Most U.S. airlines' third-quarter results fell short of their initial forecasts, as an uptick in COVID-19 cases associated with the delta variant hurt air travel demand beginning in August. In recent weeks, airline executives have warned investors to expect even bigger losses in the fourth quarter, largely due to a recent surge in fuel prices.
However, conditions are a lot different south of the border. Last week, Mexican budget airline Volaris (VLRS 1.21%) reported strong third-quarter results and indicated that it continues to have massive long-term growth potential. That makes Volaris stock's 17% dip over the past month look like an excellent buying opportunity.
Volaris stock performance, data by YCharts.
Another excellent quarter
Three months ago, Volaris reported record second-quarter results. Whereas most airlines around the world were still early in the recovery process, Volaris generated revenue of 11.5 billion pesos: up 38% compared to the second quarter of 2019 on a 22% unit revenue increase.
That enabled the company to report an excellent Q2 net margin of 13.4% and $0.67 of earnings per American depositary share (ADS). Adjusted earnings before interest, taxes, depreciation, amortization, and rent (EBITDAR) totaled 4.7 billion pesos, giving Volaris an adjusted EBITDAR margin of 40.8%.
Volaris posted similarly impressive results in the third quarter. Revenue jumped 35% compared to Q3 2019 on a 12% improvement in unit revenue, reaching 12.8 billion pesos. Unit costs increased just 2.6% over the same period.
As a result, Volaris generated EBITDAR of 5.2 billion pesos, giving it a 40.9% EBITDAR margin: solidly within the guidance range of 40% to 43% that management had provided in July. Finally, net income rose to 1.5 billion pesos ($0.64 per ADS). That beat the analyst consensus of $0.57. In the third quarter of 2019, Volaris recorded net income of just 713 million pesos.
Guidance sparks a modest sell-off
Volaris' ability to earn a strong profit last quarter even as most airlines lost money highlights its superior business model and the value of its dominant position in Mexico's airline industry. That said, Volaris issued a more cautious forecast for the fourth quarter, which likely sparked the stock's recent pullback.
Image source: Volaris.
Management said that the company plans to increase capacity 26% to 29% compared to the fourth quarter of 2019. However, the combination of overcapacity on some of the busiest air corridors in the country -- particularly flights from Mexico City to other major cities -- and rising fuel prices will pinch its profitability. Volaris expects to post an EBITDAR margin between 31% and 34%, down from 36.5% two years ago.
Investors may be overreacting to the company's guidance, though. First, Volaris' forecasts tend to be quite conservative, leaving room for the company to beat its guidance if demand continues to recover over the next few months. Second, Volaris performed especially well in the fourth quarter of 2019. The company's margin guidance implies a big improvement over its 27% EBITDAR margin in Q4 2018.
A cheap growth investment
Over the past two years, Volaris has solidified its position as the No. 1 Mexican airline, thanks to the collapse of Interjet, which had held roughly 20% of the domestic market prior to the pandemic. Last year, Volaris' domestic market share reached a record high of 38.4%. In many markets -- particularly routes out of Guadalajara and Tijuana -- Volaris has a dominant position today.
Looking ahead, Volaris is poised to capitalize on the Mexican airline industry's long-term growth. Many people in Mexico still travel on intercity buses. Convincing those people to switch to flying by offering cheap and reliable service has driven much of the company's growth over the past decade, and Volaris is still in the early innings of this "bus-switching" campaign.
Volaris stock currently trades for just 14 times the airline's projected 2021 earnings per ADS of $1.31. That's a bargain valuation for a company growing as rapidly as Volaris. Moreover, Volaris posted a big loss in the first quarter, when the pandemic was still raging, setting up an easy comparison for 2022. Thus, the recent pullback in Volaris' share price represents an attractive opportunity for long-term investors, with massive upside if the airline's growth strategy succeeds.
