Controladora Vuela Compania de Aviacion SAB de CV (VLRS) 2017 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Volaris Third Quarter 2017 Financial Results Conference Call. All lines are in a listen-only mode. Following the company's prepared remarks, we will open the call for questions and answers. (Operator Instructions)

At this point, I would now like to turn the call over to Mr. Andres 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 Suarez, CFO; and Holger Blankenstein, CCO. They will be discussing the company's third quarter 2017 results announced today. Afterwards, we will move on to your 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 will forward-looking statements constitute within the meaning of applicable securities laws. Forward-looking statements are subject to several 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 statement.

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

Thank you, Andres, and good morning to everybody. Thank you very much for being with us today. Before we start, we want to extend our solidarity to the victims of the natural disasters resulting from the earthquakes in Mexico and the hurricanes in the region. Our thoughts and prayers in Volaris are with them.

During the third quarter, demand and traffic patterns, despite a competitive fare environment, had been sequentially improving, but in September, the natural disasters in Mexico and in the regions temporarily interrupted such recovery. We continued to drive non-ticket revenue growth, managed capacity prudently and reinforced our cost control discipline, reversing the negative cost increase trend. These actions positions Volaris with a defendable and resilient business model in the current environment.

Volaris posted a 33% adjusted EBITDA margin, in line with our stated guidance, 10% operating margin and 11% net margin. This reflects a sequential improvement in profitability versus the two previous quarters.

Moving on to market environment. During the quarter, we experienced mixed conditions in the domestic and international markets. Network load factor remained strong at 86.2% for the third quarter and 85% for the first nine months of the year. The number of passengers have increased 5.2% and 10.5% for the quarter and for the first nine months, respectively. Specifically for the month of September, we were the largest Mexican domestic carrier in terms of booked passengers.

Our non-ticket revenues continue to perform strongly, reaching MXN 434 per passenger in the quarter, an increase of 13% year-over-year. Year-to-date, ancillary revenues account for 27% of our total operating revenues. Let me repeat, they account for 27% of our total operating revenues. The first checked bag for international flights continued to drive non-ticket revenue growth with an uptake of more than 50%. We also improved our digital conversion, some changes in the sales flows and the new combos. Other important initiatives have increased our commission-based revenues from travel related products, such as a new hotel selection step in the purchasing process, the cruise packages and the car rentals.

In domestic market, we saw last minute promotional activities with this constituting high (inaudible), making it hard to yield manage at the very end of the curve of the bookings. Furthermore, during the summer at the Mexico City airport, we were assigned fewer slots than in the previous years, but our allocation for the end of the year looks very positive. During September, we also experienced two earthquakes that impacted 11 states in Mexico, particularly the second one affecting Mexico City. Volaris has only 30% of its capacity in Mexico City, reflecting a much more diversified network versus our home and small competitors, and as a result, we were less impacted.

In the international market, we continued managing capacity. Our core visiting friends and relatives routes performed better than the leisure destinations. Unfortunately, during the quarter, we also experienced the hurricanes in the region. Accordingly, we remained cautious to manage capacity, decreasing our international ASM's by 3% quarter-over-quarter and an increase of only 12% percent year-over-year, continuing improving our U.S. dollar-denominated markets, which is our natural hedge against devaluation.

On the bus switching front, we continued to make further inroads by proactively executing our marketing efforts and promoting on diverse fares within the bus switching program.

With respect to costs, the third quarter was about returning to cost control and discipline. We reversed the trend of five quarters of soft cost creep and pressure. In terms of unit costs, we reduced our CASM and CASM ex fuel year-over-year by 5% and 6%, respectively, with a lot of actions pressuring the cost down. Our unit cost structure of USD 4.9, excluding fuel equivalent, places the company as one of the best five lowest unit cost operators in the world.

We faced some fuel head winds, particularly in jet fuel refining cost. Our economic fuel price per gallon posted a year-over-year increase of 13%, which was partially offset by our fuel hedging program. From the fleet perspective, in line with our capacity management in airports, we only took delivery of one aircraft in the first nine months of the year. In addition, we redelivered three aircraft in the same period ending September with the total amount of aircrafts of 67 units.

On the Central American operations front, we can share with you that we obtained U.S. DoD approval to be able to operate direct from our Central American destinations to the U.S. While we finalized the certification process of the FAA, we improved our Central America itineraries and added Tijuana Cross Border Xpress to San Diego as a destination. Effective November 18, the itineraries have been published and sales, for example, from Guatemala look very solid. This provides a functional connectivity from Central American to Southern California at a low cost.

Before passing it onto Fernando, let me summarize by giving you some color for the fourth quarter given the uncertainty that we (inaudible) at the end of this quarter. We continue to see a solid sequential improvement in the international market with better base fare levels, improved non-ticket revenues and capacity control.

In the domestic market, we see a very resilient volume traffic, but still with a challenging base for environment that we are addressing with cautious capacity management and reducing our unit cost. Our current outlook for the fourth quarter is one of a more normalized environment. And as a result, we see sales in line with our expectations, and we will continue to manage capacity cautiously and pricing it accordingly. The booking curves for November and December are in line with our expectations. We now expect full year 2017 ASM growth of 13% to 14% given the fact that during the first nine months, we had to reduce our ASMs to lower utilization, redelivery of our aircraft and no new aircraft arrivals in the first half of the year. A 13% to 14% growth in an environment where economy grows 2% to 3% is an amazing number in terms of growth for any airline in the world.

Now I will hand it over to Fernando to elaborate on our financial performance for the quarter.

Thank you very much, Enrique. I'll be reviewing our results for the figures filed with the SEC and BMV this morning. Total operating revenues were MXN 6.6 billion for the third quarter, a decrease of 2.2% year-over-year, notwithstanding the negative effect of the natural disasters and the soft fare environment during the quarter. Non-ticket revenues were MXN 1.8 billion for the third quarter, an increase of 18.6% year-over-year. Non-ticket revenues per passenger were MXN 434 for the third quarter, increasing 12.8% year-over-year.

TRASM had a sequential improvement of 6.8% quarter-over-quarter, reaching [MXN 0.138] for the third quarter and a decrease of 11.2% year-over-year. U.S. dollar-denominated collection was 39%, partially helping to insulate the company from exchange rate pressures and reflecting the company's effort to further diversify its network.

Moving onto costs. CASM decreased 5.0% year-over-year to [MXN 0.124] for the third quarter with an average exchange rate of MXN 17.82, a year-over-year decrease of 4.8% and despite an average economic fuel cost per gallon of MXN 31.8, increasing 3% year-over-year. CASM ex fuel decreased 6.2% year-over-year to MXN 0.89 for the third quarter. The total average economic fuel costs per gallon for the third quarter was $1.75, which includes the recognition of call option premiums of USD 0.01 per gallon, offset by a net economic benefit of MXN 2.6 million from our call options exercised in the period.

During the third quarter, we incorporated one additional A320neo, the second of this engine technology in our fleet. The 320neo's we had in the fleet, operated reliable, approximately 13 hours per day during the summer. We finished the quarter with a fleet of 67 aircraft composed of 12 A319s, 45 A320s and 10 A321s with an average age of 4.6 years, the youngest fleet among Mexican airlines.

At the end of the third quarter, Volaris' fleet had an average of 180 seats per aircraft and 63% of the seats were in Sharklet-equipped aircraft, on track to continue improving fuel burn and efficiency in our fleet. Our fuel risk management program paid off in the quarter with jet fuel of USD 1.75 from late August or from late September and considering an average strike price of our Asian call options at USD 1.44 per gallon for the third quarter.

Looking to the fourth quarter. We have existing call options to hedge approximately 57% of the expected jet fuel consumption at an average price of $1.40 per gallon and are currently in the money on such positions. We also have hedged approximately 45% of 2018 at an average price of $1.74 per gallon.

Adjusted EBITDAR in the third quarter was MXN 2.2 billion. In line with our stated guidance, adjusted EBITDAR margin was equal to 33%. Operating income was MXN 634 million for the quarter, representing 10% operating margin. The FX depreciation at the end of the third quarter led us to a net gain of MXN 125 million below the operating line. Net income for the quarter was MXN 731 million with a net margin of 11%. The gain (inaudible) was MXN 0.72 and USD 0.40 per ADS.

Our balance sheet remains strong, liquid and intentionally very dollarized. Our financing profile is also comfortable and our leverage is conservative. As of September 30, Volaris had MXN 5.4 billion in unrestricted cash, representing 22% of the last 12 months operating revenues. We maintained negative net debt for a net cash position of MXN 3.0 billion. Cash flows from operating activities before changes in working capital for the quarter was positive MXN 978 million. Such changes in working capital resulted in a net cash flow used in operating activities of MXN 385 million, reflecting the seasonality of our operation. In conjunction with cash flow used in investing activities of MXN 565 million and net cash flow provided by financing activities of MXN 268 million as well as a positive net foreign exchange effect of MXN 73 million pesos from our high mix of unrestricted cash in U.S. dollars, total net cash decreased by MXN 608 million.

Moving on to fourth quarter guidance. We expect to grow ASM's by a range of 9% to 10%, as we take delivery of three new aircraft late in the quarter. Domestic and international ASM's will be around 8% and 10% year-over-year, respectively. Regarding profitability guidance, we expect to achieve an adjusted EBITDA margin in the mid- to high-20s for the fourth quarter, assuming current spot exchange rate and jet fuel prices. Our aircraft and engine rental expense for the fourth quarter is expected to be in order of $83 million.

Reinforcing our cost control discipline, we foresee a year-on-year CASM ex fuel reduction in the fourth quarter, assuming no major swing in currency. In addition to our embedded unit cost dilution coming from (inaudible), various cost savings initiatives are underway, including an organizational effectiveness exercise conducted in October.

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

Thank you, Fernando, and congratulations for the (inaudible) on the unit cost. We continue working on doing a lot of airports, reducing our costs, finding new ways to increase the non-ticket revenue, which you saw that incremented substantially, getting people to switch to us from buses and managing capacity in an amazing and very disciplined way. On the financial side, we continue working to maximize the return on investment capital by maintaining also a balance sheet with a very, very well protected U.S. dollar position. We are absolutely optimistic about the fourth quarter and beyond, in which we expect a much more normalized environment and especially because of ultra-low-cost carrier model, in which we continue to improve the execution, is performing better and better every day.

Thank you very much to all of you. Thanks for your patience during these difficult times. We keep on working for you, and we keep working to produce the best that we can produce. And thanks to all the family of in Volaris for their airports and what they have been doing.

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

(Operator Instructions) Our first question comes from Duane Pfennigwerth from Evercore.

Just wondering as we look at the industry capacity backdrop in Mexico, it feels like it's starting to adjust to a more difficult backdrop. Do you agree, and more importantly, is there anything you see in your advance book yields to suggest that maybe pricing is starting to react to a far more slow capacity growth rate?

Duane, (inaudible), we discussed this in Boston. We absolutely agree with your view. We just need to be careful. Remember that in Mexico, you can add capacity in a much more flexible way than the way you do it in the U.S. because the industry has no limitations with pilots for assigning lines lately. So we see airports, I mean -- sometimes, I mean, we think that the numbers are looking okay and then suddenly we see our numbers go off and I think this was an example of that. We saw one of our competitors having capacity from here to end of the year and the beginning of next year, okay? But in general terms, we absolutely see a trend of the entire industry to manage capacity in a very cautiously way.

Great. And then I wonder, maybe Holger, could you quantify the impact of the international bag fee in any ancillary lines so far, and can you maybe speak to the potential for adding that in the domestic market also?

Yes, Duane, so the first bag fee in the U.S. has definitely contributed to the increase in ancillary revenue. Currently, we see an uptake of around 60% -- high 60% of our international passengers that buy the first bag, and then we are charging around USD 20 depending on when you actually buy the first bag within the booking process or at the airport, prices vary. And we also are very bullish on further growing ancillary revenue in the domestic area as the new aviation law permits us to offer a preferential fare for those customers that do not want to travel with the bag. They can eliminate, then we can further unbundle our fares to offer lower fares to those customers that don't want to take a checked bag. So we are really optimistic in further growing up ancillary revenue, especially driven by first bag fee both in international and domestic.

I think (inaudible) environment where we see a deterioration of the base fare yield. It is of absolute importance that we keep on working increasing our ancillary revenues and the more we work on this, the better will be. The second thing is (inaudible) in this -- within this line, is the fact that Volaris is probably going to be the first airline in Mexico who will be offering domestic product with a lower fare and no check-in bags. We are launching that effective November 1.

Our next question comes from Pedro Balcao from Santander.

Congratulations on the cost performance, really well done. But what I wanted you guys to give us some more color was on the yields, why are they falling so much and why are they falling apparently more than the other players? Is there a component of stronger peso here affecting negatively the yields also? That is my question.

Thank you, Pedro. I will ask Holger to tackle that one.

Pedro, good morning. So in the pricing environment, we are seeing two different stories and domestically, we continue to see quite aggressive pricing activity from many players in the market, actually from all players in the market, especially in the larger airports of Mexico City, Guadalajara and Tijuana. However, in terms of volumes, demand remains quite strong. So the yield decline has been made up partially by very healthy load factors. And please remember also that we are coming off a very, very strong third quarter 2016, so the comparable base is a quite challenging comparison. Internationally, the story is a little bit different. The base fares remain relatively solid without the kind of competitive pressures we're seeing in the domestic market -- in the Mexico domestic market, especially in our niche DFR markets that we operate INTRA to the U.S. But despite the positive (inaudible) situation in the international market, the demand remains softer than in domestic markets as we continue to see uncertainty of travel towards from the U.S. that we are experiencing, as you can see in our load factors. So it is important to remember that we are a load factor access company and all our actions have the focus to keep a solid network load factor, overall 85%. And as you can see in the third quarter, we achieved a load factor of 86%. So we tend towards higher volumes and lower yields if possible.

Can you give us some color on the yield for the fourth quarter? I know it's early on but some color.

So as Enrique mentioned, the fourth quarter obviously is typically seasonally positive. We have a strong high season there built in. However, the pricing environment for the fourth quarter continues to be challenging, especially in the domestic market. And again, please bear in mind that the year-on-year comparison is a difficult comparison as last year's fourth quarter was an outstanding quarter in terms of volume and yield. Seasonally, the fourth quarter is typically relatively strong. And as Enrique mentioned, the booking curves are quite solid as we go into November and December high season.

As I mentioned also, we did get a good allocation of slots at Aeropuerto de Mexico, which is giving us opportunity to operate at least of the levels of last year, which is really positive.

Thank you very much, Pedro. Michael, would you like to make your question?

I guess two questions. I just want to go back, so it sounds like with respect to Mexico domestic, I want make sure I heard you right that you essentially can have a first bag fee rate. I mean, I guess if you're traveling and your not fine with the bag, you end up getting a discount. Is that -- did I hear that correctly?

That's going to be allowed now within Mexico domestic.

Michael, so what we are going to do is offer a preferential fare for people that don't want to travel with a bag and implicitly, we are going to able to charge for the first bag for those customers that decides to take the first bag even though they deselected and selected the preferential fare -- the lower preferential fare.

Great. That's effective November 1?

That's effective November 1, correct.

Okay, great. And then just my second question. Enrique you talked about getting the approval for the Central American operation and you had mentioned some markets and I just -- I don't know if I heard you, I think you had mentioned Guatemala to Los Angeles or maybe it was by way of Costa Rica. What was one of the markets that you're planning to fly or what --? I missed out in the beginning.

So it's two spreads in this equation. The first part of the equation is to start certifying the airline at the IATA level because once you have the DoD approval, what you have is a concession to fly between the region and the US. Now we need to do DoD approval, NTSB approval and Homeland Security approval of processes, which is going to take us some three, four months from now. In the mean time, what we are doing is we reschedule the entire fleet there, the (inaudible) aircraft, and we are adding more frequencies within Central America, and we are -- we did put some flights from Guatemala and from Santiago to Tijuana using the Cross Border Xpress to get to the U.S. in a much more easier way. The bookings for Guatemala -- and we just launched that this week. The booking from Guatemala to Tijuana, CBX, San Diego are looking very well with 50% load factor after four days of sale.

Well, that's a smart move, and you said also from San Salvador to Tijuana as well?

Exactly. The same thing from Santiago to Tijuana, and these two routes are effective from November 19.

Are these several times a week, like two to four times weekly?

Four times a week. I mean, this is really important. I mean, what you're seeing here is everything that we've been proposing during the year, higher baggage fees, better baggage fees, first international, now a domestic equation of doing it, and now we're seeing Costa Rica performing to the U.S. and starting to perform to the U.S.

Our next question will come from Helane Becker from Cowen & Company.

So my first question is I think I'm not sure if Enrique said this or who said this, but you talked about your booking curve for November/December being in line with expectations, and I'm just kind of wondering is that -- are those expectations pre or post earthquakes? In other words -- .

I mean, we have a plan for the full year and the plan is coming along in the third quarter at the level we were expecting it. So it's after the earthquake. We think, Helane, that the earthquake effect or whatever the wave was up to the earthquakes and obviously also the hurricanes, we need understand that Volaris flies to Texas, Volaris flies to Florida, Volaris flies to Puerto Rico and then you need to understand that we are not only affected by the earthquakes, but also by the hurricanes. And as a result of that, we think that the whole wave of aftertaste of all these events has been affecting the second half of September and probably some weeks in the month of October. The bookings from here to the end of the year are in line with our regional budget expectations.

Okay, that's perfect. That's what I wanted to know. And then my other question is what do you need to see in either Mexican economy or in a fare environment to kind of get a factor growing in the mid- to high-teens?

Going to be growing mid- to high-teens?

No, no. You used to have a growth rate kind of in the mid- to high-teens and where do you need to get back to -- for air fares to kind of get back to that level?

Yes, Helane, we were receiving three aircrafts in the last quarter of this year and those aricrafts are going to be capacity in reality for chart, which is basically addressing the growth in the first semester of the next year. And so we will see us keep on growing. But I think, Helane -- and here I feel a little bit frustrated every time I speak about this. This company these years is growing 13%. And I think in general, the market is not qualifying the amount of growth of the company and how the company is growing. I think a company that grows 13% to 15%, it's an amazing company in an environment where the economy is growing 2% to 3%.

Our next question comes from Stephen Trent of Citi.

Just a couple of quick ones from me and I'll -- first off is if I could trouble you to clarify, I wasn't sure you mentioned something about receiving FAA approval for the Central America flights, but you still need NTSB and Department of Homeland Security to approve some specific routes, but I didn't hear exactly what you said, if I could trouble you to repeat that.

What I said is once you get approval to fly into the U.S., which is something which is responsibility of the Department of Transportation, then you have to go through FAA and certify for an FAR129, that's the name of the certification that you need to get. And we are well in progress on that, we have been progressing before the process and obviously the official part in the process officially happens is now in the process and it's going to take us two, three, four months probably. Then after that you need to go and do the certification on security for stations and that happens at Homeland Security with the TSA and obviously, you need to do the NTSB process, which is part of the safety process to fly into the U.S. So those three things are happening as we speak. Important to say that it's something we have done several times in this company. So we're used to do that and it's just a (inaudible) that we need to pass and accomplish with everything that the authorities are requiring. It's a normal thing. And then the next step obviously is to start flying to the U.S. and we will do that eventually once we have the approvals. But in the meantime, we insist, we are using Tijuana with Cross Border Xpress to San Diego and Southern California market, which is an amazing way of starting to hit the market.

Okay, now I get what you're saying. I appreciate that, Enrique. And just two other very quick ones from me. One, I think you then said for 4Q, you're looking for an EBITDAR margin, adjusted EBITDA plus rent in the high 20s. I wasn't sure if I heard that correctly.

Right, that's correct. I mean, to your previous question, I mean, I just want to remind you that when you get to the functionality, (inaudible) in Tijuana, a, you won't need Mexican Visa, you only need U.S Visa. And second, you basically go through the floor to the U.S., you will need to make immigration and customs in next floor.

Got it, very helpful. My final question and apologies, the last question, let someone else ask a question. In the quarter itself when we think about the working capital cycle, was there anything related to that or associated with the Central America ramp up behind what seemed to be a slightly slow working capital cycle?

Steve, no, nothing out of the ordinary in the working capital cycle in the third quarter. The changes in working capital, the main activity there is the unearned transportation revenues as we get out of the high season and into low season, but nothing extraordinary regarding Central America.

Our next question comes from Joshua Milberg of Morgan Stanley.

I was actually just hoping you guys could give a little bit more color on your cost performance in the period and specifically on the big maintenance expense decline that we saw. Just wondering how much of that -- how much of any of that is due to a lower pace of aircraft returns and maybe some lower redelivery costs?

Yes, Josh, in the third quarter, we had various cost initiatives that are starting to kick in. On one side, we are getting the benefit of the upguage, which naturally gives us a unit cost reduction as we redeliver A319's and take delivery of A320neo's and A321's. That's a natural process that we're seeing in unit cost aggression. But in our positive initiatives and savings initiatives, we continue to work on. We have shown a good performance in terms of maintenance cost optimization and redelivery costs, where we we have been fine-tuning that and managing the processes better. So all of that helps in getting the unit cost down. We did get some help from FX obviously with a less volatile exchange rate in the third quarter. But in general, it's the sum of all of those cost initiatives that are kicking in and the ones that we are accelerating also for fourth quarter and to tighten up further cost discipline in the company.

Okay, that's very helpful. And then my other one was just if you guys could touch a little bit on the sort of '18 capacity growth outlook. I don't know where you are and if you're already kind of firmed up in terms of having a view on what your thinking, not just overall, but thinking Central America, Mexico domestic, International?

Correct. It's still a work in process, how we're developing the operating plan for 2018. But you should be thinking of a low- to mid-teens seat growth. That's what we have and taking into consideration the redeliviries that we have next year and the arrival of new aircraft. As mentioned, we have three aircrafts incorporating end of the year, but that permanently is going to be capacity for 2018. We will be able to schedule part of that in December, but it's primari;y capacity in the -- really in the first half of next year. We also have important maintenance work, heavy check and so forth, so available aircraft for the fleet will be somewhat that. If we take everything in conjunction, it should be a seat growth in and around low to mid-30s thing, which is what we posted this year.

At this time, I'm showing no further questions.

So thank you very much to everybody. Ladies and gentlemen, I think Volaris sees a very good performance despite the difficulties of the quarter, and I think the sequential improvement continues. Speak to us and thank you very much for your compliments.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.