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Morningstar | Our Long-term Thesis Remains Intact After Wide-Moat Pacifico Reports 2Q Results

Best Idea and wide-moat Grupo Aeroportuario del Pacifico released second-quarter results that featured lower operating margins and higher passenger traffic. We're maintaining our MXN 217 fair value estimate for local shares but raising our fair value estimate on ADRs to $116 after the peso gained against the U.S. dollar. Over the year, more than 1 million additional terminal passengers (mostly domestic travelers) boosted total passenger traffic 11%. Pacifico’s Guadalajara airport picked up two new domestic routes from TAR Aerolineas, and Los Cabos gained international and domestic routes from Sun Country and Calafia Airlines, respectively. For the quarter, Pacifico generated operating margins of 56%, down from 59% over the same period last year largely due to restructuring. Our 2018 forecast calls for a full year operating margin of 56%. The stock is now trading in 3-star territory after rallying on the heels of the Mexican presidential election but still looks a bit undervalued at a price/fair value estimate of 0.86.

Combined, aeronautical and nonaeronautical services grew 14%, bringing total revenue on track for our 2018 target of MXN 12.4 billion. Elevated revenue from Pacifico’s VIP lounges and advertising, 42% and 39% higher, respectively, boosted Mexican airport revenue year over year by 12%. Tailwinds included commercial space openings and the peso weakening during the quarter. Passenger traffic at Montego Bay, Pacifico’s international focused airport, jumped 8% and drove airport revenue 16% higher.

In the second quarter costs outpaced revenue, and a one-time charge related to organizational restructuring pushed employee costs up 34%. Costs related to maintenance and safety also rose nearly 30% due to taxiway and runway improvements and increased security personnel aimed at improving access time. Although operating margins narrowed, we still expect margins to improve 30 basis points during 2018, and we maintain our 57% midcycle margin, starting in 2022.

We believe investments during the quarter will expand operating margins over time given the high operating leverage inherent in the airport business model, combined with Pacifico’s ability to capitalize on nonaeronautical revenues. We maintain that Pacifico is the best-positioned operator to take advantage of both increasing domestic and international traffic. Pacifico yields an attractive mix of both leisure and business traffic, while also holding the largest percentage of Mexican passenger market share at roughly 26%, compared with 23% for Sureste and 15% for Centro Norte. Mexico City and other smaller airports comprise the remainder of air traffic. We expect revenues to grow at an average annual rate of 9% over the next five years, thanks primarily to passenger growth and increasing nonaeronautical revenue per passenger, combined with more subdued price increases on the regulated side of the business. We’re raising our fair value on the company’s ADRs to $116 for the strengthening Mexican peso, but maintaining our MXN 217 fair value estimate for local shares.