Controladora Vuela Compania de Aviacion SAB de CV (VLRS) 2017 Q2 法說會逐字稿

Good morning, everyone, and welcome to Volaris' Second Quarter 2017 Financial Results Conference Call. (Operator Instructions) Please note that this event is being recorded.

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

Good morning, everyone, and thank you for joining the call. With me today we have Enrique Beltranena, CEO; Fernando Suárez, CFO; and Holger Blankenstein, CCO. They will be discussing the company's second quarter 2017 results announced today. Afterwards, we will move on to your questions.

Please note that this call is for investors and analyst 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 applicable to security laws.

Forward-looking statements are subject to several factors that could cause company's actual results to differ materially from expectations for reasons described in the company's filings with the U.S. Securities Exchange Commission.

Furthermore, Volaris undertake 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.

Thank you, Andrés. Good morning, and thank you all for being with us today. Today, I'm pleased to report that Volaris is back on track. Despite a very challenging market and geopolitical environment at the beginning of the year, the company has managed to navigate through, and in the second quarter, we posted an operating profit.

In terms of adjusted EBITDAR margin, for the second quarter, we met our stated guidance, with an adjusted EBITDAR margin of 26% despite the challenging marketing conditions, resulting in a positive operating income.

On the revenue side, we made an important drive towards non-ticket revenue generation, which sequentially improved CASM to MXN 0.129 with underlying yield recovery and good volume. On the capacity side, available seat miles grew 17% year-over-year, but we cautiously managed our capacity by growing only 2% quarter-over-quarter.

On the flipside, during the first half of the year, we could continue the operating essence, as I just mentioned, that with less aircraft in line with our cautious capacity management efforts. During the same period, we redelivered 3 aircraft and we did not receive any aircraft.

Regarding volume, network load factor returned to last year's second quarter level of 86% despite the softer international traffic and resilient domestic traffic. On the other costs -- on the cost side, CASM excluding fuel returned to MXN 0.92, which is a similar amount to fourth quarter of last year.

On the macroeconomic side, indicators for the Mexican economy remained in stable, and by the close of the second quarter, we had a stronger peso and recovery in consumer confidence, 5% in same-store sales and much more stable fuel prices. Remittances in dollar terms also increased 5% in April and May. Along with this important macro development, there were several other factors that explain our improving performance trajectory for the second quarter. For example, we had a seasonal affect, where holy (inaudible) high-season weeks fell in the second quarter of the year and these helped the sequential improvement. International travel, especially to The United States, sequentially recovered month by month during the second quarter, and this is illustrated by improving international load factor to 86% in June compared with a low 76% in February, driven by less uncertainty surrounding U.S. travel and a recovery in traffic pattern.

Volaris' year-over-year ASM growth in the international market was 36% given last year's low base comparison but is only an 8% growth quarter-over-quarter. Volaris is here for the long term, and growing our international U.S. dollar base revenue remains a key stated objective to diversify our network and continue building a natural U.S. dollar hedge. For example, U.S. dollar collections now represent approximately 43%.

In the first 6 months, we took advantage of the new U.S.-Mexico bilateral agreement, which gave Volaris the opportunity to start flying important core visiting friends and relatives routes, such as Mexico City to Miami, to Houston, and to New York. We also launched 5 new routes in our Central American operation during the first half which contributed to further diversifying our network in U.S. dollar revenue sources. Still, ASM's in Central America only represent less than 2% of our total available seat miles. In the domestic market, the exchange rate devaluation in the first 6 months helped the national travel to shift from international to domestic routes. We also witnessed other trends that benefited the domestic market.

For example, the stable visiting friends and relatives market or this was -- we had the benefit of the April high season, which resulted in a relatively healthy revenue environment driven by good volume momentum, and this was, to a certain extent, offset by a capacity growth constrained at Mexico City due to an authority enforcement of the slot regime, that was at the end of the quarter. Towards the end of May and throughout June, we witnessed a recovery of U.S. travel market demand and consequently, we were able to improve yield versus the previous quarter. This recovery took place mostly in the visiting friends and relatives routes, and to a lesser extent, in the non-parlation (inaudible) markets.

Non-ticket revenue continued to perform strongly. In the second quarter, non-ticket revenues per passenger increased by 18% year-over-year, reaching MXN 426 per passenger and total non-ticket revenues now represent 29% of total operating revenues in line with our objectives to further unbundle the growth. Volaris is now within the top 5 carriers in the world in terms of non-ticket revenue as a percentage of total revenue.

The key drivers for this growth were: the first checked bag charge for U.S. international flights, improved revenues from our co-branded credit card, better sales conversion of our ancillary combos, and we also increased our commission-based revenues for travel commerce-related products, such as new hotel selection in the ticket purchase process.

Regarding the charge for the first checked bag, it is important to point out that we have obtained written criteria from the Mexican Aviation Authorities, confirming for Mexican and U.S. carriers to charge for the first checked bag on international flights. Our substantial bus switching operating strategy has been expanded to Central America. During the quarter, we gave away 60,000 free tickets in our network, enhancing our hell versus heaven concept. We executed this drop in activities (inaudible) next to bus stations in Mexico and in Central America, impacting 20 million bus users, supported with key media partners. Note that 8.4% of our customers are first-time flyers according to our internal search.

On the cost side, we continue to face some fuel and FX headwinds, but with some appreciation of exchange rate at the end of the quarter. Nevertheless, our unit cost remained within top 5 best-in-class publicly-traded operators worldwide at USD 0.05 ex fuel. The third quarter will be a strong quarter with solid volume. However, we're seeing some aggressive promotions during high season. In the Mexico City Airport, we observed yield pressures despite lots of constraints, driven by heavy competition among the main players in that airport.

In market, that represents 60% of the total domestic ASMs and thus, influences the pricing environment of, basically, in the entire market.

From our end, we continue to manage capacity cautiously. Given the fact that during the first semester we didn't take any aircraft deliveries, we expect a full-year ASM growth of 13% to 14%.

Now let me pass it to Fernando, who will elaborate on our financial performance for the quarter. Thank you very much.

Thank you, Enrique. I'll be reviewing our results for the figures filed with the SEC and BMV this morning. Total operating revenues for the second quarter reached MXN 6 billion, up 17% compared to the same period last year.

During the second quarter, non-ticket revenues reached MXN 1.7 billion, an increase of 31% year-over-year. U.S. dollar denominated collection was approximately 43%, partially helping to insulate the company from exchange rate pressures.

Moving on to costs, CASM was equal to MXN 0.128 for the quarter, a 7% year-over-year increase, mainly driven by the economic fuel price increase of 13%, and average exchange rate depreciation of 3%. The FX devaluation continued to impact dollar-denominated cost line items such as fuel, aircraft and engine rent expenses and certain traffic and maintenance costs. Note that CASM ex-fuel in U.S. dollar terms continues at USD 0.05. The average economic fuel cost per gallon for the second quarter was $1.79, which includes recognition of call option premium of USD 0.08 per gallon, partially offset by the benefit of some call options that ended in settling in the money for the quarter. As Enrique mentioned, during the second quarter, we did not incorporate any additional aircraft, hence -- nor did we post any gains on sale and leaseback transactions as opposed to the second quarter of last year. We finished the quarter with a fleet of 66 aircraft composed of 12 A319s, 44 A320s and 10 A321s, with an average age of 4.4 years, the youngest fleet among Mexican carriers. At the end of the second quarter, Volaris' fleet had an average of 180 seats per shelf, in line with our strategy to continue upgauging the fleet, and 63% of the seats were Sharklet-equipped, on track to continue improving efficiency and fuel burn in our fleet, driving lower unit cost.

We remain active in terms of fuel risk management, and as previously stated, some of our fuel hedges ended up in the money this quarter. Looking forward, for the rest of calendar 2017, we have purchased call options to hedge approximately 58% of the expected jet fuel consumption at an average price of $1.42 per gallon. We have also hedged approximately 45% of our estimated consumption of 2018, at an average price of $1.74 per gallon. Adjusted EBITDAR in the second quarter was MXN 1.6 billion, equal to 26% adjusted EBITDAR margin, in line with our stated guidance.

Operating income was MXN 39 million for the quarter. During the quarter, we experienced FX headwinds above the operating income line. However, we observed an appreciation of the Mexican peso at the end of the quarter. As you may recall, we have been active in managing our balance sheet by holding a higher yields dollar net monetary asset position, which, due to the appreciation of the Mexican peso at the end of the second quarter, led to a FX net loss of MXN 558 million below the operating line. Net loss for the quarter was MXN 520 million. The loss was MXN 0.50 per Series A share and USD 0.29 per ADS.

We remain with a strong balance sheet and comfortable financing profile. As of June 30, Volaris registered MXN 6 billion in unrestricted cash, representing 24% of the last 12-month operating revenues. We maintained negative net debt for a net cash position of MXN 3.9 billion. Net cash flow from operating activities was positive MXN 242 million excluding income tax payments of MXN 467 million, primarily related to last year's fiscal result.

Cash flow used in investing activities was MXN 502 million, and net cash flow provided by financing activities was MXN 91 million. Net foreign exchange differences were negative MXN 232 million resulting from our high mix of unrestricted cash in U.S. dollars. Our cash flow, liquidity, accounts payable, working capital, equity base and balance sheet stands healthy versus our competitors in the Mexican marketplace.

Moving on to 2017 capacity guidance. As Enrique mentioned, we foresee a full year ASM growth in the range of 13% to 14% year-over-year. Specifically for the third quarter, we expect to grow ASMs in the 9% to 11% range, broken down by 7% to 9% domestic growth and 13% to 15% international growth.

Regarding profitability guidance, we expect to achieve an adjusted EBITDAR margin in the range of low to mid-30s for the third quarter, assuming current spot exchange rate and jet fuel prices. Our aircraft and engine rental expense for the third quarter is expected to be in the order of $80 million.

Now I'll pass it on to Enrique for closing remarks.

Thank you, Fernando. The second quarter was an inflection point to the U.S. traffic and a highlight of the domestic volume. The company, I think, performed accordingly by maintaining cost control, by managing capacity in a disciplined manner, and by stimulating demand and sustaining healthy load factors and growing the non-ticket revenues to a record of 29% of the total revenue.

I'd like to conclude by thanking our ambassadors who helped us established another record by making Volaris one of the 50 most punctual airlines in the world according to OIG and also a thanks to our loyal customers who, in these difficult times, got us through this period successfully.

Thank you very much to everybody for your attention. Operator, we are ready to open the call for questions.

(Operator Instructions) Our first question comes from Helane Becker from Cowen & Company.

Just a couple of questions. So on international, I hear that you're slowing some of that growth down. Is that just because traffic from the Mexican markets to non-U. S. cities are not keeping pace with the growth? Is it that Mexicans are traveling domestically? Can you just maybe put some more meat on the bones?

Yes, I will ask Holger to support your math.

Hello, Helane. Helane, well, the international market, as you know, we are in a strategy of increasing our shelf international revenues. So we did expand capacity quite significantly earlier in the quarter. And given the geopolitical situation, and the exchange rates we then trimmed down growth in the international market. So you see lower growth rate towards the end of the quarter in international, which helped a lot and our yields. And we also saw a sea shift of travelers from the international markets given the high exchange rates to the domestic leisure destination. So I think the combination of those elements explain the lower growth in the U.S.

Okay. And then -- okay, and then can I just follow up with -- are you seeing a shift -- more of a shift in capacity from the U.S. carriers coming into Mexico? Or is it about -- can you talk about the growth rate for them versus your own growth rate, maybe?

So we do see increases in capacity from the U.S. players. And remember that the U.S. players typically operate to the beach destinations, to the leisure destinations, where we did see increases. But we did not see any significant increases into our markets -- into our most -- more VFR characteristically markets.

Our next question comes from Duane Pfennigwerth from Evercore.

Following up on Helane here. With respect to international travel demand, since the currency has firmed, what changes have you seen here into July? How long before the firmer currency starts to positively impact Mexican demand for international travel?

Duane, yes, we do see an improvement of the international loads because the currency, obviously, is much more in line with last year. So we do see a recovery of the international demand and yields. As noted as well in our June traffic release, you saw higher loads than in May and in April. And that is a result of the better currency situation and also a little bit relaxed -- more relaxed geopolitical situation between Mexico and the U.S.

Great. And then I wondered if you'd expand a little bit on your comment about slot reallocation at Mexico City. How does your position change, if at all? And how did sort of the competitor changes impact you?

Duane, look, this whole thing of the slots, I mean slot controls at Mexico City is something which is in progress and it's changing, I would say, dynamically. In the beginning of June, the Mexico City Airport established a much stronger control on slots, and we ended up with a reduction. So when you look at our slot allocation this year versus last year, when we started negotiating it, it was basically half of last year, okay? So we were able to negotiate back to a good level and a decent level of slot allocation, okay? And effective June 1, Volaris was the first company in Terminal 1 to be fully allocated in its needs for slots, okay? But I mean, what we see, Duane, is that, the slot allocation process, it's getting more difficult, a, and b, it's basically getting to its maximum level and I don't think it's going to move higher than that. As a result of that, we strongly think that what is coming is a capacity-constraining Mexico City, which Volaris has managed very well because we up-couched our aircrafts for maybe 2020, '21. And we are overcoming the situation with higher routes, and that's basically what's going on.

Our next question comes from Michael Linenberg with Deutsche Bank.

I have a couple here. Enrique, I want to go back to on Mexico City. Why -- under the reallocation, why would you see your spot allocation reduced? Where you not operating the slots that you had at the level that you needed in order to keep them? Or was it arbitrary, that reduction?

It's part of the process and the way they're allocating the slots, Michael. They -- last year, we were adding operations based on the slots that the airlines were leaving empty today and those empty slots we were basically tackling them on a day-to-day basis. Now this is much more in anticipation to that, okay? And it has to be in a much more orderly fashion, okay. But I don't want you to take my answer wrong, Michael. We got the right level of slots. We were able to get it what we needed, and we are operating it with a right capacity in Mexico City. What I am just trying to say is, it is getting much more organized, a. B, it is heading towards, I would say, highest level. And c, it's something that will be a constraint going forward.

Okay. That makes sense. And then, just on....

Volaris it is important -- I mean, it's important to add, remember, Volaris only has about 30-something percent of ASMs there versus our 2 main competitors, which -- who have more than 80% of their ASMs there. So we're a much more diversified route network airline, which has the ability to allocate capacity in any other city, and keep them growing at the rates that we have been growing and this is not going to be a constraint for us. It's going to be a constraint in the Mexico airport, which may end up in a price increase.

Okay. That's helpful. And then, secondly, I just -- I was curious about how things have maybe -- have you noticed anything since the Delta, Aeromexico JV was implemented? Maybe the way in which they market or price or schedule, because I thought it was interesting on the Aeromexico call that they're actually going to grow at a faster rate in a transborder market to the point that they're going to take 4 E190s this year, which were not in the original plan, and they pointed to the initial success that they were seeing in some of the markets that they're working with Delta. And so I was curious if that was -- if you're seeing sort of the impact of that, and if you were, if that was having any sort of negative impact? If we’re seeing a share shift? I realize, it's early. But I thought it was interesting that they'd accelerated their capacity growth in transborder, which doesn't seem like you would do that, just given kind of the backdrop. Your thoughts on that?

Well, let me give you some thoughts on Aero, and I'll let Holger to complement mine. What we're seeing is it's -- yes, we're seeing a change in much more Atlanta routes, okay? More Atlanta capacity. And the second thing is, as you mentioned, the regional E190s and then the narrowbodies moves, okay? And that's, basically, in general what we see. But let me pass it to Holger to tell you based on route-by-route.

Michael, one of the biggest changes we're seeing, obviously, is that we got several slot pairs from the Delta, Aeromexico slot divestiture, which we are putting into service. So we bought 3 slot pairs with Mexico-GSK, Mexico-San Antonio and Mexico-Los Angeles. That's what we're going to start operating. And we have 1 slot reopening for this year, and then next year, we are in the process of getting more slot pairs from that divestiture, which we were also going to put into the international markets, obviously. So that's something that we'll accelerate also for Volaris, our international growth. Remember that we are continuing to grow faster in the international market to build our U.S. dollar revenues, and the Delta Aeromexico slot divestiture will help us in that process. In terms of pricing, and in terms of yield, we have not seen any changes so far. We do continue to see relatively aggressive pricing both in the international and the domestic market from all competitors right now.

Great. And then if I can just squeeze in one last one, I was going to ask you where you were with respect to your application to fly nonstop from Costa Rica to the U.S.? And then sort of as that -- sort of second part of that, the fact that you now fly from San Jose to -- well, San Jose into Mexico as well as from Guatemala into Mexico. I'm curious about how much traffic you may actually be connecting over either Mexico City or Guadalajara into the United States. It would seem like that you would actually have a decent amount of connection traffic in the event that you don't get the nonstop rights? Any thoughts on that?

Yes. Look, Volaris Costa Rica, as we have mentioned, have submitted, throwing their cap (inaudible) license application to the USDOT. We are still pending from the DOT with solution, and we expect that an order will be issued during the coming months. And going back to the traffic numbers, yes, our Guadalajara hub, especially our Guadalajara operations, are managing, both from Costa Rica and from Guatemala, sometimes up to 78% of our traffic through that -- through Guadalajara to the U.S. cities, and connecting those parts in U.S. So it has become a very important operation from that perspective.

Now that's a -- you said upwards of like 70% to 80% is connecting from Central America into the United States, upwards of that? Is that -- did I hear that right?

It depends on the dates. I mean, for example, Semana Santa, it was 78%. And then on a regular basis, it goes down to 65%, 68%.

That's -- I'll tell you though, that's still very high. So that's a nice complement, and you've obviously built a pretty strong hub there.

Our next question comes from Ricardo Alves with Morgan Stanley.

Just 2 quick questions. One on the leasing side. You actually -- slightly higher numbers for leasing expenses for the rentals. So maybe just a quick color on what is really driving this line on a pair of aircraft in U.S. dollar terms obviously. Much of this is maybe related to a better -- with the delivery cost. It was a little bit better than what we expected maybe. And then, also, what's going to drive this quarter-over-quarter increase in the third quarter cycle. If I hear you correctly, I think you're talking about MXN 80 million for the third quarter. So just a little bit of color on the rental side. And then just on capacity, I mean, with a new guidance, I believe -- before, you guys were talking about a number that was close to 15%, and now this is 13% to 14%. We might be talking about low double-digit growth for the second half. Just maybe a little bit of your thoughts on this big deceleration of growth from the first half to the second half if this is. And maybe the new rules for the market overall? And maybe if you can talk a little bit about how you think about growth -- capacity growth in 2018 from your side, but also looking at the Mexico domestic market overall, that'd be helpful. So looking a little bit longer term.

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expenses. And then...

Sorry, Fernando. I think you're cutting off. I'm not sure if this is for the whole audio audience. But I can't hear. If you can repeat that, please? You're just cutting off.

You yourself have a lot of noise in varied decibels. Can you maybe -- you can put your phone (inaudible) in mute, so you can hear better. Operator, let us know if you can hear us fine?

Yes.

Ricardo? You were asking about lower rental expenses. They are primarily related to lower redelivery expenses that we had been seeing in the quarter. And in terms of the third quarter rental expense guidance, we are expecting an order of magnitude of in and around MXN 80 million. Part of that also has to do with the fact that we had some delays in the fleet. So we have a little bit less of available aircraft embedded in that number as well. Now as to your second question on second half growth, Holger will elaborate.

So as we said in the, Enrique's prepared remarks, we expect full year growth now to be in the range between 13% and 14% year-over-year. And specifically, in the third quarter, ASM growth of 9% to 11%, and we've skewed towards international growth. So international growth will be between 13% to 15%. For the second half of the year, we do see a reduced ASM growth, and that is mainly due to the year-on-year comparisons. Remember that, last year in the second half, we did post quite significant growth both in the international and domestic markets. And if you look at year-on-year comparisons, the second half this year will be slightly lower in terms of growth than the first half.

Our next question comes from Pedro Balcão with Santander.

In June, you reached a very healthy load factor, almost 90%. But it's still going down, at least year-on-year. Do you want to increase load even more? Or going forward, can we expect stable load and maybe some improvement in yields? That would be the first question.

That's probably the best question in the phone call. Thank you very much, Pedro. We'll have Holger answer it.

So the way we managed loads in our ultra low-cost carrier is that we try to be around 90% in high season by maximizing load and yields. And in the low season, we target typically in the low 80s to mid-80s with lower yields. That's our, I would say, policy in terms of in the ultra low-cost carrier philosophy. So you can expect relatively high load in July and August.

Second one, if I may. Why do think we have this situation in Mexico City, when it's actually a saturated airport? Apparently with not enough capacity for everybody, actually?

I think, Pedro, that's part of the dynamics of the market that we are seeing. And we are trying to maintain and control and are very, very careful our capacity so we can be at the right levels of offer. And I think that's probably much more a question you should pose to the rest of the players, because Volaris is being very organized in its capacity management.

And our next question comes from Rogério Araújo with UBS.

I have a couple of questions here. I'm sorry to insisting this question, but a follow up on Mexican city. I'm just wanted to understand in your view how bad is the situation for the consolidated market as a whole? If this can be comparable with what happened in 2011 and '12? Or this is a better situation than what happened back there? And I didn't hear EBITDAR guidance for third quarter, like you gave in the past couple of quarters. I'm not sure, if I didn't hear that properly or if you didn't give that. And if you didn't, is it possible to give us some range possible for the third quarter, so we can have a better idea as well on how bad it is, this price pressure is in Mexico City will be? This is the first question.

Well, let me answer you in part, and then I'll have Fernando complement myself. So the first part is, the pressure is there. I mean, it's -- you need to understand that this is a country that has an important amount of ASMs which are located in Mexico City, a. B, players, there in Mexico City that have more than 80% of their ASMs. So when you add those 2 players together, it will have more than 80% of their ASMs. This is an impact to more than 50% of the market, okay? And when you impact the market with more than 60% with a price pressure like this, yes, it is an impact to the rest of the market. Nevertheless, it is important to say that Volaris versus the issue in 2012 or 2013 -- in 2013 and 2014, is by far much more prepared now than we were by that time with -- because we have a much more spread out network and a diversified network which defends us, a, and b, and we do not have more than 30-something percent ASMs in Mexico City, okay? So I would say, from all the players, we are probably less a factor, but still a factor by the strategy that they are applying in the pricing and the promotions in Mexico City, even during the high season. So it's important to understand that this price competition there is in reality affecting the market, and it is a challenge for the going forward numbers. Now let me pass the rest of the question for Fernando.

Providing guidance for adjusted EBITDAR for the third quarter, we are stating low to mid-30%. Hopefully, that clarifies.

This is much, much clear. This is very clear. And just a second question, if I may. On the landing, take-off and navigation expenses. If you look at the average fees per departure, we see a -- we saw a 30-ish percent expansion year-over-year. So I just want -- and that we saw these pressured in the last quarter as well. So I wanted to understand the reason for this increase? And if this is going to remain going forward or not?

Of course, what explains the drive in the landing and navigation expense increase is primarily related to more international traffic. As you saw in the quarter, we have a 33% ASM growth year-on-year in the second quarter. So that primarily explains that. As you know, operating in the U.S. airports is substantially more expensive than your average Mexican airport. And in addition to that, we also have some FX pressure in the quarter. So that's what's driving the increase year-over-year.

At this time we have no further questions. I would now like to turn the conference back to Enrique for closing remarks.

Well, thank you, all, once again for being with us today and for your interest in Volaris. Thank you very much, again, to the family of Volaris for their efforts. We wish you a great rest of the summer and we look forward to seeing you on September 13 for our Investor Day at the New York Stock Exchange. If you want to participate, please reach out to Andrés Pliego for more details, and have a great day. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.