GOL: Fuel and forex concerns ahead of earnings

Brazilian low-fare air carrier Gol Linhas Aéreas Inteligentes (GOL, quote) is set to report earnings on Thursday after the bell. The airline will be looking to improve upon last quarter’s 516.5 million reais ($293.3 million) loss.

Last week, Gol’s management indicated that load factors will rise this fiscal year to 71-75% from 68.8%. Further, Gol claimed that yields would also rise compared to last year after a brutal fare war with domestic competitor TAM (TAM, quote) seems to have subsided. Although Gol’s management predicts that domestic aviation growth will slow to between 7-10% annually (from 15.72% last year), Gol still expects to return to profitability for FY 2012. 

Some analysts are less confident in Gol’s short term prospects. Bank of America Merrill Lynch analyst Sara Delfim “maintain(s) a skeptical view on profitability in the short term, as visibility on cost control and reduction remains very low.”

As of January, Gol’s market share decreased from 37.4% to 34.1%. Including its recent acquisition, Webjet, the total increases to 39%, below the 41% share of TAM. The loss of market share is a result of increased share by newer airlines like Azul and Avianca to the detriment of entrenched carriers like Gol and TAM.

Like its competitors in the sector, Gol is adversely affected by rising fuel costs. Gol’s management informed investors that it is 40% hedged for the next fiscal year.  However, as long as oil prices remain elevated, the entire sector will likely remain under pressure. 

If its primary competitor is any indicator, it is possible that Gol could incur foreign exchange losses this quarter. When TAM reported earnings a few weeks ago, the carrier claimed that “a weaker currency pressured costs.” Given that 60% of Gol’s costs and 80% of its debt are dollar-denominated, last quarter’s weakness in the real could impact Gol’s quarterly earnings

Over the long-term, Gol’s equity price will face pressure until it ameliorates its potentially problematic debt profile.  Gol’s net debt is 2.6 billion reais ($1.5 billion), or roughly eight times its operating earnings over the previous twelve months. This is substantially larger than TAM’s ratio of roughly five times its operating profit. 

It’s not all doom and gloom for Gol. The company could benefit from a number of medium-term positive catalysts. The company just announced its intentions to serve the United States, an expansive code-sharing agreement with Delta (DALquote), and plans to lease brand new 787s for intercontinental service.

Gol’s merger with competitor Webjet will afford Gol significant newtork synergies, in addition to more coveted landing rights at some of Brazil’s slot-controlled airports, like Rio de Janeiro’s downtown Santos Dumont airport

In regards to longer term trends, Gol will continue to benefit from Brazil’s rapidly expanding middle class, as well as the increased travel demand during the 2014 World Cup and 2016 Rio de Janeiro Olympics.

GOL’s shares have fluctuated massively over the past year. The stock is down roughly 35% year-over-year, but up a little over 60% from its October lows. However, the stock remains expensive, with a forward P/E of 26.0 compared to TAM’s forward P/E of 15.3.

Going forward, positive catalysts like improving yields and international expansion are likely to be outweighed by larger short-term concerns such as potential foreign exchange losses, higher than expected fuel costs, and loss of share to newer carriers.

Estimates for this quarter vary greatly, with analysts predicting as high as a 22-cent profit and as low as a 17-cent loss.

Barring a major upside surprise, traders of GOL could experience some turbulence ahead.   

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