Fasten your seatbelts

Some of GOL’s problems are local, including two accidents in the last 18 months which have dented confidence. Others are global, like higher fuel prices. But two recent events suggest the company may be turning a corner.

The first was a 10% rebound in the shares on mid-September news that GOL is considering going private or initiating a share repurchase program. And on October 5, it made a rather less welcome announcement. GOL predicted that its 2007 per share profit would be almost 50% less than earlier predictions, citing a range of 1.60-2.10 reais per share down from 3.00-3.50 reais. Despite this, the stock ended the day up nearly 3.00% against a 0.56% rise in the Ibovespa.

The share price reaction looks perverse, but the company believes the worst is over and investors seem to be buying that. Daniela Bretthauer, analyst at Goldman Sachs, met with management and raised her share price guidance to $29 from $26 on a 12-month basis. “It now looks to us that the worst in terms of yield pressure may be over. For the third quarter, we expect the company to show a 22% recovery in yields sequentially,” says Bretthauer.

Hard Landing
Shares were trading down by 46% in the 12 months ahead of the buy-back announcement. Even so, the rally on the news was much stronger than expected, given that the company’s intentions remain fuzzy. GOL merely noted that the owners were analyzing various options, including the purchase of shares in the market or going private. The airline declined to provide any further information on the delisting, which bucks the trend for increasing Bovespa listings, not just from Brazilian entities.

Not surprisingly, the looseness of the language fuelled speculation. This was concentrated on a supposed split in the Oliveira family – the majority shareholders – between the older and younger generations, with the former seen supporting going fully private and the younger seeing benefits from keeping a public presence.

Analysts are split on the real intentions of the company and how they should interpret the announcement. Few, however, are really convinced that GOL will want to go private and ECM bankers say it makes little sense. Bretthauer recognizes that there would be advantages, including the ability to exploit a depressed shares price to regain control. And she adds that it is attractive for a company that operates a virtual duopoly with TAM in the market not to have to discuss forward-looking plans. Still, Bretthauer reasons that cutting off a cheap source of funding for a company that is growing fast would be damaging. Since its IPO, GOL has tapped capital markets three times, and bankers say a Bovespa exit, followed by costly debt financing and a likely relisting would yield more cost than benefit.

Ray Neidl, analyst at Calyon Securities in New York, believes that it would be beneficial for the company to go private until uncertainty surrounding the Brazilian air traffic control issue is resolved. Still, he thinks that the most likely scenario is an aggressive share buy-back program. He has an add recommendation on the shares, in the belief that at very least the company will buy the dips.

The announcement has had a salutary effect on the shares of TAM too, possibly because investors repositioned themselves in the stock so that if GOL does go private, they maintain airline sector weightings. TAM declined to comment.

Supply/Demand Imbalance
The Brazilian aviation sector has faced a number of uncertainties that makes pricing airlines particularly tricky. There has been a significant downturn in passenger numbers and restrictions are in place at the country’s main hub and São Paulo’s main domestic airport, Congonhas. The accidents and chaos have persuaded many to turn back to land transport for relatively short journeys, particularly the country’s most popular trip, that between São Paulo and Rio de Janeiro, some five hours apart by road.

The downdraft in passenger numbers has come at an awkward time as airlines have been adding capacity fast. According to national civil aviation agency, ANAC, TAM witnessed a decrease of 7.1% in domestic demand year-over-year. The airline increased supply by 10.1% on the same period, leading to a fall in load factor of 11.5%. The load factor on international routes fell by 11.5% too in August, year-on-year.

The question then is how quickly will passengers return to using airlines? The media hubbub surrounding the industry and endless images of chaos in the airports seen earlier in the year has died down. And in some ways, a downturn in passenger demand offers some breathing room to get to grips with infrastructure.

The infrastructure question, however, is far from resolved. The burning question is just how much and how intelligently the Brazilian government will spend on improvements. Lack of progress in pushing forward the accelerated growth plan (PAC), the centerpiece of President Lula’s second term, suggests that long-term improvements will be slow and piecemeal.

It looks likely that flights from Congonhas will continue to be restricted to short haul of up to 1,000 kilometers and the number of flights will be limited. The lower house of Congress is discussing plans for infrastructure improvements, which are likely to include a third runway for São Paulo’s Guarulhos international airport.

Frank Boroch, analyst at Bear Stearns in New York, is relatively optimistic. He believes that in the longer-term capacity growth will normalize as the largely untapped domestic market grows. Furthermore, a solution to the air traffic control and airport crisis is more likely as much-needed investment comes on-stream in the wake of the two air accidents.

Even if these issues are resolved, the oil price surge is a threat. The ability of airlines to absorb an increase fuel prices varies from country to country, says Bob Booth, chairman of Miami-based aviation consultancy AvGroup. He believes that most will be able to increase prices through fuel surcharges. However, using this in Brazil may inflict further damage because of the high price sensitivity of customers.

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