Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (VLRS) Q1 2017 Earnings Report, Transcript and Summary

Good morning, everyone. Thank you for standing by. And welcome to Volaris's First 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. Instructions on how to ask a question will be provided at that time. Please not that this event is being recorded. At this point I would now like to turn the call over to Mr. Andres Pliego, Volaris's Financial Planning & Investor Relations Director. Please go ahead, sir.

Thank you. 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 First Quarter 2017 results announced to-date. After that 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 segments we will make on this call would constitute forward looking statements within the meaning applicable securities laws. Forward looking statements are subject to a number of 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 the call over to our CEO, Enrique Beltranena.

Thank you, Andres. Good morning and thank you all for being with us today. The first three months of the year 2017 presented an array of factors that challenged our performance trajectory. For starters we have a shift of the highly traveled Holy and Easter Weeks from the first quarter in 2016 to the second quarter of this year. So, this gives us a tough basis of comparison. In addition, 2016 was a leap year, so this quarter we are missing an extra day of operation. On top of this calendar factors, we have other external macro and geopolitical factors that impacted the travel demand between Mexico and U.S. a key market for us. Nevertheless, the macro figures in Mexico continue to be modestly strongly with same-store sales increasing 4% during March, remittance is dollar terms are also increasing by 2% in January and February, as we as consumer confidence recovery in strength towards the end of the quarter. I want to take a few minutes to go over the month-to-month dynamics of quite an experience so that you can understand the first quarter for Volaris and how we responded to adjust for these effects and put us on the right footing for the remainder of the year. Starting with D&A, as I have mentioned despite the macro and geopolitical shocks, we know there is strong demand growth in Mexico not just for airlines, we saw strong consumption indictors and a healthy demand environment throughout the country. Accordingly Volaris started 2017 with a strong January traffic sprint moving on to February, we started the month with a softer demand environment and week fares, especially in northbound leisure markets which we attribute mainly to uncertainty from the following factors. First, the U.S. discussions on travel bans, talks about stricter passengers screening methods and decking procedures, visa and migratory status debates, attention in general in the Mexico, U.S. Bilateral agenda, such threats of a NAFTA cancellation. This resulted in people being much more reluctant to travel from Mexico to Central America to the U.S. We reacted immediately with the reduction of capacity growth. From January to February, growth rates were cut by 9 percentage points and from February to March, another 9 percentage points in the ASM growth. We also had to decrease of base fare to stimulate demand in the U.S. market. For the second half of the month, we began to see and improving demand environment, which allow us to partially recover total unit revenues towards the end of the month. Now in February, load factor was soft at 80% with a low of 76% in international. This shows a strong load factor in the domestic market for a low season month. But as I mentioned, the push to sustain it was the result of a capacity reduction together with the further dilution of the base fare. We also served the markets with U.S. BFR traffic were not as impacted as the U.S. bound leisure market. In March, we had a slightly better recovery in the bookings were to February and we started to see market uncertainty decrease. Therefore demand began to strengthen. However, the year-over-year comparison among traffic and revenue indicator show the effect of Holy and Easter weeks taken place in the second quarter instead of the first as it did last year. In March, we also had our special anniversary sales, which was this effect, it show the recovery trend in the market with healthier bookings for upcoming months, still with lower U.S. bound demand. Nonetheless, we continue to be cautious with our growth to match the lower base demand environment, we're seeing in the market. Also in March, the Company implemented a new baggage policy in the routes to and from the U.S. But we are charging for the first check bag for new bookings as of March 1. In general, the implementation has been seamlessly with good customer acceptance. In addition, today, our main competitors are all charging for the first bag, which no longer puts us at a disadvantage from the consume perspective. Income during the first quarter, reflect a changing environment with the tough year-over-year comparison. Our network load factor for the quarter of 83% is a good number despite the seasonality effect and a decrease of 4.2 percentage points on the international part. Despite the 17% ASM growth in the first quarter, the Company didn't take any additional aircraft. On the cost side, we also faced important headwinds, both in fuel price and exchange rate with year-over-year increases of 68% and 13%, respectively generating and increase in our operating expenses of 48%. Nevertheless, our unit cost remains within the top operators of the world at $0.053 U.S. dollar CASM. In terms of profitability for the first quarter and despite the volatility in the marketplace, we met our profitability guidance provided during our last earnings call with an adjusted EBITDAR margin of 19%. We have positive net cash flows from operating activities of Ps. 469 million. And I want to repeat this we have positive net cash flow from operating activities at the end of the first quarter with strong cash and cash equivalents position of Ps. 6.8 billion. Now let's talk about our second quarter and how we see it perform. We have already revised our ASM growth expectations downwards by approximately 8 percentage points to a range of 16% to 18% to hit the lower demand environment. We will however continue to be cautious with our capacity growth and we will analyze the progress as we get more visibility. Everything is pointing towards being able to reinstate some capacity in June, but at this stage, we want to be cursive. Traffic registered for Holy Week in April posted strong factor growth with a stronger domestic and a softer international demand. Revenue growth for the second quarter at this moment looks in line with capacity growth that we need to pay a close attention month to month. It leads us to be cautiously optimistic that the landscape is more upbeat. The bus switching effort, we are really optimistic. Bus service we conducted in February, we now know that approximately 8% for 6% last year of our passengers were first-time fliers. Over 20% also considered traveling by bus, 15% had traveled the same route by bus and only 8% would consider traveling by bus again in the future. We also learned that when decided on flying versus taking the bus, the time it takes to make the trip have more weight than the far which makes Volaris the clear choice amongst passengers by also having very competitive fares compared to the bus. 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 BMP this morning. Total operating revenues for the first quarter reached Ps. 5.7 billion, up 9% compared to the same period last year. During the first quarter, non-ticket revenues reached Ps. 1.6 billion, an increase of 28% year-over-year. U.S. dollar denominated collection was approximately 40%, partially helping to insulate the Company from exchange rate pressures. Moving onto costs, CASM was equal to a Ps. 141.4 cents for the quarter a 27% year-over-year increase, mainly driven by the economic fuel price increase of 58% and average exchange rate depreciation of 13%. The FX increase impacted dollar denominated cost line items such as fuel, aircraft and engine rent expenses and certain traffic and maintenance costs. We also note that this quarter we did not have the benefit of any gains from sale leasebacks in the other operating income line as opposed to the same quarter last year. The total average blended economic fuel cost per gallon for the first quarter was $2.0 which includes the recognition of call option premium of $0.08 per gallon partially offset by the benefit from some of our call options that now expired in the money for the quarter. Fuel cost represented 29% of total operating expenses for the quarter. During the first quarter, we did not incorporate any additional aircraft, hence as mentioned, nor did we post any gains on sales and leaseback operations. We finished the quarter with a fleet of 68 aircraft composed of 14 A319s, 44 A320s and 10 A321s with an average age of 4.4 years. At the end of first quarter Volaris' fleet had an average of 179 seats per aircraft reflecting our fleet up gauge strategy and 52% of the seats were in Sharklet-equipped aircraft, on track to continue improving fuel burn in our fleet. We remain active in terms of fuel risk management. Looking forward for calendar 2017, we have purchased call options to hedge approximately 50% of the expected jet fuel consumption at an average price of $1.48 per gallon. We have also hedged 40% of 2018 at an average price of $1.74 per gallon. Adjusted EBITDAR in the first quarter was Ps. 1.1 billion, equal to a 19% adjusted EBITDAR margin. Operating loss was Ps. 772 million for the quarter representing a negative 14% operating margin. During the quarter, we experience FX headwinds above the income line, however we have served 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 a holding a higher U.S. dollar net monetary asset position, which due to the appreciation of the Mexican peso, that ended the first quarter led to an FX loss of Ps. 1.1 billion below the operating line. Conversely, when the Mexican peso has depreciated in previous quarters, we have booked important FX gains below the line. Net loss for the quarter was Ps. 1.4 billion with a net margin of minus 24%. The loss for Series A share was Ps 1.3 and $0.71 U.S. per ADS. On the balance sheet, we continue to build financial strength with our cash liquidity position that provides us with flexibility to grow at healthy rates and maintain a comfortable financing profile. As of March 31, Volaris registered Ps.6.8 billion in unrestricted cash, representing 29% of the last 12 months operating revenues. We maintain negative net debt or a net cash position of Ps. 4.8 billion. During the quarter, we had a positive net cash flow from operating activity of Ps. 459 million. This together with financing and investing activities as well as a net foreign exchange effect of minus Ps. 533 million from our high mix of unrestricted cash balance in U.S. dollars resulted in a total net cash decrease of only Ps.233 million. Moving on 2017 capacity guidance, in terms of ASMs, we have elements that make us believe we can maintain our full year guidance of in or around 15% growth. Specifically, for the second quarter, we expect to grow ASMs in the 15% to 18% range, again bearing in mind the seasonality effect of having Holy and Easter Weeks in the second quarter, plus delays on aircraft deliveries. Regarding profitability guidance, we expect to achieve and adjusted EBITDAR margin in the range of 26% to 29% for the second quarter, assuming current spot exchange range and jet fuel prices, which could represent up to 10 percentage points of adjusted EBITDAR margin improvement quarter-over-quarter. We will not have any sale and leaseback transactions in the second quarter. If we make a pro-forma of the first quarter of last year, which included the Holy and Easter weeks by adjusting to current FX and fuel prices and excluding the benefit of sales and leaseback gains from such quarter, the result would be an adjusted EBITDAR margin similar to our second quarter 2017 profitability guidance that we have just given. On rental guidance, our aircraft and engine rental expense for the second quarter is expected to be in the order of $80 million. Now I will pass it over to Enrique for closing remarks.

Thank you very much Fernando. I think that given the environment that we have in the first quarter, the Volaris team reacted promptly to the challenging market and the geopolitical environment. We managed capacity and modulated growth. Despite the headwinds, we believe that the Company's fundamental remain strong. We continue to have a cost advantage, we keep on rolling our unbundling flow of strategy by growing non-ticket revenues. Our bus campaign remains actively producing bus fixtures. And as Fernando said, we think that our quarter could be 10 percentage touch points of adjusted EBITDAR margin improvement quarter-over-quarter. On the financial side, we generated positive cash flow and we had a strong U.S. dollar balance sheet. We currently perceive a more normalized environment for the second quarter, part of which has already been reflected in certain key macro indicators such as the make recent Mexico peso appreciation and specifically the domestic air travel market remains strong. I want to conclude by thanking our management team, our ambassadors, our loyal customers, because when we are in crisis, we are much more thankful for the support that we get from everybody of them and for getting us to experience success. Thank you for your attention. Operator, we are ready to open the call for questions.

[Operator Instructions]. The first question will come from Michael Linenberg with Deutsche Bank. Please go ahead.

Hey good morning everybody. I have a couple of questions here. Enrique or maybe Holger can answer this. You know, you've talked about the depression in northbound traffic Mexico to the U.S. can you give us any sense on how much that has shifted? I mean if absent capacity additions, are we seeing that market, has it slowed? Is it negative? I mean any color that you can tell us about that market in particular how that has shifted?

Hello Michael, good morning. The northbound leisure is obviously very much affected by the exchange rate of the Mexican peso. As the Mexican peso depreciates it gets more expensive for Mexican tourist to go to the U.S. So what we've seen when the peso was a 20, 21, there was a big decline in northbound leisure demand. This has changed in the end of February I would say and throughout March building up to the Holy Week and Easter, where the peso has recovered to levels below 19 and people are making travel plans to go to the U.S. again. Nevertheless, we've been very cautious with our capacity additions to those markets and we have trimmed capacity in some of those markets, in order to be able to recover our load factors.

Michael, let me tell you, I think with the traffic in general is recovering and we're seeing much better performance clearly. But yesterday, after the talks from the President in the U.S. of NAFTA, peso devaluated $0.25 and so it's still very volatile. So, that's what has us concerned. Okay, the volatility has us very concerned.

That's helpful. I guess just a question to Fernando on your fuel price, so you obviously got the benefit of a fuel hedge that brought it down to like a $1.64, but then I know you talked about I guess there was some hedge impact maybe some negative hedge impact of $0.08 per gallon. And I'm just curious, how – why is your total at $2 per gallon? And I know, that's the blended number, I mean why is that so much higher, are there – is it just the taxes that you have to pay on an all-in basis, is it the inter-plane costs, because it would seem like getting the benefit of that hedge based on where the market was, that your all-in fuel price would be a bit lower than $2 per gallon. What's going on there?

$2 per gallon that you have in the column of the financials, that's just a convenient translation for the end of period exchange rate, so the number was much less than.

Oh, I see. Okay. The actual price is, Okay, that's helpful. And then just my last question…

Let me just give you the actual number that we stated. The actual average was $1.82 per gallon.

Okay great. And just my last question and maybe this is for Enrique, with the Costa Rican operation looking to fly to the United States several carriers have come out. At least one carrier has come out and started you know questions the citizenship of the carrier. Are there ways that you can address that from the citizenship perspective so that the Costa Rican operation can fly non-stop to the U.S.? Is there like a Plan B?

We do have a Plan B. Michael you have to be sure about that. We cannot comment right at this moment on that topic, because we're in the middle of the discussions and we still have no trial that were answered. But you can be absolutely sure that we have a Plan B.

That's what I figured. Okay, great. Okay. Good luck with it. Thanks Enrique. Thanks everyone.

Thank you very much.

Thank you for the question. The next question will come from Helane Becker with Cowen & Co. Please go ahead.

Hi guys, thanks for the time. Fernando just really quickly, I though you said $1.52 a gallon, $1.52 isn't that right?

$1.82 per gallon.

Okay, sorry. I guess I heard that incorrectly. Okay. Thanks for that clarification. Now, I just have a few questions. Can you saw what Easter exactly impact was in the first quarter and what you know you think the recovery is in the second quarter?

I think what Fernando said is very, very nicely when he presented that shift and we adjusted first quarter of last year with fuel and exchange rate adjustment and we take away the benefit of the purchase of one aircraft that we have in the first quarter of last year. Our second quarter looks with same margin of last year, so that's a very successful change, okay, and I see it very positive.

Okay, so we've looking at something like, I think you said 10% margin improvement first quarter to second quarter?

Absolutely.

Okay. Perfect. I'm sorry.

Up to 10% is correct.

Up to 10%. Okay. And then the other thing is, can you say what the bag fee benefit was in March. You know and if there is anything weird in the booking curve that maybe would come through into the second quarter?

Helane, we started charging for the first bag for new bookings starting March 1 and please consider that we already had certain amount of booking as we went into March. So, it's only for the new bookings from thereon. So, the effect for March is relatively small and the effect of the first batch will ramp up throughout the second quarter as we get more and more booking under the new policy. The uptake has been relatively strong and we don't see any material decrease in conversion rates of people that take their first bag which is very positive and we've been able to pass along a little bit of better fares to our U.S. customers in return for charging the first bag. And that has helped stimulate demand.

And then just one last question, if the market continues to be kind of way it is right now, yesterday comments by our – yesterday's comments not outstanding. You would expect margin, EBITDAR margins to improve further in the second half of the year from the second quarter?

Yes. I mean absolutely, but I mean here the answer is, do you know if the comment will continue wanting for it to happen and we don't have any certain appeal to that.

And specifically third quarter is seasonally our strongest quarter, so yes we expect better quarter-over-quarter margins.

Okay. Right. That would make sense. Okay, well, thanks for your help guys.

All things being equal, okay, exchange range very important okay.

It's pretty straight forward and we know pretty much what's going on with this year. But the exchange rate is something that we need to track.

And on fuel again, we have cost certainty for 80% to 50% of our consumption for the year, so that give us strong visibility on the cost side.

And then just on the aircraft schedule, are you going to put an updated aircraft delivery schedule in the 10-Q or 6-K when you file it?

Yes. We will. As stated we're currently at 68 aircraft at the end of the third quarter. We re-delivered one aircraft in the first quarter. We're going to re-deliver two aircraft in the second quarter, we're just going to get one delivery in the second quarter and the capacity guidance that we are giving for the second quarter, and we have been experiencing some delays from the manufacturer, so we will probably be ending the year with less aircraft than originally planned which should be in around 71 aircraft.

Okay. Thanks guys. I appreciate your help.

Helane thank you very much always for supporting us.

[Operator Instructions]. The next question will come from Duane Pfennigwerth with Evercore. Please go ahead.

Hey good morning. With respect to the 8 points in lower capacity growth versus your initial plans, can you just remind us how much of that is a reduction in sort of Mexico to the U.S. how much of that was Mexico domestic and how much maybe relates to Central America?

So, for Central America we have not changed our capacity plan. For the U.S. bound leisure markets, we have – we've trimmed capacity as I mentioned before. In general, we are little bit more cautious on the U.S. Mexico transporter market, so we've reduced our capacity estimate as they are more than in domestic market. Domestic market volume has been quite stable and has been quite bullish as people shift their travel plans from the U.S. to Mexico.

Okay. I mean, maybe just a follow-up here. Would you care to put a finer point on those regions with respect to kind of revenue growing in line with capacity? Are there any regions where you see revenue growing faster than capacity?

Well, I would like to reiterate that in the domestic market we are seeing revenues growing quite strongly, better than capacity growth, that is mostly due to the seasonality effect and we are cautious on the transporter market, cautiously optimistic on the transporter as we have seen booking pick up as well in those markets?

By the way Duane, in the second quarter we are recuperating our sales percentage to level by far better than in the first quarter, even outmatching the amount of incremental ASMs, so that means that, I mean remember the problem we have in the first quarter had happened at the end of January, so it was in the middle of the quarter. We couldn't react as much as fast as we wanted, because sales were already done. This quarter I mean the capacity will clearly be matching the amount of growth that we are expecting on the revenue side.

Thank you. And just lastly, maybe I wasn't paying enough attention during Helane's question, but it feels like you got not contribution basically from the international bag fee or very de minimus in the March quarter. What do you see that contribution being when it's probably run rated? Thanks for taking the questions.

Thank you, Duane. So, what we're seeing in the March quarter, we started the new baggage policy on March 1. So late in the quarter and only for new bookings, so the effect of the first bag was relatively minimal in March. However that is going to ramp up throughout the second quarter and third quarter, as more and more customers' book under the new policy. What makes us relatively optimistic on the bag fee is that we don't see any significant decline in people take first bags on their trips to the U.S. or from the U.S. So, currently we are charging round about $20 for the first bag depending on when you book it, and we don't see any meaningful decline in converse rates.

And would you care to share what those conversion rates are? How many – you know what percent of your customers take a first bag with them?

Its north of 70%.

Thank you.

No, thanks to you Duane. Thank you very much for the questions.

The next question will come from Renato Salomone with Itau.

Hi good morning. Thanks for taking my question. Can you please give the color of the competitive environment key domestic routes, more specifically, are there any – if there is any market or route where you are seeing unusual commercial aggressiveness?

So, Renato, we're seeing short-term demand presence obviously from everybody in the – due to the FX and uncertainty around traveling across the world, so there is a general demand of softness. In particular, what we've seen our competitors do in Mexico City International Airport, Aeromexico and Interjet are both competing head-to-head in Mexico City. They have majority of their capacity in and out from Mexico City International Airport, whereas we have a more diversified network and demand in our core markets especially in the BFR markets have been relatively strong. So, we are being affected by significantly lower yields in Mexico City International Airport, but we're making a part of that through other markets in our strength in Guadalajara, Tijuana, Cancun and all around the country. So that's I would say the most important headline that I'd like to share.

Perfect. And if I may have just a quick follow-up, on aircraft utilization, you disclosed an average utilization of 12.4 hours in the quarter. Can you please give us a color of how much this utilization decreased as you build capacity in the quarter, and what can we expect for the second quarter?

So, what we've done in the first quarter is reduce some daily utilization by approximately 0.5 hours that equates to the capacity cut that Enrique mentioned in his opening remarks. In the second quarter, we estimate that demand that utilization will fall approximately in the same amount.

Thank you.

Thank you for the question. The final question will come from Stephen Trent, Citi. Please go ahead.

Good morning, everybody, and thanks for taking my questions. Most of mine have been answered, but one or two follow-ups. One, I was wondering if you could give us a little color on what Mike Linenberg was asking earlier about Central America, the kind of fifth and sixth freedom or however you're planning to handle Costa Rico to U.S. or at least Central America to U.S. flying? What we might expect there in terms of timeline?

Look, I mean, we have plan to start an operation probably to the U.S. by the end of the second quarter or beginning of the third quarter. So we do have a lot of time until we get there. We cannot provide as I said because we are in the middle of this legal discussion and we haven't filed our answer, okay, but it is something that we clearly have a B way of doing it or a C way of doing it and we are not concerned about it. We also think that this is important to say that I mean if we start at the year with one route, now we have five routes within Central America and we will have by the end of the third quarter almost 14 routes. So, don't worry.

Okay, very helpful, Enrique. And just one more question. I was wondering if I could get your thoughts regarding Mexican Aviation Authorities potentially relaxing foreign ownership restrictions on Mexican Airlines. I mean, it seems from what I can tell not such a big deal for you guys given holding company structure, but any thoughts around that with respect to implications for you or your competitors?

No, not really. I think the Company structure when we launched the IPO, it's a structure that has been working pretty well in terms of investments, but they are talking about this moving that level from 25% from 49% and or if something makes it easier.

Okay, very helpful. Let me leave it there and thank you again Enrique and team.

Well, thank you very much to you, Steve. And thank you very much for everybody for being in this call. I really appreciate your questions, your participation, the interest in the Company. And I remind you guys that we feel cautiously optimistic, that I think an improvement from one quarter to other of 10 percentile points in the EBITDAR level. It's something impressive. So thank you very much for being here and stick to us.

Ladies and gentlemen, this concludes today's conference. You may now disconnect your lines.