Description
One-liner recommendation: Buy TAPTRA 5 5/8% '24s at €93 for a relatively uncorrelated 15% one-year total return (18% for USD-denominated investors) to likely €101 make-whole takeout in October 2023.
Recommendation: Long TAP (Bloomberg bond ticker "TAPTRA") 5 5/8% '24s, offered this morning at €93 (9.5% YTW, +740 OAS). US investors currently pick up an additional 300 bps of yield from euro to dollar hedging (assumes rolling three-month forwards; see Bloomberg FXFA screen), driving dollar denominated yields to 12.5%. TAP just started non-deal roadshows and intends to at least partially redeem its unsecured '23s and '24s within the next 12 months.
Investment thesis: Over the last two years, TAP received €3.1bn of restructuring and other emergency aid and effected deep and enduring cost cuts that leave it significantly better competitively positioned than it was pre-covid. Much of the European Commission's final decision is redacted, but one of its key elements, which we have confirmed with TAP management and which management has discussed on recently quarterly earnings calls, is a requirement for TAP to test the market to obtain new financing with or without state guarantees. TAP has approval from the Portuguese government to issue up to €300mm with 90% state guarantee. Just earlier this week, TAP launched a non-deal roadshow and is currently meeting fixed income investors in London, Paris, and Frankfurt.
Despite current high yield market turmoil, I think it is highly likely TAP can complete this 'test raise' on terms acceptable to the company, and will likely seek to repay a majority of its 4 3/8% unsecured bonds maturing June 23, 2023 (€200mm outstanding) and a meaningful portion of its 5 5/8% '24s (€375mm outstanding). The current make-whole on the '24s is €105.4 but with benchmark bund forwards higher, should drop to €101 by October 2023.
First, TAP is already seeing the benefit of cost cuts and lease renegotiation in its cost structure. TAP is the only airline of ~10 I cover that has both cut adjusted CASK ex-fuel and grown unit revenues (PRASK) from 1H'19 to 1H'22. TAP generated adjusted EBITDAR of €157mm in Q2 and €231mm YTD, up 24% and up 75%, respectively from 2019 levels. At €675mm of EBITDAR for the full year (up 28% y/3y) TAP will generate €80mm of FCF. I have EBITDA up slightly in 2023 and 2024 with passenger yields down 4% and flat, respectively, and with CASK ex-fuel increasing to greater than 2019 levels as draconian salary cuts roll off, based on Brent crude averaging $90 and $85/bbl, respectively. FCF will be pressured slightly relative to 2022 as TAP begins to make lease deferral payments but should remain comfortably positive.
Second, TAP has €890mm of cash on the balance sheet as of 6/30 and will receive the final €990mm of state aid in Q4 of this year, leaving it with roughly €1.3bn of excess liquidity relative to its 2019 ending cash balance of €500mm. TAP, like other airlines, will likely maintain higher minimum liquidity levels post-covid but could have €800mm available for debt paydown even with €1bn of minimum liquidity.
TAP's total financial debt (ex-leases) is €934mm as of 6/30, but TAP has no incentive to prepay €360mm of that (€117mm of private bonds with a 3.873% coupon and 2034 maturity and €242mm of low cost local bank debt). Thus, a full takeout of the 2023s and a takeout of the majority of the 2024s before they go current in December 2024 is likely.
Swapping euros to dollars picks up 303 bps of annualized yield assuming a dollar denominated investor rolls three month hedges (see Bloomberg's FXFA), 244 bps assuming one year term, and 200 bps to lock in for two years. The dollar yields below assume an investor hedges for three months and rolls, and assumes a constant 303 bps yield pickup.
Key links:
Brief background/situation overview: TAP is Portugal's flag carrier. The Portuguese government owned TAP until 2015, when JetBlue founder David Neeleman and Portuguese entrepreneur Humberto Pedrosa bought a 61% equity stake through their Gateway consortium. The parties subsequently renegotiated the economic/voting rights so that by June 2017 the Portuguese government owned 5% economic/50% voting, Neeleman/Pedrosa owned 90% economic/45% voting, and TAP employees owned 5% economic/5% voting stakes. In mid-2020, the Portuguese government loaned TAP €1.2bn (later converted to equity), and as part of the deal took its ownership to 100% of the company, squeezing out Neeleman. That loan was the first component of an eventual €3.1bn rescue package approved by the European Commission in December 2021 (see Commission press release).
Overall, TAP received €1.2bn in 2020, €1bn in 2021 (restructuring aid and "covid damages compensation"), and will receive €990mm in Q4 2022. In exchange for the aid, TAP agreed to cap its fleet at 99 planes (vs. 105 pre-covid), to give up 18 of its slots, and to forego M&A and advertising related to Portuguese state support through 2025. TAP will restructure its Airbus-based fleet such that its share of fuel efficient neos will rise from 66% to 88%, with an emphasis onn longer-range aircraft that will deliver lower unit costs and enable the company to capitalize on its position as the effective gateway to Lisbon from North and South America.
The slot give-up should have a minor impact. TAP has >300 slots in Lisbon; it will give up 18 to easyJet, and TAP was able to negotiate the slot give-up so they were not concentrated in peak hours.
The restructuring allowed TAP to accelerate its fleet modernization, renegotiate aircraft leases, and significantly cut labor costs (TAP cut headcount by 23% and cut labor costs by 44%, with cuts focused at the exec level). TAP will enjoy a labor cost advantage as it operates under emergency agreements for the next four years, or until it negotiates a new collective bargaining agreement.
Cap table, financial model, and other exhibits:
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
High yield market test currently under way