Controladora Vuela Compania de Aviacion SAB de CV (VLRS) 2018 Q1 法說會逐字稿

Good morning, everyone. Thank you for standing by, and welcome to Volaris' First Quarter 2018 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.

Thank you. And good morning, everyone. With me today we have our CEO, Enrique Beltranena; and our EVPs, Fernando Suárez and Holger Blankenstein. They will be discussing the company's first quarter 2018 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 constitute forward-looking statements within the meaning applicable -- 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 statements.

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

Hello, guys. Good morning, and thank you all for being with us today. Thanks, Andrés. The first 3 months of the year have been 2 different stories, so to speak. The first one is the domestic market, in the first quarter was influenced by a significant capacity increase which permeated throughout Mexico. This has put substantial pressure on fare levels. And the second part is that in the international market routes between Mexico and the U.S. had a base fare environment that has been recovering. The traffic patterns are still soft, but continue showing improvement, and we've started to observe recent capacity cutbacks.

The macroeconomic environment has remained mixed due to the following reasons: first, the Consumer Confidence Index posted declines of 6.8% from December 2017 through March 2018. We had a higher fuel price environment; potential negative effect on FX from NAFTA; and in general, uncertainties surrounding U.S. immigration policies, such as DACA; and finally, the upcoming Mexican presidential elections, which have created uncertainty. Despite these conditions, during the last years and specifically in the last 9 months, Volaris has prepared itself for a very challenging capacity and fare environment dip in the market. This has resulted in: first, having the lowest unit cost, which is the most important competitive advantage in this environment; a, a low-cost model that is in -- that in the first quarter has produced a total 9% lower system CASM ex fuel year-over-year, resulting in a MXN 0.90 or USD 0.048 ex CASM.

Let me remind you that these numbers are a blended mix of costs between international and domestic networks. As you can expect, our domestic unit cost is lower than international. Our A321 capacity, which is our best (technical difficulty) unit cost is precisely based in the domestic market and, more important, basically in most of the Mexico City operations. We are absolutely committed to being and remaining the low-cost leader in Mexico, leveraging our superior scale and our financial strength; b, Volaris is targeting to be at USD 0.045 CASM ex fuel or lower by the end of the summer and even lower in the domestic market, and is doubling down efforts to continue this unit cost reduction. We continue committed to improve our ranking among the top 5 lowest unit cost operators in the world.

Second, the network load factors remain the most important driver to defend our core markets and produce high aircraft utilization, which drives lower CASM. Aircraft utilization in the first quarter achieved a historical high 6% versus last year, achieving 13.2 block hours per day. Load factor in the quarter was preserved at 82%. We reduced our fares significantly to bring the volume on board and remain very competitive. We are convinced that volume generation remains the most important driver of the top line and a healthy corresponding increase in our ancillary business.

Three, capacity management is key in this new environment, in which the low-cost carriers model is here to stay. Let me remind you that over half of the domestic market is already in LCC hands. And hence, the pricing environment is more challenging and we'll see the LCC carriers filling in the gap that higher cost carriers cannot afford to continue operating. The visiting friends and relative traffic patterns are very distinct from the traditional business and connecting traffic patterns, which makes seasonality much more pronounced as we are seeing it today.

Number four, in this new environment, we'll be cautious managing supply, but we intend to maintain our capacity leadership in our core markets of the Mexico-Pacific corridor, like Tijuana and Guadalajara, as well in our important market in the South Cancun.

From a market structure perspective, we are more and more close to a capacity realignment.

Our ancillary revenue performance surpassed its previous 28% mark and reached 34% of our total revenues.

Six, a structurally U.S. dollar-rich and liquid balance sheet is fundamental to navigate through volatile macro and geopolitical environment. Our international revenues and collections represent now 34% and 39% in U.S. dollars, respectively. Despite an operating loss, we generated operating cash flow and increased our net cash position, now standing at 29% of last 12 months' revenues, the highest level of any competitor in our market.

Number seven, risk management remains as one of our priorities. We have approximately 60% of our fuel consumption hedge for the remaining of the year that positions very well in the money. And as Fernando will elaborate later, we have also started to hedge FX.

Let me give you some color on the second quarter. Specifically, on sales and booking curves, our anniversary promotion conducted in March was a -- was tremendously successful. We have been building good volumes, as reflected in the load factor, although at the expense of discounted domestic base fares. Nevertheless, we expect uncertainty around NAFTA and the upcoming elections to increase during the quarter, which makes it very difficult to predict our customers' behavior and further price sensitivity. We expect international market to improve further on in terms of yields and a little bit in volume. Central America direct service to the U.S. started successfully this quarter and loads from unit revenues are performing well at the expected levels.

Ancillaries will continue very strong, as demonstrated by reaching the 34% of total operating revenues in the first quarter.

On CASM ex fuel, we also expect a year-over-year reduction in the second quarter, as Fernando will further elaborate. We have now the largest Neo and A321 fleet in Mexico, driving lower unit cost.

In sum, despite all the challenges mentioned earlier, we expect a better second quarter than the first quarter. Our codeshare agreement with Frontier Airlines is on target to launch sales during the third quarter, and this will enhance our distribution channels in the U.S. and offer new destinations to our customers, which will add incremental load factor to our existing network, giving us a better look in the U.S. market for the second quarter.

Before I pass it to Fernando, let me inform you that we have a better visibility from the aircraft and engine manufacturers now, confirming a good outlook on the Neo delivery fleet schedule for the second half of the year underlying our growth plans.

Now Fernando, please go ahead in elaborating our financial performance for the second quarter.

Thank you very much, Enrique. I'll be reviewing our results as per the figures filed with the SEC and BMV.

During the first quarter, we adopted IFRS 15, Revenue from Contracts with Customers, which replaces existing revenue recognition guidance. It has a different classification and timing of recognition of certain ancillary items such as bags, advanced seat selection, itinerary changes and other air travel-related fees. These ancillary items are now recognized in other passenger revenue. This change did not have a material impact on our income statement or balance sheet in any period presented.

Total operating revenues were MXN 5.9 billion for the first quarter, an increase of 2.7% year-over-year. Total ancillary revenues now represent 34% of total operating revenues, increasing 17% year-over-year, partially compensating the base fare decline. Total ancillary revenues were at MXN 1.9 billion for the first quarter. Total ancillary revenues on a per passenger basis now under this IFRS 15 adoption were a record MXN 461 for the first quarter, increasing 9.1% year-over-year.

In the transborder markets, our ancillary levels per passenger are now among the leading ULCCs in the world. During the first quarter, U.S. dollar-denominated collection was 39%, partially helping us to insulate the company from exchange rate pressures and reflecting the company's effort to have a natural hedge through a diversified network. This mix in our collection substantially closes the gap on any FX mismatch and brings us closer to being FX neutral.

Moving on to costs. CASM decreased 5.4% year-over-year to MXN 1.34 for the first quarter despite a net increase in our average economic fuel cost per gallon of 8% year-over-year, substantially offset by our fuel hedging program. CASM ex fuel decreased 9.1% year-over-year to MXN 0.91 for the first quarter. You need to recognize the company's effort at this level since continuing our reduction of unit costs while being among the top 5 lowest unit cost operators in the world.

The total average economic fuel cost per gallon in the first quarter was USD 2.20, which includes a net economic benefit from our fuel risk management program of $3.6 million. Looking at the second quarter, we have existing call options for approximately 60% of the expected jet fuel consumption at an average price of $1.74 per gallon. For the third and fourth quarter, we also have hedged approximately 50% at an average price of $1.81 per gallon. All these positions are substantially in the money.

Adjusted EBITDAR in the first quarter was MXN 822 million. Adjusted EBITDAR margin was 14.1%. Operating income was negative MXN 906 million for the quarter, representing a negative 15.5% operating margin, partially impacted by the increasing fuel prices as explained earlier and lower base fares as Enrique has stated.

The FX appreciation at the end of the first quarter led us to a noncash FX net loss of MXN 691 million below the operating line, given our net U.S. dollar monetary asset position. Net loss for the quarter was MXN 1.1 billion. The loss per Series A share was MXN 0.0111 and USD 0.60 per ADS.

Cash flow generation from operating activities for the quarter was MXN 1.1 billion positive. In conjunction with cash flow used in investing activities of MXN 313 million and net cash flow provided by financing activities of MXN 65 million as well as negative net FX effect of MXN 478 million from our high mix of unrestricted cash in U.S. dollars, net cash generation in the first quarter was MXN 366 million positive.

Our balance sheet remains strong, liquid and intentionally very dollarized. We are also comfortable with our financing profile and our adjusted leverage is conservative at below 5x.

As of March 31, Volaris had MXN 7.3 billion in unrestricted cash, representing 29% of the last 12-month operating revenues, which on this basis represents approximately twice the liquidity of our largest competitor in the Mexican market and more than 5x versus our next competitor. We maintained negative net debt or a net cash position of MXN 3.9 billion.

Complementing our risk management activities, given the macro and geopolitical uncertainties surrounding Mexico and FX volatility and despite the natural hedge that we continue to build, we have decided to mitigate part of that FX risk. Specifically, we have hedged approximately 20% of our dollar-denominated lease rentals via FX forwards. The notional amount of these FX forwards in U.S. dollars is USD 60 million.

From the fleet perspective, during the first quarter, the company did not incorporate any additional aircraft, and one aircraft was redelivered in February. As of March 31, Volaris' fleet was composed of 70 aircrafts with an average age of 4.8 years. At the end of the first quarter, Volaris' fleet had an average of 181 seats, 57% of which were in sharklet-equipped aircraft, on track to continue upgauging and reducing fuel burn in our fleet.

Additionally, last week, we received our first A321 Neo. This aircraft with 230 seats will continue to enhance our network in Mexico City and will further reduce unit costs.

Regarding capacity guidance for the second quarter, we expect to grow ASMs in approximately 9% and full year guidance of 9% to 12%. We are willing to provide unit cost guidance for the second quarter given that we locked in certain prices for fuel and other costs as well as early results from our cost-reduction initiatives. We expect to have a total CASM of MXN 1.32 to MXN 1.34 assuming current fuel and FX prices. This includes an aircraft and engine rental expense assumption for the second quarter to be in the order of $81 million equivalent. We will be in a position to complement such guidance with unit revenues later on in the quarter.

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

Thanks, Fernando. In a nutshell, despite the revenue environment, all the structural things have happened and are on track. We're focused on cost reductions, balance sheet strengthening and mitigating risk while upgauging our more cost-efficient fleet, diversifying our network and growing our ancillary product suites. We are poised for long-term success.

Thank you to our ambassadors, to the Volaris management. Specifically, thank you to the Board of Directors in these difficult times. And thank you very much to the preference of our customers who continue committed to maintain a successful business in Volaris, the lowest price operator in the Mexico market.

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

(Operator Instructions) And your first question comes from Duane Pfennigwerth with Evercore ISI.

Just with respect to the variance in expectations about improving margins year-over-year here in the first quarter, and I appreciate you rattled off a lot of issues, but was it more of a domestic or more of an international issue? And I wonder if you could talk about yield trends specifically in the first quarter across those 2 segments?

Thank you very much, Duane. Let me pass it to Holger.

So yes, it's basically a tale of 2 stories. The international market, the CASM was actually quite solid and the yield trends were quite solid. We did see a good performance in the U.S.-Mexico market and also in Central America in terms of fare environment and fare development versus last year. In the domestic market, the fare environment was a lot more difficult and certain markets were under a lot of pressure. However, there were some exceptions, like the Mexico City market, which performed better than last year. I'd like to remind everybody that our most important traffic is the VFR traffic and the price-sensitive leisure traffic, which is a lot more elastic than the business markets of some of our competitors. In addition, in the first quarter, the VFR and leisure markets are especially hard to stimulate due to seasonality, and that's what we saw in the domestic market, specifically.

Okay. And then, just with respect to the capacity changes that you have made, maybe you could just review for us, relative to what you were thinking about maybe 30 or 60 days ago, how you plan to grow domestic versus international, and where you've made the larger cuts. And then just coming back to my first question, I wondered if you could quantify what the FX headwinds to your yields were in the first quarter?

Duane, let me answer your last question first. So we estimate that the yield headwinds due to an appreciation of the Mexican peso in the first quarter was roughly 3%. And regarding your second question, in the international market, we did cut back growth quite a little bit where we took out some underperforming routes in the big markets, like New York, like Los Angeles. And we grew the domestic market at around 11%, which is very much in line with the market growth. And we continue to manage capacity supply quite cautiously. We intend to maintain our capacity leadership in the core markets of the Mexico-Pacific corridor like Tijuana and Guadalajara as well as in Cancun, as Enrique mentioned. And we believe that from a market structure perspective, we are getting closer to a capacity realignment for the market as a whole. We did cut capacity in some underperforming domestic markets like Monterrey and like Toluca.

I guess, just for my last question, obviously you guys have had a very dynamic scenario from currency. But as you think about maybe a firmer peso relative to where we were at the start of the year or the end of last year, I mean long run, is this a higher margin business with the peso here than 10% weaker? Or how do you think about the long-term margin perspective for the company relative to currency?

Duane, I think you are asking me to speculate.

And your next question comes from Michael Linenberg with Deutsche Bank.

Just a couple questions here. I want to go back to -- Holger, you had mentioned LA, and it looks like you pulled out of LA to Puerto Vallarta. You're pulling out -- you pulled out of LA-Acapulco. I think LA-Mexico City declines. What's -- I mean, you would think coming in with the low fares and in a big market and the ability to stimulate, or is it because OpenSkies has just unleashed so much capacity into that market? I also saw that you're pulling out of Mexico City-San Antonio. So is that the issue? Is it OpenSkies? Or is it not getting gate access at LAX? And as a result, what are you -- the Mexico City slots, are they better utilized within the domestic system? I know I'm asking sort of, I guess, it's like a 2-, 3-part question within 1 question, but I'm trying to figure out some of these international markets and why they just -- they're not doing well?

Michael, thank you for your questions. So what we have done is in the U.S. markets, the recently opened bilateral between Mexico City specifically and the large U.S. markets, we did see quite a lot of capacity increase from all competitors during last year. And we have decided to trim back our network in those markets to reflect -- because we saw lower loads in those markets. And we decided to focus on our core markets, which is the VFR markets and the niche markets between Mexico and the U.S., which have been tremendously successful.

I think, Michael, let me add to what Holger is saying, okay. I think what he said is perfect, but I would like to add that when you are in a process of margin deteriorations because of the fare environment, when you are in a process where you have a consumer environment which is shrinking, I mean, I would expect any airline in the world to focus in their core markets. And I think this company has reacted in a very fast way adjusting capacity to focus in our core markets as we said during our presentation, okay. And I think that's basically important for us, it's basically important for the future of the company, and it is a way of managing, cautiously, capacity.

Okay. Now that makes sense. And then, Enrique, just one question, one more just for you. When you were going through the various attributes of Volaris and how you were well positioned, you did make the comment that the June quarter should be better than the March quarter and that just for -- from a seasonal perspective, that should be a given. And I thought maybe what you were trying to say is that the March quarter, while margins were down year-over-year from the March quarter a year ago, were you suggesting that June quarter of '18, the margins are going to be better than June quarter March of '17? Or were you not saying that? You were just highlighting the seasonal difference? I want to just clarify.

No, I was saying that -- I mean, we recognize that we had a difficult first quarter and I was saying that we're expecting a better second quarter. As Holger said, the elasticity of the visiting friends and relatives and the leisure markets are better towards the shoulder season. And as a result of that, we typically have a second quarter better than the first quarter, a. And second, when we look at our booking curves, and when we look at where we -- our performance is coming and how the performance of the special offer that we did in March was, we see a better performance in the second quarter. And that's what we can say today. As Fernando said, the uncertainty in terms of consumption and the uncertainty in terms of FX and uncertainty in terms of, I mean, what is going to happen? Are we finally going to sign the NAFTA agreement? What is going to happen with DACA, which is supposed to prove or have better news during the month of May? I mean, all those things are creating a humongous uncertainty, okay. And what we're saying is the bookings look better, and that's all we can say today.

And your next question comes from Helane Becker with Cowen.

So Enrique, this is my question for you. Your stock's down 15% today and down, I don't know, conservatively, 60% from the all-time high, which was, I guess, 2 years ago now. Would you consider a share repurchase program?

Let me tell you, Helane, and this is a question that we've been seeing in the last, I would say, 6 months. I think with an environment that we're living on the commercial side, we need to be really prepared to use our cash flow reserves and everything to continue: a, growing and to -- and maintain our core markets in the right way. The second thing, it's not that we have a humongous amount of cash, okay. I mean we do have a 29% last 12 months' cash, which is probably the highest level of any company in the market. But in order to make a program like that, you need at least to sacrifice $75 million to $100 million in a program like that. The third thing is, we don't think that given the geopolitical problems that we are having now that we -- that a fundamental purchasing or repurchasing program would make a dramatic change to the performance of the share. So I think the bottom line of this discussion has been that we want to focus in our business, preserve cash and focus in our long-term investment, which is what we really are here for.

Okay. That's a fair answer. You've obviously given it a lot of thought. So my other question is, with respect to this domestic issue and overcapacity in the domestic market, how does that change? Do you see your competitors, your other low-cost competitors, reducing their capacity in the market? I think Aeromexico, they reported earnings earlier this week and they also reported a loss. But it seemed to be a little more from FX and they are not -- I guess, they are focusing more on their international business. So from your perspective, does it make sense to try to convince Mexicos -- Mexicans, sorry about that, Mexicans to travel internationally rather than domestically to sort of dig yourself out of this hole that you're in?

Let me slice your question a little bit. I will ask Holger to speak a little bit about how he sees the domestic market, and then I would like to say some other things. Let's start with that Holger, please.

Yes. Thank you, Helane. So if you look at the overall picture and the long-term picture, we are convinced that the eventual winners in the domestic market are going to be the ultra low-cost carriers. Volaris will continue to focus on its core markets, as we already pointed out, in the Pacific corridor, in Guadalajara, especially in Tijuana and in Cancun. We have a very successful transborder business as well, and we've created a new AOC in Costa Rica for new growth opportunities and for opportunities to allocate capacity in the future. If we look at the domestic market in particular, in the last -- in the first 2 months of the year, those 2 months we have data on, official data, we see a growth of market demand that is very much in line with previous months. 11% approximately was the market growth, which continues to be a very high growth, and it's in line with fast-growing emerging markets. Demand is growing at a tremendous pace. And our capacity and the market capacity grew in line with that high-demand growth. So yes, while we see fare pressures, we do see a market demand that is coming along with capacity growth. However, we will be and we will continue to be cautious with managing supply -- seat supply in the markets, and we will continue to focus on our core business.

So adding to what I think was a very good answer from Holger, I think something that it is really important, Helane, is I remain very convinced that this market, with a 0.34 air trips per capita, well beyond Panama, Peru, Colombia, Chile and Brazil and, by far, beyond from the U.S. and the European mature markets, we still have room to grow. One, we still have a room to keep on doing bus switching, okay. And we need to understand that emerging markets like ours are not only based in the fact that they simply grow because they're in line with what Holger said, how the total market is growing, but it -- there's also a switching factor from the buses, which we strongly think we need to keep on enforcing and that make -- that gives Volaris a potential to keep on growing in the domestic market, okay. And I think if we do not recognize that fact that we can keep on doing that, if we do not recognize the fact that we are doing it, that, I mean, 6% to 8% of our travelers are first-time travelers, that 22% of our travelers first board the buses, I mean, we would be neglecting the reality that we can keep on growing in the domestic market. So I strongly think that we need to continue growing in the domestic market. And I strongly think that the economics will get right in -- going forward.

Can you slow your growth in the domestic market by returning more leased aircraft?

No. No, I don't want to do it, specifically for the reasons I just said. And I also think that, I mean, the Mexican market, since it has changed in the mix of the passengers, when you look at this market 5 years ago, it was predominantly a business and a corporate traffic. Now, which is a middle-class and lower-class type -- kind of passenger likes to fly within Mexico, is growing. That's the class that's growing in Mexico. And then you need to remember that when you look at the statistics, the middle class is growing towards a 50% in year 2030. So I think that maintaining our focus there is the right answer.

Got you. And my last question is, one of your competitors looked like it was running out of cash. And in more recent weeks, they've announced that they are talking to a number of Chinese airlines about codeshare agreements and all sorts of other agreements. So does that just prolong -- if they're successful in doing that, does that just prolong the overcapacity situation in the domestic market?

Well, I cannot answer for them, okay.

And your next question comes from Rogério Araújo with UBS.

Just a follow-up on yields. So in Brazil, in the end of 2015 and beginning of '16, we saw a similar situation in terms of market deterioration. It was for different reasons. But here, we saw the airline companies reducing capacity drastically and fast. And this made the sector at least recover and the company to stop burning cash. So do you see anyone in Mexico is starting to do that? And would Volaris be willing to do that if instead of seeing additional improvements, that you actually saw further deterioration in the upcoming months? So my question is, do you see us in the area where you or any other players start actually reducing drastically the capacity in order to recover profitability? And my second question is on the Central American market. I would like to know, how is it growing? You already mentioned that yields are actually not bad in that market, but is it pushing yields downwards or upwards on the mix? And how much does Central America represents from Volaris' ASK right now? And how much we should see it reaching in the upcoming quarters? So it would be great to get more color on that front.

Rogério, we, in the last year, saw both Aeromexico and Interjet pulling out capacity from the domestic market and pulling out in a very important way, okay. You heard Aeromexico saying a reduction of minus 5% in ASKs in the first quarter, okay. So I think that's actually happening, okay. I remind you, guys, I'm the lowest cost operator. And being the lowest cost operator, I'm committed to the domestic market and I'm committed to continue doing the bus switching, okay. So I don't see a reason to reduce capacity right now. Central America, Holger will answer it.

Yes, Rogério, in terms of capacity, we have currently 3 airplanes allocated to Central America, which is approximately 3% of our ASMs. And we are continuing to build the business. We started operations from Central America to the U.S., LA, JFK and we're about to launch Washington as well with flights from Central America. And we've seen an improvement in the revenue situation in Central America. Our most important competitor, a legacy competitor in Central America, has pulled back from certain markets' capacity. And we're seeing a healthier fare environment than last year. And on the new U.S. routes from Central America, the competitive environment has been quite rational. So we're seeing quite a healthy revenue environment there for us as well.

Okay. And just follow-up here on the 3%...

I would add to what Holger has said in Central America that we see markets almost duplicating in terms of world.

Okay, makes sense. And the yields, is yields in Central America higher or lower than Volaris' average? Can you say that?

Well, let me tell you, I think, our TRASM is better than in the rest of the network.

And there are no further questions at this time. I would like to turn the program back to Mr. Beltranena for any closing remarks.

Well, thank you very much to all. I mean, as I said, I mean, we keep on doing the structural changes that we need to do. We need to maintain the company with a core, very well-structured company. And we'll continue doing the efforts that we have to do in a difficult time. Hopefully, the uncertainty of the several geopolitical things start vanishing and we get into a better times. Thank you very much for everybody.

And this concludes today's program. Thank you for your participation. You may now disconnect.