Grab a cheap flight to the Philippines

Until a couple of years ago, the Philippines was a market that most foreign investors happily gave a miss. It was a backwater, famous for being open only half the day (to lunch) and a place with which a leading Western investment bank was so displeased after the Asian financial crisis in 1997/98 that it sold its brokerage operations for a song to its local management.

During my Asian studies, we spent an awful lot of time trying to figure what went wrong with the Philippines. How had one of the richest countries in the region in 1960 turned into the basket case of the 1990s?

Today, the opening hours are mostly on par with the rest of Asia, and foreign investors haven been queueing up to get a slice of the new Philippines. The catalyst for change was the election of Benigno Aquino III (‘NoyNoy’) as president in mid-2010, which ushered a new optimism in tackling corruption and kick starting a programme to upgrade a chronically poor infrastructure system.

The other big catalyst has been emergence of the Association of Southeast Asian Nations (Asean) as a new trade bloc. The explosion in multilateral trade and investment in this region helped the economy grow 6.8% last year. And foreigners have invested almost $1.7bn so far this year, a great endorsement given that most Asian markets have registered large outflows.

Cebu Air Inc (CEB.PS) is a great example of the kind of stock that is benefiting from these catalysts. The leading low-cost carrier in the Philippines, it is trading on a low valuation despite very, very healthy growth prospects. It’s companies like Cebu Air that offer British investors the opportunity to tap into fast growing economies at a cheap price.

And to be honest, I think companies like this – the ones thriving on the growing interdependence of the Asean economies – give you the chance to make returns that could dwarf anything available in Britain today.

A very buoyant carrier industry

There are several reasons why I think this low-cost carrier industry looks promising. A few simple facts will illustrate this…

First, there are nearly 100 million people living on 7,000-odd islands with an inadequate infrastructure in the Philippine archipelago. So airlines are the most efficient mode of transportation.

Second, with an average age of 23, many people are flocking into the big cities in search of better education and job opportunities. Many are finding jobs in a robust outsourcing industry – where its English-speaking population is competing with India’s own business processing industry.

Third, the country is famous for having sent their skilled and semi-skilled workers worldwide – from hospitals in America to oil fields in the Middle East, maids in Hong Kong and seamen plying the global maritime routes. Many of these workers make frequent trips home to stay in touch with their families and friends.

Fourth, located in the heart of Asia, the archipelago nation has a nascent tourism industry that has great growth potential. The market based on flights within operating range of Manila is four billion people – more than half of the world’s population.

Cebu Air looks very promising

Cebu Air Inc, the country’s largest airline by seat capacity and the third largest low-cost carrier in Asean after Lion (Singapore) and AirAsia (Malaysia) looks particularly interesting.

As broker Maybank ATR Kim Eng points out, “it is the only Philippine airline that is profitable. It has the largest market share, most efficient operations, youngest fleet, lowest unit cost, arguably the best service and it is popular among Filipinos.”

The stock trades on an undemanding 8.5 times 2013 earnings, a 30% discount to its historical average and is the cheapest listed low-cost carrier in Asia.

The low valuation is due to the fact that in 2010, the carrier reported strong earnings triggering the entrance of two regional low-cost carriers resulting in two years of losses and intensive competition.

Not any longer.

This year the number of low-cost carriers has been reduced from five to three and one hybrid carrier, helping Cebu to report strong first quarter earnings. BoA Merrill Lynch forecasts an average 30% a year recurring earnings over the next three years fuelled by strong demand, less intensive competition and stabilising fuel costs.

The earnings could increase if the negotiations about increasing flights between Japan and the Philippines are successful, as Cebu has only a 3% market share on these routes.

The icing on the cake is that it is a potential takeover candidate. Foreign airlines capitalising on the Asean Open Skies agreement (a single aviation market for the region) in 2015 would find it easier to acquire an existing operator given the poor infrastructure and limited landing slots.

Obviously there are serious risks here. Whenever you buy an airline stock, you run the risk of higher fuel costs. And of course, an economic slowdown in the region – though unlikely – could hurt spending on air travel. This industry can be subject to irrational competition and policy mistakes. But I do think Cebu Air looks like an interesting play on the new Philippines. And while it’s not among my recommended buys in my Profit Hunter portfolio – I have several other tourism stocks that I prefer – there is serious potential for a big return here. This is one worth keeping an eye on.