VLRS - Volaris Stock: Creating Potential For A Rewarding Investment Opportunity

2023-09-21 04:34:21 ET

Summary

• Volaris stock has underperformed despite a bullish view, prompting a review of its valuation.
• Base fares declined, load factors softened, and there are problems with the GTF that powers part of the Volaris fleet.
• Opportunities include increased services to US airports, and market penetration potential in Mexico.

Volaris (VLRS) has been one of the companies that I have been bullish on. Despite a bullish view, however, the stock has not performed to satisfaction and went from easily outperforming the markets since my buy to underperformance. That has sparked a review of my valuation for Volaris.

Why Is Volaris Stock Down?

The question that many shareholders likely have is why the stock is down. Volaris stock peaked at $15.05 in June, but following its earnings release in July the stock has been sliding. Looking at the results it was observed that base fares declined, which is never something that investors are liking though Volaris sees it as a sign of its ultra-low cost model functioning as its ancillary revenues per passenger are strong.

Total revenues per unit capacity were down 4% year-over-year while load factors softened due to a rumor of a potential strike at Volaris and there are challenges with the geared turbofan from Raytheon Technologies ( RTX ) that are equipped on the Airbus A320neo family airplanes operated by Volaris. The airlines currently has a fleet of 70 A320neo family airplanes with two more to come but the delivery of two airplanes could be delayed due to OEM constraints while the scale of the issues with the turbofan exacerbated in September and potentially affects flight schedules. Adding to the pressure is that there is some overcapacity on the domestic market, and there are constraints at the airport of Mexico City specifically while oil prices are also on the rise, increasing the fear that costs are increasing while top line growth is fading.

Having read the Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (VLRS) Q2 2023 Earnings Call Transcript , the undertone was negative even though management tried their best to present it as best as they could. The reality is that there is pricing pressure and the company has guided up for capacity leaving its topline guidance unchanged which points towards further pricing pressure. Q2 2023 earnings also missed expectations by $39.1 million or nearly 5% while EPS of $0.05 missed expectations by $0.15.

What Are The Opportunities For Volaris?

While there is some pressure on the pricing and some airplane and airport related challenges, things are not all bad. The appreciating peso has a negative effect on costs, but a positive effect on TRASM and one thing that seems to be significantly overlooked is the fact that the Category 1 safety rating for Mexican airlines has been reinstated by the FAA allowing airlines to increase their services to US airports. For Volaris this means the market gets bigger and the pressure on the domestic market pressure might somewhat ease. Furthermore, utilizing the new engine option, airplanes such as the Airbus A321neo on longer routes will be a positive to the unit cost profile for the airplanes. While for nearshoring and reshoring trends and growth I am a bigger fan of investment in Mexican airports , Volaris could also be enjoying a tailwind from this trend which is boosted by the upcoming connectivity expansion to the US.

Furthermore, on the domestic market there still is a lot of market penetration potential as around 25% of the routes that can be flown rather quickly is still being served by bus. And Mexico is somewhat underpenetrated when compared to other countries.

Is It Time To Sell Volaris Stock?

Looking at the results of Volaris, I was inclined to prepare a downgrade report which in my mind would be carried by a dimmed outlook. The opposite, however, is true for the coming years is what I found after entering the numbers into my model. After the recent sell-off, the stock should be trading at least at the $17.60 level providing 103% upside and even more in the years after, which makes the current stock price quite attractive.

Conclusion: Ugly Earnings, Bright Prospect For Volaris

While the earnings were not quite appealing and we see some capacity and pricing challenges, some opportunities such as improved US connectivity and reshoring and nearshoring trends have been overlooked. When entering the fundamentals in the model combined with forward projections, I found that the decline in stock price as seen in recent months has been nothing more than a knee-jerk reaction that could provide an excellent entry point. But note that Volaris can still be dragged down by industrywide news items about base fares and oil prices.

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