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Take Advantage Of Long Term Trends With Volaris Aviation

|About: Volaris Aviation (VLRS)
Summary

Volaris Aviation is a Mexican low cost airline also flying between Mexico and the US.

The company benefits from 2 secular trends: increase in tourism and more people (immigrants) flying between Mexico and the US. Therefore the company has good growth potential.

Being a so-called falling knife the stock is a very good bet on a statistical basis.

I define falling knives as stocks with more than 60% decline in the last 12 months. Based on statistics such stocks are good investments, if your investment horizon is a moderate 3 years. Many of them will revert in price in this time.

Therefore every month I rank global falling knives on multiple criteria predicting even better returns. This allows me to compare these cheap stocks systematically. One of the top stocks in the list is Controladora Vuela Co Avcn aka Volaris Aviation (VLRS). I recommend it although I have not been able to buy it myself because so far there were even better choices for me in other (international) stocks.

On Seeking Alpha Marketplace I share research of many other net-nets, low EV/EBIT stocks, cheap momentum stocks, cheap nanocaps and falling knives. In total I provide research on global stocks from 6 quantitative investment strategies.

See also this free overview article for a more detailed description of 4 of these 6 investment strategies. You can get more information by taking a free trial of my marketplace newsletter here.

In the rest of this article I share basic findings and data. I have updated them from my marketplace research published in June 2018. In the table below the share price is in US dollars and numbers like the market cap are in millions of Mexican pesos.

Ticker,

Piotroski

Share price

Analyst target

Market cap

EV

EV/EBIT

EV/Revenue

P/Tan B

P/Ret Earn

US:VLRS

4

5.96 USD

8.8 USD

9955 MXN

5682 MXN

-

0.23

1.13

2.4

Date

cash flow

EBIT, ttm

until mrq

Cash flow

from ops

Free cash

flow

P/FCF

2018-03-31

-115 MXN

1609 MXN

-913 MXN

-

Volaris Aviation is a low cost airline in Mexico. The company offers domestic flights and flights between Mexico and the US. There are also some flights between other Central American countries.

The company leases each of its 71 aircraft, with on average 181 seats. The company is modernizing its fleet to reduce fuel and maintenance costs. On the balance sheet (December 31, 2017) there is for 2.4 billion MXN of improvements on these leases. The company purchased 109 Airbus planes with deliveries scheduled between January 2018 and November 2026. However though it purchases planes I think they will still be leased via sale-and-lease-backs after the initial purchase. The risk is the company might have problems getting favorable sale-and-lease-back deals due to unforeseen circumstances.

An internet search on the company name and keyword “fraud” revealed interesting links. In the first half of 2015 a class action against the company was started because of misleading disclosure. In 2016 the judge decided the misstatements were not materially wrong. Also in January 2018 Mexican authorities started an antitrust investigation for the period between April 2008 and February 2010. The maximum possible fine for this would not be material for the company.

During the last 10 years the company did not pay any dividends. Neither did the company buy back significant numbers of shares. Currently the company has no intention to initiate a dividend or to repurchase shares. The company did repurchase minimal amounts of shares in the past. I think this was done to mitigate the diluting effect of 12.4 million outstanding options at 5.31 MXN (less than 1.4 USD per ADS).

Multi-year metrics do not suggest any durable competitive advantages. In particular the ratio Gross Profit/(Total Assets -excess cash) has decreased over the last 7 years. This decrease might also be the result of temporary volatility, for example in fuel prices and the exchange rate of the Mexican peso. It could still be this ratio is pretty constant over a longer period of time.

Volaris Aviation is also a bet on the Mexican peso. A large part of the company’s costs is in USD. So the lower the peso the lower the profit. Currently the peso is still very low, even after its recent appreciation. I expect the peso to appreciate more. It is even possible travelers are trying to time the bottom of the peso, and therefore delaying new bookings. Another good reason for the low stock price is the ongoing uncertainty around a new trade agreement between the US and Canada and Mexico. Lastly the recent election of a new leftish president in Mexico could also be a negative for the stock. I think stocks with much "fuzzy" uncertainty, like this one, have better returns on average.

The company benefits from 2 long term secular trends: tourism increases more than the general world economy and an ever increasing number of immigrants fly between the US and Mexico. No, I do not think politicians will be able to stop or even limit immigration to the US. During last conference call the company said the Mexican flight market has grown by 11%. 

Also nice to know: market penetration of low cost airlines in the US is much lower than in Europe. So lots of growth opportunity.

See the recent quarterly report (March 31, 2018) and the annual report over 2017.

Tangible Assets/Tangible Equity is about 2.7. Despite this ratio being above 2 the balance sheet is still strong. Leverage is more operational than financial and the company has a healthy cash balance combined with smaller debts.

Retained earnings are 3.83 billion MXN plus the legal reserve of 291 million MXN. Therefore Market cap/Retained Earnings = 9.96/(3.83 +0.29) = 2.4. Before the company is allowed to pay a dividend the legal reserve fund should probably contain about 580 million MXN. Each year the company has to add at least 5% of the net profit to the legal reserve fund.

There are approximately 1.01 billion shares.

Substantial shareholders: Blue Sky Investments 11.4% (with Mexican fund managers), funds managed by Indigo 18.0% (incorporated in The Netherlands, fund manager William A. Franke). Directors own together directly 1.1% and another 1.3% via stock options.

Mexico does not allow foreign investors to have voting rights in public companies. Therefore constructions have been set up such that shares held by foreigners do not have voting rights, including American Depositary Shares (even if held by Mexicans).

There are several large transactions with directors and a couple of smaller transactions as well. All maintenance and repair work is done by a company of one the Mexican directors for over 10 million USD per year. In addition the call center has been outsourced to the company of another Mexican director for over 10 million USD per year.

Become a statistical investor. Investing is mostly a game of luck. Therefore it is dangerous to invest based on conviction with large positions. But investing with many small positions in undervalued stocks with statistically great returns works just as well. So that is what I do.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.