CONTROLADORA VUELA COMPANIA VLRS
September 13, 2020 - 12:29am EST by
AIFL
2020 2021
Price: 8.04 EPS 0 1.34
Shares Out. (in M): 101 P/E 0 6.7
Market Cap (in $M): 812 P/FCF 0 10
Net Debt (in $M): -225 EBIT 0 230
TEV ($): 587 TEV/EBIT 0 2.55

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Description

I’m going to keep this one rather short and sweet - I didn’t have a writeup prepared for this, but I think the market is giving us a unique opportunity to purchase shares of Volaris cheaply before the business inflects. I encourage you to read om730’s pitch from 2018 here for more background.

 

Before I get into the details... Yes, this is an airline. Yes, I know air travel is still down upwards of 60% in most regions. Yes, I know air travel likely won’t return to 2019 levels anytime soon.  However, Mexico seems to be an anomaly here, hence the opportunity. 

 

Elevator Pitch:

 

1. Traffic Rebound - Just like all other airlines, Volaris’ traffic numbers in April, May, and June were awful. However, the Mexican market, and Volaris in particular recovered much faster than the rest of the world. July RPMs at Volaris were down only 47% total yoy and only 39% for domestic travel. August RPMs rebounded even further, with total RPMs only down 31% yoy and domestic RPMs down 25%. This rebound is from numbers down between 70-90% from April through June. 

 

2. Liquidity - Volaris has a net cash balance ex-leases. To my knowledge, it is 1 of only 3 airlines around the globe that can say that. 

 

3. Declining Competition and Price Wars - Covid has forced a lot of competition out of the Mexican air travel market. Most notably, Interjet has had most of its fleet repossessed. Aeromexico is currently in chapter 11 and likely downsizing its fleet. The domestic air travel market only has 4 players, and 2 of them have just taken a lot of capacity out of the market.  

 

4. Declining Input Costs - Jet fuel is currently at the lowest level we’ve seen in 5 years.

 

5. Massive Growth Runway - Ignoring all other factors, Volaris should have a massive runway for growth in a less competitive market moving forward. 



Mexican Market - Declining Competition and Price Wars

The current domestic air travel market in Mexico only has 4 players - Volaris, Viva Aerobus, Aeromexico, and Interjet. Volaris & Viva, the 2 ULCCs, have been steadily taking share from Aeromexico and Interjet for over a decade. In 2015, market share was as follows:

Aeromexico (35%), Interjet (25%), Volaris (24%), Viva Aerobus (11%)

By 2019, market share stood as follows:

Volaris (31%), Aeromexico (24%), Viva Aerobus (20%), Interjet (19%)

At the start of 2017, Interjet - being the most financially levered of the 3 and consistently losing market share - began aggressively discounting fares. This began a price war as all competitors fought to retain their market share. This has led to depressed margins over the past few years for all 4 domestic players, but has also led to share increases for Volaris and Viva. It’s not difficult to understand why - I believe Volaris has the lowest normalized unit costs of any airline (roughly in line with Wizz Air), with a CASM ex-fuel of 4.07 cents in 2019. In fact, Volaris’s RASM is actually lower than either Aeromexico’s or Interjet’s CASM, so neither can effectively compete with Volaris over the long term. 

 

However, the above is effectively moot. The main point of this thesis is that for the past few years, the Mexican air travel market has had a lot of excess capacity, hence low returns for all players. However, due to covid, a very meaningful amount of capacity has been taken out of the market. 

 

Interjet has had a vast majority of their fleet repossessed. Pre-covid, their fleet consisted of 66 planes, mixed between Sukhoi Superjets and Airbus A320s. According to different aircraft lessors, all of their Airbus planes have been repossessed. They are left with only 7 operating Sukhoi Superjets. Interjet has actually been attempting to get rid of its Russian-built Sukhois for a while now - they have a fleet of 22 Sukhois, but more than 50% of them haven’t flown since 2018. Apparently, they are a maintenance nightmare and receiving aftermarket support out of Russia is not ideal. With their fleet slashed to a small number of maintenance nightmare Sukhois, Interjet has reduced its numbers of domestic routes by around ~80-90%. 

 

Aeromexico is currently in chapter 11. They have already been released from leases of 19 aircraft (10 Boeing 737s and 9 Embraer E170s), reducing its fleet from 124 aircraft to 105. They are apparently targeting to have only 80 aircraft by the end of 2020. That is a ~35% reduction in its fleet.

 

Between Interjet and Aeromexico, a bit over 30% of the TOTAL capacity of the Mexican aviation market has disappeared. This should prove to be a boon for both Volaris and Viva in terms of pricing as well as market share. 

 

The only other meaningful domestic player is Viva Aerobus. Viva and Volaris tend to be rational in regards to each other, focusing on different airports. Volaris focuses on Tijuana, Guadalajara, and Mexico City while Viva focuses on Monterrey and Cancun. At the airports Volaris focuses on, Volaris and Viva compete on less than 40% of the routes. Volaris competes more heavily with Interjet and Aeromexico at its main hub.

 



Traffic Rebound

Traffic in the Mexican air travel market, and at Volaris in particular, has rebounded much quicker than all other airlines around the globe. In August, Volaris’ RPMs were already around 70-80% of its prior year numbers (down 31% total, 25% domestically). Load factors are already around mid-70%. Compare this with August numbers from other ULCCs across the globe (which should rebound much faster than other airlines as regional travel will come back faster):

  • Allegiant Air:

    • RPMs: down 48% yoy

    • Passengers: down 49% yoy

    • Load Factor: 44%

    • Share Price YTD: Down 24%

 

  • Wizz Air:

    • Passengers: down 41% yoy

    • Load Factor: 70%

    • Share Price YTD: Down 14%

 

  • Ryanair:

    • Passengers: down 53% yoy

    • Load Factor: 73%

    • Share Price YTD: Down 20%

 

  • Volaris

    • RPMs: down 31% yoy

    • Passengers: down 35%

    • Load Factor: 73% 

    • Share Price YTD: Down 24%

 

These ULCCs are the cream of the crop, and Volaris’ numbers are significantly better. Volaris has been able to bring back significantly more capacity than any other airline, and is still able to fill its planes. Despite this (and the fact that Volaris and Wizz are the only 2 here with a net cash balance sheet), Volaris’ share price has been punished more YTD than any other airline on this list. The most ridiculous comparison here is that Allegiant, which carries net debt/FCF of about 4x, has had no material capacity taken out of its market, and has recovered to less than 50% capacity is down the same YTD as a company with net cash, a significant amount of capacity taken out of its market, and has recovered to about 75% capacity. 

 

Yes, Volaris’ stock price has run quite a bit since the release of their July and August traffic numbers. However, analyst coverage for Volaris still hasn’t even updated capacity for Q3 numbers. Consensus is still about 15-20% below what actual results would suggest. Further, looking out 3-5 years, I believe Volaris is massively undervalued and isn’t getting credit for likely margin rebound and market share gains due to market capacity reductions.   



Liquidity

As stated - to my knowledge, Volaris is 1 of only 3 public airlines with a net cash balance sheet. On top of that, during Q2 (April-June) which was the height of covid, Volaris only burned $23mm vs net cash of about ~$225mm. This was with RPMs down on average 70-90% during these months. With RPMs back upwards of 70%, Volaris should at the very least be cash flow even, and will in all likelihood be cash flow positive.

 

As an aside on liquidity - Volaris has come to an agreement with Airbus to defer 24 neo deliveries from 2020-2022 into 2027-2028 which postponed $200mm in pre-delivery payments. This provides Volaris with flexibility by currently enhancing liquidity, but giving Volaris the option to pull those deliveries forward if demand recovers quickly. This should prove very useful as Volaris will likely be given the opportunity to take plenty of market share given demand returns to 2019 levels within the next year or 2.  

 

 

Declining Input Costs

This one is fairly straightforward, but jet fuel prices are at the lowest point we’ve seen in 5 years. Fuel is the largest line item for just about every ULCC across the globe. Over the past 5 years, fuel has represented about 35% of Volaris’ total expenses. Margins have fluctuated directly in line with the rise and fall in jet fuel. In times of low jet fuel, like 2015-2016, Volaris averages around a 14-15% net margin. In times of high jet fuel, like 2013-214, Volaris averages a 2-3% net margin. 2017-2018 margins are a bit of an anomaly due to the intense price war initiated by Interjet, but we know that has now come to an end. 



Massive Growth Runway

Volaris faces a massive growth runway mostly because of the state of the Mexican air travel market. The Mexican market is experiencing accelerating secular growth, which is likely to continue. Over the past 12 years, air travel passengers have increased at a CAGR of about 9.7% which is astoundingly high. However, if you look at the base and where the market is today, the market still has plenty of room to grow. 

 

Consider the following -  Mexico’s intercity bus market is still multitudes larger than its domestic air travel market. In Mexico, there are about 3 billion intercity bus passengers annually. This is compared to the domestic air travel market with 53 million passengers in 2019. The size of the market for buses carrying passengers from city to city is over 50x larger than its domestic air travel market! Interestingly enough, Volaris’ management claims that on 40% of their routes, their only competition comes in the form of buses. All this despite the fact that Volaris’ flights are actually the cheaper option more often than not, and take a small fraction of the time. I think this alone will provide Volaris with a multi-decade long tailwind.

 

 

Also consider the average Mexican only flies by air around .4 times per year (up from about .2 times per year in 2006) compared to the average American which flies almost 3 times per year. Even if it takes Mexico 40 years to catch up to America’s numbers, that passenger growth would still provide the Mexican air travel market with about double GDP growth.