Grupo Aeroportuario Del Sureste (ASR-NYSE, $155.54). Strong Q2 Cost Control Fully Offset by A Terrible Mexican Macroeconomic Overhang.

Q2 earnings were fine. A reduction in capital spending and stringent cost control has served to produce a record Q2 EBITDA margin of 67.5%. Net liabilities were reduced by more than 28% YOY. That’s the good news. Now for the bad news.

1. International passenger traffic heading into Mexico, specifically the Mayan Riviera region of the Yucatan peninsula, and that represents the main driver of retail revenues at the Cancun airport were essentially flat, and that’s the first worry. Whether this is a shorter term blip, or a potential end of a trend, for a host of reasons that are completely outside of the control of ASR, bears monitoring closely.

2. ALL Mexican businesses now have an “AMLO” problem; the president of Mexico (Andres Manuel Lopez Obrador, or AMLO for short) is clearly considered by business to be a leftist nut. In terms of actions, President Obrador has done nothing to assuage any fears since taking office. His first official move was to cancel a partially completed contract to build a new Mexico city airport.

The very recent recent departure of AMLO’s finance minister, considered to be a voice of reason, in a public huff, makes anyone with Mexico business or investment interests rightfully concerned. At the top levels of Mexican government, there is no clarity on business policy; everything done is accomplished on a series of one-offs. Recent Mexican GDP forecasts have fallen to levels consistent with stagnation, not expansion and there is growing uncertainty over both fiscal and monetary policy at the domestic level.

Specific to ASR, my fear is that that the presidents next pet project, the widely touted “Mayan Train”, a new rail line to serve the Mayan Riviera and the Yucatan peninsula, will be so costly, and sufficiently underfunded, that private companies, including ASUR, might get arm-twisted into providing funding for a potential white elephant, or else suffer severe consequences in reprisal. Given the relatively low forecast passenger count estimates for the train, there is no carrot for a private firm to be involved in any component of the Mayan train project. The sticks that could be employed by AMLO to coerce ASR into some funding agreement would be via some sort of chocked up referendum designed to pry the Cancun airport concession from ASR if management does not go along with train funding; alternatively, a punitive tax could be rolled out. There are an immense number of tools in AMLOs arsenal to force private firms to go along with his whims and limited protection under Mexican law. Since AMLO proved capable of scuttling the Mexico City new airport, managed by Carlos Slim (the wealthiest industrialist In Mexico and a global force) just what hope a much smaller operator have of offsetting the arbitrary contrivances of the current president?

Think tank warns of potential for a huge cost overrun on Maya Train

3. An important secondary issue is the persistence of massive sargassum blooms, stretching almost unabated throughout the entire Mayan Riviera coast. This unsightly seaweed (it is actually an algae) emits a sulphurous odor and can render even the most pristine beach unusable. The 2018-2019 outbreaks seem to be an ongoing issue; even long term visitors to the Mayan Riviera are sufficiently put off by the condition of many beaches, to the point that alternative holiday plans are being contemplated. Sargassum outbreaks exacerbate as ocean temperatures increase. There is no feasible resolution in sight to the issue and continued sargassum issues might have an impact on the 2019-2020 high season for international tourism.

4. A point to monitor in the coming year is the increased cartel violence along the Mayan Riviera. On the Pacific coast of Mexico, violence has abated somewhat; in all likelihood one of the organized crime cartels has beaten rival cartels into submission. This is not the case in the Yucatan; several drug cartels, based on anecdotal reports, are escalating their turf wars. Until a victor is declared, increased public violence is likely to be noted. The negative impacts on international tourism of increased violence is always an overhang.

ASUR is a well run company and is continuing to report record revenues and produce record EBITDA. That is the business case for continued ownership. If ASUR was not for operating in a country featuring a quasi socialist president, one that could revoke an airports license to operate, in one second, on a whim, if its key business market wasn’t located in an area of Mexico featuring increasing cartel violence in the Mayan Riviera, if the seaweed wasn’t so bountiful that that even an army of beach cleaners cannot keep up (sargassum is so stench ridden that tourists equate it to sewage waste), all of which are clearly outside of ASUR’s ability to control, or even predict, the stock price would look quite tempting on a historical valuation level.

The macro issues in Mexico are clearly capping potential for upward momentum from operational improvements, at this time.

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