LATAM Airlines Group S.A.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

LATAM Airlines Group S.A. is a leading Latin American airline group, providing passenger and cargo transportation services. It is primarily based in South America with subsidiaries throughout Latin America and has a significant international network connecting Latin America with other parts of the world.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: LATAM operates a complex network spanning various geographical regions, mainly in South America, where it serves multiple domestic and international routes. The company’s operations are heavily influenced by economic, political, and regulatory conditions within Latin America, which can lead to significant instability and uncertainty. This is one of the core challenges they face, making sustainable high profitability hard.

The airline industry is inherently cyclical and intensely competitive with high capital expenditure and operating costs and sensitivity to fuel prices.

  • Revenue Distribution: The majority of LATAM’s revenue is generated from passenger operations, especially through its domestic and regional routes. The company also derives revenue from cargo transportation, though to a lesser extent. The main drivers for revenue are passenger yield, load factor, and capacity (number of seats). These metrics can be extremely influenced by global and local economies.
    • Revenues are highly influenced by exchange rate fluctuations between local currencies and the U.S. dollar.
    • Passenger operations are classified as Domestic (originating and ending in the same country) and international. As of 2022, the largest amount of revenue has been in Brazil followed by Colombia and Peru.
    • Cargo operations are split into domestic and international and contribute a smaller portion of the business’ total revenue
  • Industry Trends:
  • The airline industry is witnessing increasing consolidation through mergers and acquisitions, which can lead to enhanced market share for a few players. * Increasing competition from low-cost carriers. * Increased regulatory oversight to ensure compliance. * Demand continues to be influenced by external factors, such as economic cycles, geopolitical events, and pandemics.
  • The airline industry is becoming increasingly focused on technology adoption, particularly in areas of reservation systems, aircraft maintenance and operation, and digital customer service.
  • Margins: Given the nature of operations of the company and the need to stay competitive, the company is very sensitive to fuel prices and other cost fluctuations. Operating margins are highly variable and depend on several external factors. The airline industry is a very high capital, operation cost and labor cost industry. Their operating profit also depends on the pricing power of the company. Given this, they are in a very volatile industry
  • Competitive Landscape:
    • LATAM faces competition from local airlines within South America, as well as major international players.
    • Key competitors include Avianca, Copa Airlines, and Aeromexico in Latin America, and major international airlines on longer routes.
    • A main concern for the company is their position with the low cost carriers, as that is where future growth appears to be.
  • What Makes the Company Different: The company positions itself as the leading airline in Latin America with a vast network and diverse destinations. They are trying to build a stronger brand perception and recognition, specifically on long haul routes, while maintaining strong routes for domestic and regional operations. They are also trying to grow their LATAM Cargo business.

Financial Analysis:

  • Profitability:
    • LATAM has a history of profitability challenges, especially following the bankruptcy filing. The volatility in the airline industry and external economic factors are the biggest drivers behind this.
    • The company has shown a negative return on equity for many years.
    • The company’s performance has been largely affected by the COVID-19 pandemic and the bankruptcy proceedings.
  • Liquidity and Leverage:
  • As the company is highly capital intensive, leverage becomes an important risk factor. They have struggled to bring their balance sheet in order since bankruptcy, and have continued to have negative total shareholders’ equity.
    • While LATAM has improved its financial condition after bankruptcy, it still relies heavily on debt financing.
  • Net debt is still a major financial risk for the company. Their balance sheet is still in shambles after their bankruptcy.
  • Cash Flow:
  • The company has generated negative cash flow for many years, which was exacerbated by Covid-19. However, as of last report, the company has made large increases in free cash flow, but mainly from operating revenues. As they still rely heavily on financing, cash flow is one of their greatest risks.
  • Recent Financial Performance: In the most recent period (Q4 2022 & YTD 2023), LATAM has had very strong operational performance due to the reopening of borders, with passenger revenues increasing in every sector, resulting in a sharp turnaround in cashflow. However, this has come from a low base. For 2022 the company had an operating income of $1.7 billion, an incredible increase from previous year losses.
  • Net losses, while still negative, were a fraction of those of previous years due to better financial performance.
  • The company also experienced a significant increase in cargo revenues. * They are trying to aggressively recover their load factors and yields that they lost over the COVID period.
  • The company is trying to use increased profits to aggressively pay off debts. They are aiming to reduce net debt over the coming years.
  • However, given their increased expenses and increased aircraft deliveries, the path forward is still murky.

Recent Concerns/Controversies & Management Response

  • Bankruptcy Proceedings: LATAM had to file for bankruptcy in 2020 due to COVID-related financial stress, which was a significant financial setback. As of recent reports, they have successfully come out of chapter 11, but the entire process had a very large toll on the business, both in terms of operations and reputation. While this process is done, this makes a large amount of investors wary of the company, since they had filed bankruptcy only two years prior.
  • Debt Load: The company is still saddled with high levels of debt, which is a key financial risk and has required major restructuring efforts in the recent past. As they came out of bankruptcy, the main concern for them is that the new terms of debt and any potential interest rate increases will severely affect future profitability. They are seeking to reduce leverage in coming years.

  • Fuel Costs: The company is always very vulnerable to the price of fuel, which can have large impacts on earnings. This is a major risk that will always put pressure on the company’s operations and profits.

  • Management’s View: During their latest earnings calls, management noted that their main focus will be on maintaining high margins, maintaining cash and reducing debts, while carefully expanding in the most important markets. They are seeing strong signs of recovery, which they have tried to highlight in their latest reports. They did acknowledge external factors, like fuel prices and interest rates, that can have a material negative affect on their performance.

Moat Analysis:

  • Economic Moat: LATAM’s economic moat is rated at 2 out of 5, mainly because their competitive advantages are very weak and susceptible to external factors. As a network carrier, they do have an advantage in terms of network and routes, but other low cost carriers and airlines can replicate this. Their brand is not as powerful as those of similar industries.
  • Sources of Advantage:
    • Network: They have a substantial network in Latin America which can have certain network effects, making their routes harder to replicate, but the value of this advantage has diminished over the past years.
    • Cost Efficiency: While they are not yet a low cost carrier, they have been trying to reduce operating costs and build internal efficiencies in their operations.
    • Market Position: They are a top player in Latin America and have strong presence in many key routes, giving them significant market power. But their financial difficulties have limited them.
  • Risks to the Moat:
    • Technological changes and changes in consumer expectations can affect brand loyalty.
    • External economic and political pressures can erode cost structure.
    • Increased competition from low-cost carriers and airline bankruptcies, as seen in the past, can affect profitability.

Business Resilience:

  • The business has some strong areas of resilience. There are high barriers to entry in the airline industry, which makes it hard for new competition. The company is also well integrated into Latin America and has a considerable presence in its key markets.
  • However, the company’s high operating leverage makes their profitability very volatile in downturns, and they can be severely affected by macro factors, and a volatile economic landscape.

Understandability:

  • Rated a 3 out of 5, LATAM’s core business model is relatively easy to understand, as they mainly rely on selling tickets for flights and also on carrying cargo. However, understanding all their financial numbers and different risks is very challenging given the numerous segments, subsidiaries and external economic influences.

Balance Sheet Health:

  • Rated a 2 out of 5, the balance sheet for the company is relatively weak with high net debt and equity of -1.6 billion dollars. It has had years of heavy losses, which has severely impacted it’s asset base. The company has restructured its debt, which is a positive sign, but its dependency on debt financing for operations increases risk and uncertainty.