Following two years of exceptionally weak results, Volaris (VLRS 0.21%) has bounced back in a big way in 2019. The Mexican budget airline has finally beaten back the competition in some of its core markets, leading to better unit revenue results. Meanwhile, fuel costs remain moderate and Volaris has continued to improve on its industry-leading cost structure.
These favorable trends allowed Volaris to achieve stellar earnings in the seasonally strong third quarter. The outlook for the fourth quarter and beyond is solid, too. As a result, while Volaris stock has already doubled since the beginning of the year, this dynamic airline stock still holds more upside for long-term investors.
Another quarter of strong margin expansion
In the first half of 2019, Volaris' operating margin improved by more than 10 percentage points on a year-over-year basis, reaching 4.4%. The company still posted a small net loss, excluding the impact of a gain related to currency fluctuations, but that was far better than its performance a year earlier.
By contrast, Volaris earned a big profit in the seasonally stronger third quarter. Revenue per available seat mile (RASM) rose 11.4% year over year, driven by rising non-ticket revenue, strong traffic, and higher average fares. Nonfuel unit costs ticked down by 0.3%, thanks to Volaris' efficiency initiatives. Most impressively, Volaris reported a huge improvement in fuel efficiency for the third quarter. The carrier increased its capacity 16.9% year over year last quarter, but it used only 7.2% more fuel than it did a year earlier.
The net result is that Volaris increased its operating margin by about 10 percentage points for a third consecutive quarter (from 8.2% to 17.9%). Excluding a foreign exchange loss, Volaris earned about $61 million last quarter, giving it an adjusted pre-tax margin of 12.5%. Earnings per share for Volaris' U.S.-listed shares came in at $0.36, easily beating the average analyst estimate of $0.29. The carrier's profitability also surpassed the very conservative forecast that management had provided in July.
Clear skies ahead
Volaris didn't provide specific guidance for the fourth quarter. That said, its full-year outlook implies that its profitability will probably continue to improve, albeit at a slower rate as year-over-year comparisons get tougher. This will allow the carrier to post a solid full-year profit.
The grounding of the Boeing 737 MAX may have helped Volaris on the margins this year, as top competitor Aeromexico was forced to reduce its capacity. That said, Volaris' management said that the 737 MAX grounding affected Aeromexico's international routes to northern South America more than its service in the domestic market (where the two carriers compete). Volaris will still manage capacity cautiously next year, particularly after the 737 MAX returns, but management is optimistic about the airline's ability to maintain the RASM gains it achieved in 2019, and perhaps even build on them.
Volaris also expects unit cost trends to remain favorable overall in 2020, although the company will face some additional lease return expenses as it retires a few of its older aircraft. Over the next several years, Volaris will reap substantial incremental benefits from switching to new fuel-efficient jets. Indeed, the A320neo and A321neo will account for more than half of its fleet by the end of 2022, up from around a quarter today. And Volaris' newfound scale and track record of success allowed it to negotiate improved financing terms for its future aircraft deliveries.
The Mexican air travel market is still far from maturity and has been subject to rapid shifts in both supply and demand. As a result, Volaris shareholders should be prepared for more volatility in the years ahead. Nevertheless, the company is well positioned to post strong earnings growth over time as its consolidates its leadership position in the Mexican aviation industry.