I'll be the first to admit that I generally take a dim view of the investment opportunities in the airline industry. After all, the airline business is labor-intensive, requires extremely high levels of capital expenditure, carries a heavy dose of government regulation, and is frequently affected by issues beyond its control, such as high energy prices, SARS, and terrorism, to name a few. These factors contribute to razor-thin operating margins even in the best of times, and the past few years have certainly not been kind, as airlines (with a few exceptions) have operated in the red -- or descended into bankruptcy -- with monotonous frequency.
That being said, there are exceptions to every rule, and I recently came across an airline operator that fits the criteria I look for in emerging market companies: It holds a dominant share of its home market, it has excellent growth prospects on both the domestic and international fronts, and its stock is attractively valued. Furthermore, unlike all too many carriers, this airline has been consistently profitable since it was fully privatized back in 1994 and should continue to benefit from both strong economic growth and favorable demographic trends in its target markets.
No, I'm not talking about Ireland-based Ryanair Holdings
I know, I know . it seems a little radical to jump from viewing the entire industry with a great deal of skepticism to being bullish about an airline that serves the politically and economically volatile Latin American markets, but please bear with me, as there's a Foolish method to my madness.
As I mentioned previously, LAN Airlines, formerly known as LAN Chile, is one of the top passenger airlines in Latin America, as well as being the largest cargo operator in the region. The company's business is conducted through five main subsidiaries -- LAN Chile, LAN Express, LAN Peru, LAN Ecuador, and LAN Argentina -- that make up the LAN Alliance. Through this alliance and code-sharing agreements, the company operates a fleet of 75 passenger jets and nine cargo aircraft (under the LAN Cargo brand) that serve 67 destinations in Latin America, 25 cities in North America, and a further 18 locations in Europe and Asia. The company is also a member of the oneworld alliance -- a partnership with seven other major carriers, including American Airlines
Well, I don't know about you, but that generic description of LAN's business almost caused me to nod off, so I believe it's time to get to the reasons why long-term, risk-tolerant investors might be interested in Chile's de facto flag-carrier.
A booming economy
LAN is well-positioned to benefit from continued strong economic growth in Latin America and positive demographic trends in the region. According to the International Monetary Fund, Latin America weathered the financial storms of May and June in fine form and posted growth of 4.75% in 2006 and a further 4.5% in 2007. The Chilean market, LAN's largest, is set to outperform the regional average and is projected to expand by 5.2% in 2006 and 5.5% in 2007.
Demographic trends are also favorable, as the World Population Reference Bureau estimates that Latin America's population will grow 44% over the next 45 years, from roughly 559 million in 2005 to more than 805 million in 2050. Just to put this growth in perspective, the population of Western Europe is actually expected to fall 2% over the same period.
Hmm . strong regional economic growth in the short to medium term and favorable long-term demographic trends . Can you say increased demand for air travel?
The likelihood of increased air travel demand in Latin America due to the abovementioned factors should dovetail nicely with the strength of LAN's operations in its target markets. As of Dec. 31, 2005, LAN Airlines controlled a 76% share of the domestic airline market in Chile, a 66% share of the Peruvian domestic market, and a 14% share in Argentina . not an impressive number until you realize that LAN Argentina only started operations in June of that year.
Similarly, the company holds an equally impressive share of the international route markets in these countries. As of year-end 2005, LAN possessed a 50% share of Chile's international airline market, a 29% share of the Peruvian market, and a 21% share of Ecuador's international flights. In these three countries, international passenger traffic grew an average of 13%.
Let's also not forget that just this past August, LAN Argentina began international operations. It now has a daily flight from Buenos Aires to Miami, with future routes to be decided, as the company recently received the right to add up to 25 new and international destinations.
Now, while positive macroeconomic trends and LAN's leadership position in its target markets make up two legs of my investment thesis, the third leg is the company's track record of operational efficiency.
Let's take a look, shall we?
As I mentioned previously, LAN Airlines has been consistently profitable since the company was fully privatized back in 1994, a claim that can be made by few airlines over the same time period and a testament to the company's operational efficiency. One example of this efficiency is the fact that LAN is an industry leader in terms of integrating the planning and scheduling of its passenger and cargo routes so that they overlap as much as possible. This allows the company to ship a significant amount of cargo on passenger aircraft, lowering the break-even load factors while maximizing revenue and profitability.
Another illustration of LAN's fixation on running a streamlined business is evident in the high utilization rates of its aircraft. In 2005, the company's long-haul aircraft were in operation for more than 15 hours a day -- a figure that is likely to increase, as LAN is in the process of modernizing and simplifying its fleet to lower maintenance time and costs.
It's these types of initiatives that allowed LAN to post net income of $51.5 million in the third quarter ended Sept. 30, 2006, up 116% over last year's period and well ahead of the 23% increase in revenue as net margins nearly doubled from 3.8% to 6.8%.
Sounds interesting, doesn't it?
After a recent run-up, shares of LAN trade at roughly 13 times fiscal 2007 consensus estimates, roughly a 44% discount to its projected growth rate over the next five years. Given the growth prospects in Latin America, its leadership positioning in its target markets, and the company's history of operational excellence, I would suggest that patient, risk-tolerant investors kick the proverbial tires on this potential high-flyer.
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Fool contributor Will Frankenhoff is enjoying his time writing for the Fool more than playing golf, reading The Financial Times, or taking a nap. He welcomes your feedback. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.