Tam Upgraded on Market Strength - Analyst Blog

We upgrade our recommendation on TAM S.A (TAM) from Neutral to Outperform.

The company foresees a strong and growing market in 2012 and hence strives to remain focused on its efforts to increase the company’s profitability and yield. The company continues with its effort to emphasize the importance of increasing the number of flights, destinations and connections among high-demand flight stoppages, thereby establishing strategic partnerships and agreements with market leaders. This, we believe, will sustain the company’s position in the competitive market and boost revenue for the coming quarters.

TAM’s fleet development and renovation programs along with restructuring old operations have been consistently increasing efficiency. Recently, TAM made a change in its fleet plan, anticipating 157 aircrafts by the end of 2012, instead of 159 anticipated in August 2011. Such restructuring measure has been targeted by the company to control cost, avoid overcapacity and expand revenues with better load factors, going ahead.

With a strong future outlook, management estimated that the trips from and to Brazil will remain high in demand in 2012, especially due to Brazil’s momentum in the global economy. In the domestic market, the expansion in the number of passengers, which started a couple of years ago, is expected to continue.

With this backdrop, the company continues to emphasize on investment across all market segments through enhanced economy travels, easy availability of credit for retail products like air tickets which are strategic approaches to improve profitability.

TAM’s net revenue improvement during the fourth quarter of 2011 was based on rising passenger demand across the company’s domestic and international route network. The upside domestic and international load factor also portrayed rising international market share. Such strong net revenue and load factors appear encouraging and we expect EPS to reach $1.07 in the first quarter of 2012.

However, over the past few months, worldwide economic growth has been dwindling, with a sluggish pace of GDP growth in Europe and US, leading to slower-than-expected business activity. Under such circumstance, we are concerned about the potential risk of fall in customer demand, which is a function of the weak economy. Such fall in demand could adversely impact expected revenues and earnings for the upcoming quarters.

The company is exposed to market risks arising from its normal business activities, principally related to changes in interest rates, exchange rates or aviation kerosene. Such variations can negatively affect its cash flows and future expenses. Volatility of fuel price poses one of the most important financial risks for the airline companies, which may affect its top-line results.  Moreover, a possible appreciation or depreciation of the Real against the U.S. dollar may impact the company’s financials.

It may also be noted that the aviation industry faced repeated accidents. This has revealed inefficiencies and problems at all levels of the industry, such as insufficient airport capacity, few air-traffic controllers, antiquated air-traffic equipment, inadequate runways, unclear regulatory authority—to mention a few. Such infrastructural crisis may affect flight operations while negatively impacting results.

However, hope remains, as the company strives to sustain its competitive position with increased number of flights, destinations and connections.

TAM S.A., operating through its subsidiaries, TAM Linhas Aéreas and TAM Mercosur, is a renowned air transportation services provider, both in the domestic and international markets. TAM competes directly with its peers, such as AMR Corporation and GOL Linhas A (GOL). The company has a Zacks #1 Rank, which translates into a short-term Strong Buy rating (1-3 months).