Mexican ultra-low-cost carrier Volaris (VLRS 4.53%) has recovered nicely this year from a disappointing 2014 performance that was marred by overcapacity in the Mexican air travel market. Through the first nine months of 2014, Volaris posted an operating margin of negative-2.2%. By contrast, it has generated a solid 13.6% operating margin in the first nine months of 2015.
Volaris' stock price has responded. Shares doubled from around $9 at the beginning of the year to a high of $18.20 reached late last month. However, Volaris stock has slumped this week, after the company announced a secondary stock offering. Shares briefly fell below the $16 mark on Tuesday before bouncing back to $16.65 as of the end of trading on Thursday.
Volaris YTD Stock Performance, data by YCharts
This recent drop simply makes Volaris stock more attractive for long-term investors. The secondary offering has no impact on revenue, earnings per share, or any other relevant metric. Meanwhile, Volaris' business has strong momentum that should continue into 2016.
The "scary" secondary offering
Sometimes, secondary stock offerings are genuinely bad news for investors. If a company decides to sell more stock after its IPO, it's usually a sign that it doesn't have adequate liquidity. That's fine in the case of a Tesla Motors that's growing rapidly and investing heavily in further growth initiatives -- but in other cases it indicates that the business is a dud. Either way, it leaves current shareholders owning a smaller percentage of the company.
However, Volaris isn't selling any stock in this secondary offering. Instead, two of Volaris' main pre-IPO investors -- a private equity fund and an investment fund run by El Salvadoran airline executive Roberto Priete -- are selling a combined 10%-11% of the company's shares.
This means there will be no share-count increase and no corresponding ownership dilution or reduction to EPS. That two major investors are selling shares could be perceived as a negative -- but they have had their money locked up in Volaris for up to 10 years. It's not surprising that they want to cash out some (but, importantly, not all) of their stake after the stock's terrific run this year.
In short, this secondary offering is really a non-event for investors with a time horizon more than a few months.
Here's what really matters
Interestingly, the secondary offering-related stock drop has left Volaris shares slightly below their $16.75 closing price on Oct. 19 (i.e., just before the company's Q3 earnings report). Volaris' Q3 EPS reached $0.67, or about $0.44, excluding foreign exchange gains. That was in line with the $0.40-$0.50 figure I had expected, but far above the $0.37 Wall Street analysts projected.
Volaris' Q3 earnings smashed analysts' estimates. Photo: The Motley Fool.
So in essence, investors are getting the company's blowout third-quarter earnings for free. If there was any doubt about Volaris' strong earnings trajectory before the Q3 report, those worries should be gone now.
Volaris continues to see strong demand for its low-fare service both within Mexico and on its international routes (primarily to the United States). It's facing cost headwinds from the strong dollar, which is driving up aircraft costs, but Volaris is offsetting some of this pressure by increasing aircraft utilization and putting more seats on each plane. For example, it grew capacity 28.9% year over year in October, with a 14.6% increase in the size of its aircraft fleet.
Meanwhile, Volaris is benefiting from low fuel prices, while its growth is driving down peso-denominated unit costs. This situation enabled Volaris to improve its operating margin by 11.7 percentage points year over year last quarter.
Finally, Volaris' rapid expansion should keep adjusted earnings on a growth trajectory next year. Volaris plans to grow its fleet from 56 planes at the beginning of 2016 to 65 by year's end. Most of that growth will come from adding extremely cost-efficient A321 and A320neo planes to its fleet. This situation will solidify Volaris' ability to earn strong profits with rock-bottom fares -- and pave the path for future share-price gains.
