LAN Airlines: Flying high on Chile

by Jack Adamo, editor Insiders Plus

I’ve been enthusiastic about Chile ever since I started looking into it a few months ago. It has had some of the most consistent growth in the world over the last decade and its government has the highest rating for honesty of any government in South America.

Our latest recommendation, LAN Airlines S.A. (LFL), serves 76 destinations connecting Latin America to North America, Europe, and the South Pacific, as well as 93 additional international destinations through various code share agreements.

It has strategic alliances with American Airlines, Iberia, and Qantas. Though the stock’s capitalization is a solid $9 billion, it is still a relatively small company.

As of June 22, 2011, it operated a fleet of 123 passenger aircraft, as well as 14 dedicated air freighters. It was founded in 1929 and is based in Santiago, Chile.

When I first looked at management’s explanation of its 2011 drop in profits, it sounded like "My dog ate my homework." Two of the three big rises in cost seemed pretty far-fetched.

One was a volcanic eruption and the other was an earthquake. Okay, it’s Chile, so the earthquake isn’t so unexpected, but volcanic ash?

As it turns out, volcanic ash from an eruption in the south of Chile, actually did hinder air traffic during Q2 and sporadically afterward.

The ash affects not only visibility, but engine safety because of the potential for fouling the jet intakes. Flights had to be cancelled and many more had to be rerouted at higher fuel costs.

In addition, the company took the high road and made good to its passengers on cancelled flights. I think LAN’s policy created a lot of goodwill with its customers. The estimated cost was $37 million.

Disaster movie number two, the earthquake, caused some cancellations and damaged the airline’s main terminal for an overall hit to earnings of $30 million.

A $588 million rise in fuel costs and one-time expenditures for an acquisition all added up to a perfect storm to downgrade LAN’s profits for the year, yet net income only fell $120 million to 94¢ a share.

Analysts expect $1.32 in profits for 2012. The forward P/E of 21 is high for my taste, but the company has a great track record.

The stock is up 30-fold in the last decade and despite last year’s troubles is only 10% off its all-time high. Moreover, it has doubled from its pre-2008 crash price.

The current dividend is only about 2% but its compound annual growth rate for the last 8 years has been 21%.

Some of that was undoubtedly helped by the strengthening of the Chilean Peso against our greenback, but that long-term trend should continue, albeit with occasional counter-trends.

With the P/E this high, obviously this is not a stock for the faint of heart, but I think there’s a lot of long-term value here.

In February, the stock broke into the usually bullish "golden cross" of the 50-day moving average above the 200-day. Because of general market conditions, however, we will start with only a small position. Buy LAN Airlines up to $31.

Learn more about this financial newsletter at Jack Adamo's Insiders Plus.

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