Mexico's Top Budget Airline Has Big Growth Plans

Mexican ultra-low cost carrier Volaris (VLRS 2.36%) saw a sharp decline in profitability in 2014, but it bounced back quickly, reporting record results last year. With the company now generating a healthy profit margin, Volaris is looking to capitalize on the numerous growth opportunities ahead of it.

The Mexican air travel market is soaring
Air travel has been rising rapidly in Mexico in recent years. Total passenger volume grew 12.3% in 2015, following three consecutive years of 8.3% annual growth. Volaris has played a big role in stimulating this demand growth by significantly reducing the cost of airline tickets in Mexico. The rise of the middle class is also helping.

Volaris' management believes that the Mexican air travel market will continue growing at a rapid rate for the foreseeable future. In 2014, the number of air trips per capita was more than eight times higher in the U.S. than in Mexico. Even within Latin America, Brazil and Chile had about twice as many air trips per capita as Mexico.

Volaris' low fares are driving rapid growth in the Mexican air travel market. Photo: The Motley Fool.

Volaris thus faces a very different environment than No. 1 American ultra-low cost carrier Spirit Airlines (SAVE -2.90%). The U.S. air travel market is quite mature, so in order to maintain its high growth rate, Spirit has to either gain market share from larger carriers or find potential customers who have been priced out of the market previously.

By contrast, Volaris operates in a rapidly growing market, so it is primarily growing along with the market (though it is also gaining share gradually). This may shield it from some of the pricing battles that have affected Spirit Airlines and other U.S. airlines in the past year.

Rapid near-term capacity growth
To meet rising demand, Volaris increased its capacity by 18.8% year over year in 2015, with growth accelerating as the year went on. In fact, over the past six months, year-over-year capacity growth has averaged about 25%.

Volaris expects to maintain its 2015 growth rate for at least two more years. Based on the company's current fleet plan, management expects capacity to increase 18% in 2016 and 19% in 2017. Volaris currently projects that capacity growth will fall back to 11% in 2018, but it has plenty of time to adjust its fleet plan upward if demand stays strong.

Digging into Volaris' capacity growth
Because the Mexican air travel market is growing so quickly, most of Volaris' capacity growth is coming in its existing markets as it adds flights or "upgauges" to larger aircraft. New routes represented less than 20% of Volaris' 2015 capacity growth. In 2016, new routes could account for about 30% of Volaris' growth, but the bulk of its capacity increases will still go to existing markets.

In many new markets, Volaris starts with a few flights a week and uses low fares to stimulate demand. Volaris CEO Enrique Beltranena told me in an exclusive interview earlier this month that domestic markets mature in about six months, while international markets can take about 14 months to mature. At that point, Volaris starts to add more capacity.

This is another big difference relative to Spirit Airlines. Spirit typically begins routes with one daily flight, and most of its routes stay at that level. Volaris' strategy is advantageous because it is typically less risky to add capacity on an existing route relative to starting a new one.

Lots of long-term opportunities
In the long run, Volaris will have plenty of opportunities to expand to new routes in addition to increasing capacity on its existing routes. In fact, the carrier has identified about 250 additional routes that it could eventually serve.

Just within the domestic market, Volaris has identified 57 potential routes where large numbers of people currently travel by bus to visit friends and relatives. Volaris has had great success in markets like these, using low fares to convince people to switch from buses to air travel.

Volaris has also dramatically grown its presence in key Mexican leisure markets in the past five years. It currently works with Best Day Travel to sell vacation packages within Mexico. The company eventually hopes to offer similar packages for U.S. travelers visiting Mexican beach markets like Cancun and Puerto Vallarta.

In short, Volaris has numerous ways to pursue growth in the coming years. This will give it lots of flexibility to react to market conditions in order to keep its earnings marching steadily higher.