GOL Linhas Aereas Inteligentes SA - GOL

I have responded to a few queries on what’s my approach to “research” as a retail investor and if I can share my research on the stocks I “track” or own. In response, I have decided to share my research on specific stocks in this blog as and when time permits. I will start with my largest holding ELOS and the international company that fascinates me the most, GOL (though arguably ELOS is international to – an Israeli company that I happen to “track” under a small-cap Medical Appliances and Equipment category.

GOL Linhas Aereas Inteligentes S.A., (GOL) provides airline services on routes between the cities of Brazil. It offers approximately 350 daily flights to 42 business and travel destinations in Brazil and Argentina. As of June 30, 2005, the company operated 34 single-class Boeing 737 aircraft serving 39 destinations in Brazil and 1 destination in Argentina. GOL Linhas Aereas Inteligentes is headquartered in Sao Paulo, Brazil.

GOL which is growing incredibly rapidly began life just a few years ago as the brainchild of a Brazilian bus company. They are copying the early moves of Southwest Airlines very closely - they fly all Boeing 737's so far to standardize training and maintenance and keep costs lower, they are doing a great job of cost containment, and they fly direct routes to where people want to go. It's smart to follow the lead of the most successful airline in the Western Hemisphere, and in doing so they have grown their traffic rates more than 50% in the last year.

GOL is basically an amalgam of JetBlue, Southwest Airlines, RyanAir and the other successful low cost airlines, but it's in Brazil. They are taking the best features of many of these budget airlines that have revolutionized western air travel and combining them into one service that is dramatically changing air travel in the largest country in South America and looking to expand to all of Latin America. But they have also moved beyond that SWA model quickly in one significant way. They are aiming to become not just the airline of choice for Brazil, but for international and domestic flights throughout South America. They have started nearby, with Bolivian and Argentinean flights, and they are even moving into Mexico with a franchise deal has caught some attention as well (though there's plenty of low-fare competition likely in that country, for sure).

GOL is still quite small and an upstart in its home country -- they operate about 400 daily flights and have a market share of around 30% at the moment, but it looks like a great story. The airline was founded by the Oliveira family, which owns and operates a large intercity bus system in Brazil, and this is clearly a family that understands how to build and run a business to move a large population.

The key for me is that GOL is growing quickly and, with the limited amount of research I've done so far on South American air travel, they've got the chance to really become a dominant force given the way they've hit the ground running. So what's keeping me? The stigma associated with investing in any airline given the way the US fliers have performed, and they've already grown and seen their stock appreciate very quickly - it's trading at a PE of about 30, which is not cheap for a Brazilian stock. Bu I do like their growth and their remarkably low cost structure, and the fact that they're not very well followed here in the US – well until recently. Of late they have definitely started to catch the world's attention with their excellent returns, and the number of US analysts on their earnings conference call has gotten significantly higher.

GOL is growing at well over 50% a year and still building out with massive plane orders in place, and they're just starting to tap into debt financing. Recent development suggests that GOL is partnering to bring its model to Mexico. They added routes to Bolivia several months ago ... then Paraguay, Uruguay, and Argentina were announced just in November.

The Bull case for GOL:

--They're following an established strategy, albeit one that hasn't been tried in many countries, in basically mimicking the successful low cost airlines with good service, low frills, and great prices.

-- They are changing the marketplace - not content to just operate a business to serve existing customers, which in Brazil might have been profitable given the significant amount of business travel, they're bringing in people who've never flown before, putting them on their first airplane, and building a big customer base. Like the "Southwest Effect" before them, they're calling this the "GOL Effect" - it's now cheap enough for lower and middle income Brazilians to fly when they never would have considered it before. One of the smart things they are doing is flying a lot of cheap overnight flights - using planes that would be otherwise sitting on a runway and selling much cheaper flights for those unfriendly hours, thereby bringing still more fliers into the market.

-- They have massive insider ownership. Regardless of their actual night flights, this is not a "fly by night" company that will try to take advantage of the hot environment for Brazilian stocks and then disappear. The founding family's company owns roughly 75% of the shares and they're trying to build a business that will stand the test of time and revolutionize South American travel.

-- They have huge advantages over comparable US airlines in cost control. I admit that I still suffer from the admonition "never buy an airline" but GOL seems different. Price controls from the government through Petrobras allow them to have much lower fuel costs than most of the rest of the world. A dramatically different operating environment allows them to provide world class service at developing world salaries without nearly the legacy costs of their competitors -- so their pilots, for example, make about $35,000 a year versus over $200K at Southwest. And unlike the bankrupt Varig, the flagship airline in Brazil, they don't have the same kind of legacy costs as the US carriers. That means they can operate at a profit even while charging rock bottom ticket prices -- right now, the operating margin for GOL is 37%, which blows every other airline I've ever heard of away.

The Bear case for GOL:

-- Currency risk with the recently appreciating Real (R$)

-- Political risk with the leadership scandals and just the general emerging market risks that we take on when we invest outside the established western investor world.

-- Varig, the current flagship carrier of Brazil and GOL's largest competitor seems to be finding its way out of bankruptcy. Varig has been faced with very similar problems to the US flagship carriers in the past couple of years, including a legacy of heavy regulation, huge labor costs, and large liabilities and big debt on the books. There is some risk that their bankruptcy will enable them to dramatically cut costs, as some of the big US carriers have done, which theoretically would enable them to move more toward the low fare model that GOL has followed to great success. Just a remote risk, given US Airways is not a viable competitor for JetBlue and Southwest today, even though they've been through bankruptcy twice! :-)

-- Government regulation of the airline industry was a significant issue 20 years ago in the US, and it can certainly be argued that the removal of regulatory controls dramatically changed the landscape and brought real competition and allowed new entrants to grow into the marketplace, making air travel much more feasible for all Americans. Brazil is not about to deregulate its airline industry, as far as I can tell. The governmental philosophy is dramatically different -- as evidenced by the controlling stake the government holds in Petrobras, the big oil company. The government is committed to letting private enterprise grow, but in my opinion it is also very concerned about directing growth in their economy. The focus on overall steady growth and the lack of a truly free market means that GOL’s competitive picture should remain relatively steady. GOL now has a significant edge over the small upstarts that might fly a dozen or so routes and who want to build their business -- GOL is now an established company with 400+ flights a day, and they can certainly make a stronger argument for their ability to effectively manage additional routes than can a very small and, in most cases, financially unstable competitor. So the way I read the regulatory landscape in Brazil (and I'm no expert on this topic), GOL has some protection from smaller carriers that might try to horn in on it's routes by buying market share with even lower prices, because the government doesn't want to see that kind of instability (prices moving dramatically up and down, small companies betting the farm on their ability to buy market share until they run out of money. Compare with Independence Air for the US version of this cautionary tale).

-- The biggest bear case would be the discussion of if I have sat and watched this too long and if it has already had its run and I am too late for the party. This stock would be a case for Buy High, Sell Higher and is not really “value-priced” (unlike another stock I will blog on today – ELOS)

The reason my interest has really perked up lately, in spite of the excellent run GOL has had:

-- GOL just increased their guidance for 2006

-- Petrobras, which controls prices for oil in Brazil under governmental guidance, just cut jet fuel prices by 5.3%, according to both Investors Business Daily and Marketwatch articles on Feb 15^th. So this aids in GOL’s relatively cheap jet fuel in Brazil, where they do most of their fuel consumption and where prices were already well below international market rates.

Disclosure:

Position: None, but bullish on GOL and looking to buy some on any pull back.

Last Updated: February 20^th 2006

SeekingAlpha: This blog also appears in the Transport Stock blog of SeekingAlpha at http://transportstockblog.com/article/8729