In The Second Quarter
Relative at least to Pacifico, Sureste had a better second quarter at least in part due to the timing of new tariffs, its more diverse base of operations, and ongoing strength in non-aerospace revenue.
Revenue rose 20% as reported, but it’s the 18% growth in revenue ex-construction that most analysts and investors follow, and this was about as expected. Aerospace revenue rose 24% year over year, slightly below expectations, while non-aero revenue rose 7% and beat expectations by about 3%. On a per-passenger basis, aerospace revenue rose 21% to MXN 257 (versus a 4% year-over-year decline to MXN 299 at Pacifico in Q2’24), while non-aerospace revenue rose 4% to MXN 138 (versus 15% growth to MXN 113 at Pacifico). OMA has not yet reported second quarter results, and is scheduled to do so on July 29.
Revenue in Mexico was up 18%, with 27% growth in aero revenue driven by a 33% increase in revenue per passenger (driven by newly-authorized tariffs) offsetting the 5% year-over-year decline in traffic. Sureste saw a worse decline in domestic traffic than Pacifico (7% versus 6%) as well as a steeper decline in international traffic (2.5% vs. <1%), with overall traffic to Cancun down about 8% (about 74% of total traffic for its Mexican airports). Non-aero revenue grew 4% overall and 9% per passenger, trailing the double-digit growth at Pacifico, with a decline in food/beverage and weak duty-free revenue dragging down growth in car rentals and parking.
Revenue in Puerto Rico rose more than 5%, with 2% growth in aero and 9% growth in non-aero revenue (down 6% and up 1% per passenger, respectively), on almost 9% traffic growth. Revenue in Colombia rose 35% on 34% aero growth and 40% non-aero growth (up 11% and 16% per passenger, respectively), with traffic up 21%.
On the profit side, challenges like higher wages had a predictable impact on margins. Consolidated EBITDA rose 18% yoy, with margin up 80bp to 69.2%, but declined 4% sequentially (margin down 220bp), and that was enough for a 2% beat. EBITDA in Mexico improved 18% (margin down 30bp to 74.1%), while Puerto Rico rose 2% (margin down 190bp to 52.6%) and Colombia rose 49% (margin up 540bp to 58%).
A Comparatively Better Set Of Drivers And Risks
As I discussed in a recent article on Pacifico, one of the challenges facing Mexican airport operators is the trouble with Pratt & Whitney aircraft engines that is forcing major carriers like Volaris (VLRS) and VivaAerobus to ground plans (and/or look for wet leases to compensate). Although conditions are improving at Volaris, management still guided to a 14% decline in capacity for 2024 because of the need to ground aircraft for engine repairs.
The good news for Sureste, though, is that they have far less exposure here. Only about 16% of Sureste’s total traffic is carried by Volaris and VivaAerobus, and only about half of that is exposed to the GTF engine issue, so only around 8% to 10% of traffic is really at risk here.
Offsetting that is some moderate risk to the capacity constraints at the Mexico City airport. At the risk of oversimplification, there’s simply too much demand for traffic to and from Mexico City, and with efforts to divert traffic to other airports (like Filipe Angeles International Airport) having limited success, the federal government has pushed a reduction in movements (takeoffs and landings) from 61 in 2022 to 43 as of early this year. With nearly half of Sureste’s domestic traffic passing through Mexico City, it’s an ongoing headwind to monitor.
As far as other factors go, I do still see some economic risk to Sureste’s business, given that it’s more tourism-oriented than other operators. The appreciation of the peso has made Mexico a somewhat more expensive destination, and I do think that is playing some role in traffic volumes. On the other hand, the opening of the Tulum airport doesn’t seem to be hurting traffic to Cancun all that much – overall domestic volume is up about 17% relative to Q2’19, while Cancun’s volume is up about 14%.
One other area where I feel a little better about Sureste’s positioning is with its concession arrangement. The company finalized its most recent Master Development Program with the government late in 2023, and I believe that leaves the company comparatively less exposed to potential changes in government policy.
That said, the government is pursuing a range of initiatives, including changing the process by which the justices of the Mexican Supreme Court are chosen, that could impact business and regulation in the coming years. Moreover, the government wants to pursue a range of social programs that could lead them to look for incremental sources of revenue, including a bigger tax on concessions and/or less favorable terms in the future. Offsetting this is my belief that the government recognizes the importance of concession operators to the economy and the need for functional infrastructure to support growth opportunities like reshoring, and I believe changes will likely be modest in scale.
The Outlook
I don’t expect 2024 to be the strongest year for Sureste, but I do still like the long-term opportunity that the company has to leverage tourism growth in Mexico and Puerto Rico, as well as air travel growth in (and from) Colombia. While there is likely less upside here in non-aero revenue per passenger in the Mexican operators, Colombia in particular could still offer some longer-term upside.
I’m looking for around 12% revenue growth from Sureste over the next five years as the company implements the new tariffs and continues to benefit from traffic growth to major destinations like Cancun. Longer term, I see growth slowing toward the mid-single-digits, but that should still support around 9% long-term annualized growth.
On the margin side, I do expect EBITDA margin to dip to around 57% in the coming years, but stay relatively stable at that level. Longer term, I do expect more leverage as the company exits its capital investment program and I believe long-term free cash flow margins can average out in the high-20%’s to low-30%’s. I do believe that changes to the tariff/concession program (like the higher tax) will reduce the long-term ceiling on margins and FCF, but I’d also note that non-aero revenue is an important differentiator that can drive higher margins for Sureste relative to its peers. All told, I expect low double-digit adjusted FCF growth.
Discounted cash flow and multiples-based valuation approaches all suggest that Sureste shares are undervalued today. Discounted cash flow tends to be more the more conservative approach and here it would seem that the shares are at least 10% undervalued. Turning to EBITDA and P/E, if I apply the same 15% discount to long-term average multiples that I use for Pacifico (to account for increased operating risk), I get a fair value a little above $400, or almost 30% above today’s level.
The Bottom Line
I’m honestly surprised that Sureste screens out as undervalued as it does given how the shares have been performing. If nothing else, perhaps it reflects how sentiment toward Mexican stocks has changed since the election and how investors are worried that the government will meaningfully alter the terms of concession agreements in the future. I do still see some risks to air traffic in Mexico through the end of 2024 but the valuation seems to more than price that in and these shares are worth a look now.
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