Azul Bond Returns Diverge After Airline Strikes Creditor Deal

Published 5 December 2024, 17:06:33.699 GMT

By Giovanna Bellotti Azevedo

(Bloomberg) -- Azul SA executives have maneuvered all year to keep the troubled Brazilian airline out of bankruptcy protection, handing investors holding its stock and most of its debt some of the worst returns in Latin America. But one of its securities is emerging as a surprise winner.

The dollar bonds that mature in 2028 have handed investors returns of 5.3% this year, including coupon payments, outperforming the average for Latin American airline debt and blowing away the losses for its stock and other bonds.

The reason: deals with bondholders and lessors will slim down Azul’s balance sheet and remove the imminent risk of filing for Chapter 11. The 2028 bonds are senior to most other debt, meaning that if a recent financing deal goes through those bondholders will be paid at par. The notes trade at nearly 101 cents on the dollar after the recent rally.

It’s a rare bright spot for one of Latin America’s largest airlines, which has struggled with high debt levels and the impact of a weak Brazilian real. After being hit with losses earlier this year, the company expects to generate earnings and cash in 2025.

Ian Snyder, an analyst at JPMorgan Chase & Co, said Azul can significantly reduce debt levels through its agreements with creditors, aircraft lessors and parts suppliers.

“A band-aid can become more transformational,” he wrote in a note. JPMorgan maintained its overweight on the first-lien debt, given strong collateral coverage and protections for investors.

Representatives for Azul didn’t reply to messages seeking comment.

Azul expects to close the deal in the first quarter of 2025, completing the debt-for-equity swap of the 2029 and 2030 notes, executives said during an earnings call with analysts. It was considered a default-like transaction by ratings agencies.

Second-lien bonds due in 2030 are handing investors a loss of 21% year-to-date — the worst this year among corporates in a Bloomberg index of emerging-market debt.

The financing deal, inked in October, allows for as much as $500 million in new senior secured debt, as well as a “collaborative” effort to improve cash flow by $100 million per year, according to filings. If that goal is reached, as much as $800 million of existing debt may be converted into shares.

That came on top of a crucial deal with lessors and parts suppliers that allowed Azul to reduce its debt by 3 billion reais in exchange for 100 million new preferred shares.

JPMorgan cut its recommendation for the second-lien bonds due in 2029 and 2030 to neutral, as they are set to be converted into equity. After shares fell 70% this year, Azul’s market value is currently 1.67 billion reais (about $280 billion), compared with a face value of over $800 million for the bonds.

Seaport Global, though, is touting Azul’s debt as an “attractive opportunity.” Its call includes the second-lien bonds, because they offer “tremendous upside through undervalued equity,” analyst Bevan Rosenbloom wrote in a note to clients.

Execution Risk

Still, the deal has execution risk.

“We will only have visibility on the deal’s real impact on Azul’s capital structure after all of its steps are completed,” said Carolina Chimenti, an analyst at Moody’s Ratings. Reducing debt by $800 million can start to solve the underlying problem and help rebalance the company’s books, she said.

Josseline Jenssen, a credit analyst at Lucror Analytics, said she is weighing upgrading the first-lien bonds — but only after the exchange happens. She currently has a sell recommendation.

“If you buy now it will be cheaper, but only if you want to take the risk,” she said. “In the end, you will have an attractive yield for those bonds, and your payment is secured because of the large collateral the company is providing.”

--With assistance from Rachel Gamarski.