Gol: Flight Path Has Changed But Still Flying High

Aviation
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Gol takes off

Gol (GOL) ADRs have been up and still going strong since disclosure of its plans for a major corporate reorganization on October 14 (+77%). (more information here)

The company had proposed a merger between its core air travel business with its loyalty program, Smiles (OTC:SMIFF), and simplification of its capital structure to trade solely common shares in order to meet the criteria required to migrate its stock to the “Novo Mercado” segment.

Terms of the deal upset some of Smile’s minority shareholders and on December 16, Brazil’s stock exchange rejected the plan. However, the corporate reorganization is still very much alive as the company is looking into new structuring opportunities that have become available for the Brazilian airline industry. In fact, several industry-changing events are making for a compelling case for investors who have faith in Gol (GOL), including Brazil opening its aviation industry to foreign capital at both the air transportation and aircraft manufacturing levels. As investors struggle to figure out whether the current turbulence shaking markets is just a correction or if we are seeing the start to a bear market, a sharp drop in oil prices has helped Gol’s business by lowering its jet fuel costs. Gol’s margins could further improve as its top-line is expected to benefit from the bankruptcy of competitor Avianca Brasil and air travel could potentially grow as the local economy recovers.

Corporate reorganization to take new form

The market’s initial read on the incorporation of Smiles (OTC:OTC:SMIFF) by means of a merger with Gol (GOL) was that it would be positive for Gol’s shareholders at the expense of Smiles’ shareholders. However, news on B3’s rejection of the plan had little impact on Gol’s stock because the company will still carry forward with the corporate reorganization but under a revised structure, which might even include some form of foreign-owned capital, such as that of current Gol (GOL) shareholder Delta Airlines (DAL). In fact, Gol (GOL) has already declared that it is considering alternatives. “Novo Mercado” complies with higher corporate governance standards and bringing the loyalty program business that had been spun off in 2013 back into Gol (GOL) is in line with the industry trends as most players have already incorporated this complimentary business to be back being run in-house. Some analysts believe Gol (GOL) might look for a deal similar to that of LATAM (LTM) when it incorporated its loyalty program Multiplus back in September.

Provisional Measure No. 863 could open Brazil’s airline industry to more foreign-owned capital

The Brazilian government seems to be willing to open its aviation industry to foreign capital. In the aircraft manufacturing industry, it green-lighted the Embraer (ERJ) – Boeing (BA) deal, although after some going back and forth on political issues. Now, Brazil seems to be following the same path in its airline industry by removing a cap on foreign capital. Michel Temer, Brazil’s president, signed on December 13 Provisional Measure No. 863, a decree that removes a 20% cap on foreign capital’s participation on local airlines’ voting capital that is currently in place. Foreign-owned Delta Airlines (DAL) and United Continental Holdings (UAL) hold Gol (GOL) and Azul (AZUL) equity, respectively 10% and 8%. Now, this presidential decree must be approved by Congress, which is expected by 1H19. Nevertheless, reception to the government’s signaling its willingness to facilitate foreign investments has been positive, especially considering the greater stability it creates in the long-run for such a capital-intensive and volatile airline business.

Avianca Brasil’s loss is Gol’s win

On December 11, following the announcement that Avianca Brasil had filed for bankruptcy protection, ADRs of competitors Gol (+13%) and Azul (+8%) rose as investors saw these companies strengthening their position especially in the more concentrated domestic segment where Avianca Brasil has been strong with roughly ~14% of market share.

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Source: ANAC

Colombian Avianca (AVH) and Avianca Brasil both belong to Synergy group but the Brazilian subsidiary operates independently. Avianca Brasil filed for bankruptcy protection in response to aircraft lessor Aircastle’s request to repossess 11 Airbus on lease to Avianca Brasil, who was late on its payments to the lessor. This accounts for a significant portion of Avianca Brasil’s fleet (over 20%) and the absence of these aircraft would force Avianca into terminating its service at several domestic routes. Avianca Brasil’s recent struggles have been familiar to the local industry as it had already declared back in August that it would be reducing its fleet. Also, other lessors took legal action seeking the return of up to 13 Airbus aircraft. According to local press and regulatory filings, Avianca Brasil’s indebtedness exploded in 2018, growing by at least 50%, and its debt is over R$100 MM with airports alone.

Azul (AZUL) has emerged as a potential buyer for Avianca’s Brazilian operations. Local press reported that David Neeleman, Azul’s founder and Chariman of the Board, was studying a cash deal for Avianca Brasil. Although, John Rodgerson, the company’s CEO, has declared that they aren’t talking with Avianca Brasil just yet but could look into a potential acquisition in the near future. Regardless of who ends up buying Avianca Brasil, the local industry’s landscape is about to change and there are several significant overlapping routes.

Momentum: oil prices and Brazilian economy

Oil prices have dipped below US$50/ba in December, driven by worries of an oil glut. This is the worst monthly drop since 2008. While the tumble in oil has most investors worried, Gol (GOL) benefits from diminished jet fuel costs.

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Source: NASDAQhttps://static.seekingalpha.com/uploads/2018/12/21/4865841-15454112172797053.jpg

Gol (GOL) might continue flying high in 2019 as there might be much upside in a potential improvement in air traffic in Brazil. The country’s new government is set to work on critical reforms in 1H19 which could bring much-needed macro stability. A better Brazilian economy and stronger Brazilian real currency might lead to more air travel and Gol (GOL) seems to be well-positioned.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GOL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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