While many investors are loth to invest in airline equities, by employing a pair trade, investors can mitigate some of the inherent risk associated with aviation companies. Like in any other sector, it’s always a good idea to be long a thriving company and short a struggling one when creating a pair trade.
The pitfalls of investing in airlines – especially ones from developed countries – are well known: high labor costs, volatile fuel prices, and fluctuating demand, to name a few.
However, some emerging market airlines are able to avoid these unattractive facets of airline investing. Panamanian carrier COPA (CPA, quote) has been able to be consistently profitable while providing decent service and keeping low labor costs low. The company’s hub in Panama City is ideally locating to serve connecting traffic between North, Central, and South America, a rapidly growing market. Because the company generates income from dozens of countries, COPA is not overly exposed to a single currency. At a forward P/E of around ten, COPA offers good value.
On the other hand, Brazilian low-fare carrier Gol Linhas Aereas Inteligentes (GOL, quote) does not benefit from the same advantages that COPA does. Competition in the Brazilian domestic market is fierce; while observers had hoped that the consolidation from GOL’s merger with Webjet would see more airline profitability, AviancaTaca’s expansion and concomitant rising market share ensured that the Brazilian market remains as competitive as ever.
As a result, GOL has had to shed capacity in order to maintain profitability. According to reports from Brazil, this strategy has yet to pay dividends; GOL’s planes are flying with only a 64.9% load factor, well below market leader LATAM (LFL, quote) at 75.1%. Furthermore, labor costs are rising, GOL is overexposed to a weakening real, and the company has little exposure to more lucrative international routes. As the company contracts, it’s hard to see a scenario in which the company returns to profitability over the next few quarters.
Fundamentally, COPA appears better positioned to move higher than GOL; technically, the Panamanian carrier is also in a superior position. COPA is currently holding around its 52-week high. If the stock can make a new high, COPA could move significantly further higher.
Conversely, GOL is in a short-term downtrend, hovering just above its 100-day moving average; a technical breakdown could see the stock fall much lower.
Savvy traders should consider putting on this pair trade. Traders can take advantage of a well-run company with an attractive valuation by going long COPA while shorting a less fundamentally sound company in GOL without worrying about being overly exposed to the pitfalls of the airline industry thanks to the long/short nature of a pair trade.