Azul: Prepare For A Long And Painful Recovery (NYSE:AZUL)

Since the publication of our initial article on Azul (AZUL) back in May, the company’s stock increased by around 10%, and currently, it continues to trade in a distressed territory, way below its pre-COVID-19 levels. Considering the latest developments, it seems that bankruptcy is off the table and the worst-case scenario for the airline is no longer in play. However, Azul will continue to burn cash on a daily basis and will not become profitable anytime soon. With an improved liquidity position, we’re shifting our stance on the company from “Bearish” to “Neutral”, since there’s every reason to believe that Azul has more financial flexibility to survive the pandemic in comparison to its Brazilian counterpart Gol (GOL), which might go under at any time. Despite this, the recovery to its pre-COVID-19 levels for Azul will be long and painful, and for that reason, we stick to our opinion that it’s better to look for stocks with a more attractive risk/reward ratio.

Major Developments

Recently, Azul announced its Q2 earnings results, which disappointed investors. From April to June, the airline’s revenues decreased by 84.7% Y/Y to R$401.6 million, while its GAAP EPS was -R$8.45, both below the Street consensus. Azul also reported that its cargo revenues were down 0.8% Y/Y, while its total net loss was R$1.5 billion. Despite such a loss, Azul cut its workforce salaries by 48% and implemented several cash preservation measures, which should lead to R$7 billion in savings from March 2020 to December 2021. The airline also ended the quarter with R$2.3 billion in cash and its total liquidity stands at R$6.6 billion, which includes maintenance reserves, unencumbered aircraft, and investments. The management was also able to renegotiate payments on its aircraft leases, and as a result, its lease payments will be down 77% from the original agreement until the end of this year. This will help Azul to have up to R$3.2 billion in working capital relief, and at this stage, the airline has enough liquidity to survive at least until the end of 2021 at the current cash burn rate.

The airline also continues to negotiate with the Brazilian government about the additional injection of liquidity. According to various sources, Azul could receive a loan of up to R$1.2 billion from the Brazilian development bank BNDES and an additional R$0.8 billion from the private sector. However, the aid will come in the form of convertibles and a fixed interest rate loan, which will increase the airline’s already high debt load.

Another downside of this is that there’s no guarantee that the airline will receive the exact sum of R$2 billion and it’s also unlikely that any funds will be wired in the near term. The talks have been ongoing for more than five months already and no deal has been reached yet. At the same time, even if the deal will be reached anytime soon, the funds are not going to be wired at least until late September. Here’s what Azul’s management said about the possibility of receiving the state aid:

We’re still waiting for corporate to come back, there are some green shoots from corporate, but we can’t guarantee.

Considering all of those developments, we’ve shifted our stance on the company from “Bearish” to “Neutral”.

Limited Upside

Going forward, Azul is still going to face several challenges, which will limit its upside. First of all, Azul will continue to be exposed to the poor state of the Brazilian economy. As the country continues to be the major epicenter of the pandemic in Latin America, its annual GDP is expected to decline by 5.1% this year, while its currency already depreciated by more than 30% to the United States dollar since the beginning of the year. Considering that the majority of Azul’s debt is dollar-denominated, the depreciation of the currency is a negative development for the airline. At the same time, the airline has $3.55 billion (~R$19.25 billion) in total debt. While capital leases, which were deferred, account for the majority of that debt, Azul will be required to pay higher rates on those leases from 2023 and beyond. For that reason, the major rating agencies continue to have a negative outlook on the airline and give it a junk rating.

Despite having one of the most sophisticated route networks in Brazil, Azul’s upside right now is limited. In July, the air travel was still at the distressed levels and the airline’s air traffic was down 77.1% Y/Y, while its capacity was down 75.7% Y/Y. In August and September, Azul’s capacity will be down over 60% and 50%, respectively, and by the end of December, it will still be down 40% Y/Y. At the same time, Azul will continue to burn R$3 million per day and the Street doesn’t expect the airline to become profitable in the next couple of years. For that reason, Seeking Alpha’s quant rating has a bearish view of the company.

Source: Seeking Alpha

Considering all of this, it’s safe to say that Azul is a speculative investment at this stage. While the airline thrived before the pandemic, its recovery to the pre-COVID-19 levels will take years. By preserving cash and deferring expenses, Azul is not going to become bankrupt anymore, but we stick to our opinion that it’s better to look for other investments with a greater upside and a more attractive risk/reward ratio.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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