Volaris Aviation's (VLRS) CEO Enrique Beltranena on Q2 2016 Results - Earnings Call Transcript

| About: Volaris Aviation (VLRS)

Volaris Aviation (NYSE:VLRS)

Q2 2016 Earnings Conference Call

July 20, 2016 10:00 AM ET

Executives

Andres Pliego - IR

Enrique Beltranena - CEO

Fernando Suarez - CFO

Holger Blankenstein - CCO

Analysts

Duane Pfennigwerth - Evercore ISI

Stephen Trent - Citigroup Inc.

Helane Becker - Cowen & Company

Ulises Argote - Santander

Michael Linenberg - Deutsche Bank AG

Renato Salomone - Itaù Unibanco

Operator

Good morning, everyone, and thank you for standing by. Welcome to Volaris' Second Quarter 2016 Financial Results Conference Call. All lines are in a listen-only mode. Following the Company’s prepared remarks, we will open the floor for question-and-answer. Instructions on how to ask a question will be provided at that time. Please note that this event is being recorded.

At this point, I would now like to turn the conference call over to Mr. Andrés Pliego, Volaris' Financial Planning and Investor Relations Director. Please go ahead, sir.

Andres Pliego

Good morning, everyone, and thank you for joining the call. With me today, we have Enrique Beltranena, CEO; Fernando Suarez, CFO; and Holger Blankenstein, CCO. They will be discussing the Company's second quarter 2016 results as we announced today. Afterwards, we will move on to questions.

Please note that this call is for investors and analysts only. Any questions from the media will be taken on an individual basis.

Before we begin, please let me remind everyone that some of the statements we will make on this call would constitute forward-looking statements within the meaning of applicable securities laws. Forward-looking statements are subject to a number of factors that could cause the Company's actual results to differ materially from expectations for reasons described in the Company's filings with the U.S. Securities and Exchange Commission. Furthermore, Volaris undertakes no obligation to publicly update or revise any forward-looking statements.

It is now my pleasure to turn the call over to our CEO, Enrique Beltranena.

Enrique Beltranena

Thank you, Andrés. Good morning, and welcome to everyone participating on the call today. Volaris continues delivering a strong financial and operational performance, driving the improvements in revenues and operating metrics as well as seeing profitability, despite exchange rate pressures and a seasonally weaker quarter.

Adjusted EBITDAR for the second quarter increased 42% year-over-year with an adjusted EBITDAR margin of 35%, a 4 percentage point increase year-over-year in line with the guidance given in our prior earnings call.

Volaris' ability to increase total revenue per available seat mile or TRASM resulted in a 5% unit revenue growth year-over-year, hence demonstrating that we can combine high growth with unit revenue expansion. We keep on stimulating demand with our low base fares and switching bus passengers to air travel. In a region, total non-ticket revenues increased 35%, 35% year-over-year. We operated at a low factor of 86% derive from an RPM and ASM growth of 24% and 19% year-over-year respectively.

It reflects the company's efforts focused on continuing our growth and a network diversification strategy, despite not having the benefit of the Holy and the Easter weeks during this year's second quarter.

Volaris plays an increasing role as a key market player, being [indiscernible] of -- for over two-thirds of the Mexico's passenger volume growth, primarily because demand stimulation of our bus switching campaign. The Mexican DGAC statistics reflected solid market demand with overall passenger volume growth for Mexican carriers of 9% year-over-year during April and May.

Volaris passenger volume for the quarter increased 26% year-over-year, transporting 3.6 million passengers. The average aircraft utilization in our network was of 12.5 hours for the quarter. In addition, we added eight new routes, six domestic and two international, in line with our point-to-point strategy.

We continue our push towards growing on ticket revenues. Many of our ancillary products are maturing, and we have also improved our commission based revenues and travel commerce platform. We also continue to refine our dynamic pricing strategy in the ancillary products that we started at the end of 2015. We have rollout our new website focused on driving conversion especially on ancillary products. In addition, our new website adjust to any screen size be it mobile, tablet or desktop.

On the cost side, we continue with the best-in-class unit cost structure. Our cost per available seat mile CASM ex-fuel was $4.5 sales equivalent for the quarter. We expect to continue to further efficiencies to our updating program and new aircraft engine technology and we remain the lowest cost operator in the Americas. In sum, we are very satisfied with Volaris' solid financial and operating performance, which were the result of Volaris' actions and initiatives we have executed throughout the year.

Our ambassadors, as we commonly refer to our employees, again were key in achieving such performance that we would like to extend our gratitude to them. On the regulatory front, the Mexican Senate has ratified the US-Mexico bilateral agreement amendment, and we expect exchange of diplomatic notes to take place shortly in order for the agreement to enter into force. We are looking forward to the growth opportunities the bilateral agreement amendment may offer for Volaris.

Our Central American strategy continues to progress. The Costa Rican AOC certification process is in the fourth out of five phases, which includes the table top exercises under locker and US authority certification on the maintenance program operations. We'll share with you any recent developments on the Costa Rican AOC process in [indiscernible] as soon as they become available. Our ultra-low cost carrier model has been very successful and resilient, resilient in Mexico and in the U.S. We believe it can successfully work in other markets and we plan to continue diversifying our geographies.

Fernando will now review the financial results in detail for the period. So Fernando, please go ahead.

Fernando Suarez

Thank you very much, Enrique. I look forward on expanding upon our financial performance for the period. Total operating revenues for the second quarter reached Ps. 5.1 billion, an improvement of 25% compared to the same period last year.

During the second quarter, non-ticket revenues reached Ps. 1.3 billion, an increase of 35% year-over-year. Non-ticket revenues now represent 26% of total operating revenues for the company.

U.S. dollar denominated revenues represent approximately 30% of total operating revenue, helping partially insulate us from exchange rate devaluation pressures.

Moving on to cost. CASM was Ps.1.19 [ph] for the quarter, a 6% year-over-year increase, mainly driven by the average exchange rate devaluation of 18%. This impacted dollar denominated cost line items such as fuel, aircraft and engine rent expenses, and certain traffic and maintenance costs. When looking at CASM in dollar terms, CASM for the second quarter decreased 13%, down to $0.063 [ph]. It is important to note that we do not get the one-to-one U.S. dollar fuel price production benefit, because of the devaluation of the exchange rate.

The total average blended economic fuel cost per gallon for the second quarter was $1.50 per gallon, which includes the call option premiums recognition of $0.08 per gallon. For the quarter, fuel costs represented 29% of total operating expense. In order to offset the cost pressures deriving from exchange rate and fuel price volatility, the company continues to invest importantly on its fleet plan by way of upgrade [ph] and access to new aircraft and engine technology.

During the second quarter, we incorporated two additional A321s with 230 seat configuration, and we expect to incorporate six additional A321s for the rest of the year. We estimate that the unit cost reduction of the A321 is approximately 10% versus the A320. Last year, we completed our retrofit program, adjusting the seat density of our A320s from 174 up to 180 seats. At the end of the second quarter, we had an average of 171 seats per aircraft, and 51% of our seats were in sharklet-equipped aircraft.

Additionally, we plan to incorporate our first two A320 NEO aircraft soon, bringing the expected additional fuel burn savings of approximately 16% according to the manufacturer. We remain active in terms of fuel-risk management. Looking forward for calendar year 2016 and 2017, we have purchased call options to hedge approximately hedge 55% and 50% of the expected jet fuel consumption at an average price of $1.99 per gallon, and $1.51 per gallon, respectively. We have also hedged 37% of the first half of 2018 at an average price of $1.67 per gallon.

Adjusted EBITDAR in the second quarter was Ps. 1.8 billion, equal to 35% adjusted EBITDAR margin; spot on with our given guidance, and a 4 percentage point increase year-over-year.

Operating profit was Ps. 388 million for the quarter, representing an 8% operating margin. Despite FX headwinds above the operating income line, we have been active in managing our balance sheet by holding higher U.S. dollar net asset position that enables us to offset such pressures at the bottom line.

We booked an FX gain of Ps. 923 million during the quarter, resulting from the depreciation of the Mexican peso on our balance sheet, monetary U.S. dollar net asset position. We currently hold Ps. 11.2 billion in net monetary U.S. dollar asset position.

Net income for the quarter was Ps.935 million with a net margin of 18%, an increase of 10 percentage points compared to the same period last year. Earnings per series A share were Ps. 0.92 and $0.49 per ADS.

On the balance sheet, we continue to build financial strength with a cash liquidity position that provides us flexibility to continue with good growth rates and a comfortable financing profile. As of June 30th, Volaris registered Ps.6.9 billion in unrestricted cash, representing 34% of the last 12 months operating revenues. We maintain negative net debt or a net cash position of Ps.6.1 billion.

During the quarter, we generated Ps.194 million in operating cash flow. Our high mix cash balance and equivalents in U.S. dollars generated a net foreign exchange effect of Ps.409 million. These combined effects together with financing and investing activities resulted in a total net cash increase of Ps.564 million.

With a cash flow generation and EBITDAR expansion, we have been reducing leverage, achieving a ratio of 3.2 times adjusted net debt to EBITDAR. Our pre-delivery payment requirements for the remainder of the year and next year’s deliveries are fully financed with our revolving PDP line of credit.

All 2016 Aircraft deliveries are also financed by a way of executed sale lease back agreements. We have also committed PDP financing for our 2017 and 2018 Airbus deliveries. On the fleet side, we ended the quarter with 64 Aircraft, comprised of 18 A319s, 42 A320s and 4 A321s. We continue to have the youngest and most efficient fleet in Mexico, and one of the youngest in the Americas with an average age of 4.5 years.

Moving on to capacity guidance, for the second-half of 2016, we expect to operate in a strong market demand environment and see a healthy booking curve. ASM wise, we are maintaining our full year guidance of 17% to 19% growth, in line with the demand environment and growth rates for an emerging and under-penetrated air travel market.

We had a higher growth in the first-half, due to our old comparison base. Specifically for the third quarter, we expect an 11% to 13% ASM growth. On profitability guidance for the third quarter, we’re expecting an adjusted EBITDAR margin in the high 30s, assuming current spot exchange rate and fuel prices.

Third quarter aircraft and engine rent expenses are expected to be approximately $77 million, which includes contingent rent from pre-delivery expenses.

Now, before passing it back to Enrique for closing remarks, we would also like to note that as a result of increased share trading volume and liquidity of our local our Series A shares, Volaris joined the Mexican Bolsa IPC Index 35 Composite Index, and we thank our investors for that.

Enrique Beltranena

Thank you, Fernando. Well, as you can observe, Volaris reported a very strong quarter today, despite the exchange rate pressures and a seasonally weaker quarter. This was a direct result of rigorous work and execution across the company, service to our customers and focus on value creation for our shareholders. All in, the company produced the last 12 months pre-tax adjusted ROIT of 22%. I think our ultra-low cost carrier model has been very successful and resilient in Mexico and the U.S. We believe it can successfully work in other market and we plan to continue diversify in our geographies.

Once again, I wish to thank our management team for its dedication and of course our ambassador's daily efforts make Volaris one of the most dynamic companies in the airline sector around the world. I also want to thank you my direct management team, who is doing an amazing job. Thank you for your attention.

Operator, we are ready to open the call for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time, the floor is open for your questions. [Operator Instructions] Our first question comes from Duane Pfennigwerth with Evercore ISI.

Duane Pfennigwerth

Hey. Thanks, guys. Good morning.

Enrique Beltranena

Hey, how are you doing Duane? Good morning.

Duane Pfennigwerth

Good. Thank you. With respect to your capacity guidance, 12% midpoint in the third quarter, can you give us a sense for how you're thinking about the fourth quarter, and maybe initial expectations for 2017 as well?

Fernando Suarez

Duane, we are maintaining our full year growth rate of 13% to 19%. And again the range for the third quarter is 11% to 13%. If we were to break it down between international and domestic, we would see a skew towards international in the third quarter ASM growth. In terms of 2017 we're still working on developing the plan.

Duane Pfennigwerth

Okay. Can you talk about the ancillary revenue items that may not have fully contributed here in the third quarter? What are the initiatives that you're working on that that might incrementally contribute beyond the second quarter?

Holger Blankenstein

Hi Duane, this is Holger. Good morning. Well, ancillary revenue generation continues to be the cornerstone of our commercial strategy. And we have grouped the initiatives in three different categories. First, we continue to have a long list of product that we are going to rollout and that we have rolled out in the past.

We are improving the distribution channels. I think a testament to that is our new website, which is very much focused on converting ancillary product. And third, we are doing a lot on the pricing of the ancillaries. So we’ve significantly improve the way we price ancillaries pre-purchase, during the purchase, after the purchase and at the airports. I think those will be the three elements of the ancillary.

And we have a lot of maturing products that customers continue to accept better as they understands, how does a low cost model works, be at carried on baggage, check baggage, an insurance product, a credit card, and/or Volaris club. So all of these products are maturing very nicely.

Duane Pfennigwerth

In terms of the long list of new products, can you give us a general idea of what those types of services might be?

Holger Blankenstein

Yes. We are currently very much focused on commission based products. So we are moving ahead in our credit card program, we are moving ahead in travel commerce, so hotels, rented cars, transport options for our customers, the cross-border bridge in Tijuana [ph] we are charging as a commission product. So there is a lot of things on the travel side that we're working on.

Duane Pfennigwerth

Okay. And can you give us an update on the competitive environment, how you're seeing trends in the domestic market and also in the international market in the second half of the year?

Holger Blankenstein

We do see a continued strong demand both domestically and internationally. Definitely the bilateral agreement that is about to be ratified as and commence forth will definitely bring additional momentum to the market. The fare and yield environment both in the international and the domestic market has been quite stable. We do see some growth of low cost -- U.S. low cost carriers, but that growth is very much focused on the beach destinations in Mexico. So overall, relatively positive picture, despite FX pressures.

Duane Pfennigwerth

Okay. Thank you.

Enrique Beltranena

Thank you, Duane.

Operator

Our next question comes from Stephen Trent with Citi.

Stephen Trent

Good morning, gentlemen, and

Enrique Beltranena

Hello.

Stephen Trent

Hello. How are you?

Enrique Beltranena

We are doing great, Steve. Thank you for your questions.

Stephen Trent

Great, and thanks for the time. Gentlemen, I’ve just was curious and when I think about the second quarter. Were there any cost items that you might characterize as one off so or cause a non-recurring just to get my thoughts around the operations.

Holger Blankenstein

Yes. Steve. In terms of the second quarter, we did experience an increase in contingent rents within the aircraft and engine rental. We expect to have some of it still in the third quarter within the $77 million both on rent amount that we gave guidance upon for the third quarter, but that should decrease in the fourth quarter, it should be smaller number than that.

Stephen Trent

Okay.

Holger Blankenstein

Other than [indiscernible] in rent, nothing else extraordinary that we could point out. In general, we have FX pressure across the different cost line items that we were able to somewhat offset.

Stephen Trent

Okay. Very helpful, very helpful. And on the few hedges that you guys mentioned, apologies I couldn’t hear too well. I believe you said for next year 50% of the need at, and I didn’t hear the strike price. And if I could trouble you for the strike price you mentioned one. And two, if you could also comment on whether, you’re also using a call options as a hedging strategy?

Holger Blankenstein

That is correct. Steve, we continue to utilize call options, and I’ll repeat the percentages for 2016, ’17 and the first half of 2018. We have 55%, 50% and 37% respectively for the next two years and the first half of 2018. In terms of average price of the strike price, it’s $1.99 per gallon, $1.51 and $1.67 for these periods mentioned.

Stephen Trent

Okay. Super, that’s very helpful. And just one last question if I may. What do you think about the Central America strategy, and the fifth and sixth freedom traffic rights pretend to lot out of Central America? Any color on what you’re seeing in that market in terms of competitive movements, is it primarily U.S. LCCs doing point-to-point, or how are you seeing the competitive market there?

Enrique Beltranena

Holger, can you help me out with the first part, and then I’ll complement. Okay.

Holger Blankenstein

Sure. Central America is a market that we see quite a lot of ultra-low cost potential. Currently, there is -- the fare environment and the yield environment in Central America is quite high. We’ll give you more details on the project once we have the Costa Rican AOC process continue. As Enrique mentioned in the call, we are in the fourth out of five phases, however, as we also mentioned during Enrique’s intervention, we see a potential size of the operation that is similar to what we currently operate into the U.S., as full potential.

Stephen Trent

Okay. That’s super. Thanks for that Holger.

Enrique Beltranena

Yes. So in terms of dynamics, Steve, there is one new low cost carrier, which is in the process of certification. I mean, it’s already certified and it has been announcing the launch of its operations, much more to the world’s charter operations and that’s [ph] Colorado Costa Rica.

Stephen Trent

Okay. That’s very helpful, gentlemen. I’ll let someone else ask a question, but thanks again for the time.

Operator

Our next question comes from Helane Becker with Cowen & Company.

Helane Becker

Thanks a lot operator. Hi guys, thank you for the time. Can you say Enrique, what percent of your passengers are first time fliers?

Enrique Beltranena

Yes. Helane, it’s difficult, because it’s based on each station, and specifically, because of the travel traffic that we are managing, Helane. But we think the saying is between 18% and 34% of our travelers are first check on bus fares, and the whole statistics that we manage based on the service is between 5% and 7% of our travelers are first time travelers.

Helane Becker

Okay. And that’s been, I think that’s been fairly consistent, right? It’s not increasing yet, is it?

Enrique Beltranena

It’s not increasing Helane, because of the numbers in the buses are so big, so in terms of percentage, sometimes it’s difficult to remind. But what we see is, and we were clear about that is that, the growth of the market in Mexico, more than two-thirds of it is accredited to [indiscernible].

Helane Becker

That’s really helpful. Thank you. And then just my follow-up on…

Enrique Beltranena

We are very clear that a lot of that traffic is coming from the bus shifting of it [ph].

Helane Becker

Okay. And then my follow up question is that, I think the U.S. has been kind of the driver for RASM growth. Did that continue into the second quarter? And if so, should we expect that for the rest of the year?

Enrique Beltranena

Let me pass that to Holger.

Holger Blankenstein

Helane, we’ve managed to generate RASM growth in the domestic and the international market. Demand has been quite strong in both markets, despite a significant ASM growth. So yes, the FX has helped us in driving growth in the international market, but the domestic market is also quite strong.

Helane Becker

Great. Okay. Thank you for your help. I appreciate the time.

Operator

Our next question comes from Ulises Argote with Santander.

Ulises Argote

Hi, guys. Thank you very much for the call. Quick question regarding the yields, we have seen competition increasing yields. With the FX at current levels, would it make sense for you to increase your yields? And I don’t know, if you can comment a bit on what can we expect in terms of the strategies here going forward? Thanks.

Enrique Beltranena

Can you explain, what do you mean in terms of yield?

Ulises Argote

Yes. The yield that you are charging this quarter, it fell 1.5%. We have seen the competition increasing. So I don’t know, if you can elaborate a bit on what the strategy can be there?

Enrique Beltranena

Yes. But being the bus being at the ultra-low cost carrier, when we speak about yields, we speak about call total yields. Are you asking about base fares, or are you asking about total yields?

Ulises Argote

No. The base fares. Sorry.

Fernando Suarez

So our strategy continues to be focused on total yield, so TRASM. And what you will see in subsequent quarters is that we will remain with our strategy of reducing our base fares, and that is going to be offset by increase in ancillary revenues and being a very low factor exit airline. So we are all about stimulating demand to lower base fares, and that is the strategy we will continue.

Ulises Argote

Okay. Very clear. Thanks.

Operator

Our next question comes from Michael Linenberg with the Deutsche Bank.

Enrique Beltranena

Hey, Michael. How are you doing?

Michael Linenberg

Hey. How is everybody?

Enrique Beltranena

Very good. Thanks for your question. Okay.

Michael Linenberg

Great. Hey, Enrique and Team. I guess two questions here. Maybe, Holger is the one, who can answer this. I’m just curious given the weakness in the currency over the last year. Just how travel patterns have shifted between the U.S. and Mexico. And I just, I’m curious about the how the point of sales strength has changed, like are you just, are you seeing a much bigger pickup in traffic originating in the U.S. to Mexico in your transporter markets. Anything that you can give us, any numbers on that, maybe how it shifted would be helpful?

Holger Blankenstein

Sure, Michael. Let me start with the VFR market. Remember that our core market is the VFR market, and we’ve seen quite a lot of resiliency in the U.S. VFR markets. 33% of our total revenues are U.S. dollar denominated, and there is quite a lot of resiliency in the VFR market. Point of sales here has remained quite similar, 50% in the U.S. and 50% here in Mexico.

In the leisure market, we’ve seen certain deceleration in the North bound Mexico to the U.S. North bound leisure markets, and that has shifted quite a lot to Mexican leisure destination. And we are adjusting the capacity accordingly.

Michael Linenberg

Okay. Good. And then my second question, and Holger, this maybe a question for you as well. You mentioned earlier in the call that you announced or started eight new markets, I think two international and six domestic. And I am just curious about the ramp up, typically, when you are a smaller carrier and you don’t have a lot of cities that you serve, it may take longer to ramp up to maturity. But now you have a healthy density throughout your network, and in some markets like Guadalajara, you have maybe some of the highest, you may have almost more presence than any other carrier, and that’s I believe the case in Tijuana.

So as you add new routes, including some of these routes that maybe previously had known service and cross border markets into the U.S. for example. Are you seeing a much faster ramp up to maturity or to profitability? Is that showing up with the more recent launches? If you could go into detail on that, that would be great. Thanks.

Holger Blankenstein

So in general, let me tell you quickly. We have opened eight new routes in the domestic and international markets. And typically, what we see in the domestic market ramp ups are a little bit faster between six months, and in the international markets ramp ups are a little bit slower 6 to 12 months. And yes, where we are strong, where we have a leading position, obviously our market entries are a little bit easier.

Michael Linenberg

Okay. Very good. Thank you.

Holger Blankenstein

And then as we -- and then maybe just to add Michael, as we move into Central America, and as we have the new AOC in Central America and Costa Rica specifically, while our brand is not that penetrated in Costa Rica and in Central America, so we expect a little bit slower ramp ups in those markets in Central America.

Michael Linenberg

Okay, great. All right. Thanks, Holger.

Operator

Our next question comes from Renato Salomone with Itaù

Renato Salomone

Hello, gentlemen. Thanks for taking my questions.

Enrique Beltranena

Renato, how are you doing? Welcome to the call.

Renato Salomone

All right. Thank you. My first question is regarding the cash strategy, it’s proven to be a wise and efficient strategy to hold more cash in dollars. Is it something that we can expect going forward? Is there something some bans that the Board has set for you to work with? Can you give us some more on what to expect going forward?

Fernando Suarez

Renato, you are right. We hold most of our unrestricted cash in dollars, and we intend to continue doing that, it does play a role in terms of FX hedge. And also, it’s not just unrestricted cash, we have guarantee deposits, such as fleet related and maintenance reserves, there are also dollar denominated. S

So that also helps in having a very high net U.S. dollar asset monetary position. So in that sense, we are comfortable with that.

Renato Salomone

Okay. And the next question is regarding salaries. This line has come for the past two quarters a bit higher than I had in my model and we saw since the fourth quarter a bit of a decoupling with [indiscernible] in there that we need to take into account?

Fernando Suarez

Renato, salaries basically are in line with our expectations. If you see a slight variation on the upside to that, it has -- is related with variable compensation. Remember that, we have a very variable compensation scheme. So as we hit targets for the company, we do pay a little bit more in terms of variable compensation

Renato Salomone

Perfect. Thank you.

Operator

At this time...

Enrique Beltranena

I do remember something important that is for you to consider it, as a difference in what is going on the South, South America, Mexico has been able, despite of the devaluation to control its inflation rate.

Renato Salomone

Certainly. Thank you.

Operator

At this time, we have no further questions. I will now turn it back to Mr. Enrique Beltranena for closing comments.

Enrique Beltranena

Thank you very much to everybody. Thank you very much once again to the team, and to the management team, and ambassadors -- and general ambassadors that make Volaris success in everyday.

I would also like to thank you very much our investors and tell you guys that we are confident for our next quarter results, and that we will keep on working, creating the best performance with the low cost carrier that we can. Thank you very much, and have a great day.

Operator

Ladies and gentlemen that concludes today's presentation. You may disconnect your phone lines, and thank you for joining us this morning.

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