Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (NYSE:VLRS) Q3 2023 Earnings Call Transcript

Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (NYSE:VLRS) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good morning, everyone. Thank you for standing by. Welcome to Volaris's Third Quarter 2023 Financial Results Conference Call. All lines are in a listen-only mode. Following the company's presentation, we will open the call for your questions. Please note that we are recording this event. This event is also being broadcast live via webcast and can be accessed through the Volaris website. At this point, I would like to turn the call over to Ricardo Martinez, Investor Relations Director. Please go ahead, Ricardo.

Ricardo Martinez: Good morning, and thank you for joining the call. With me today is our President and CEO, Enrique Beltranena; our Airline Executive Vice President, Holger Blankenstein; and our Chief Financial Officer, Jaime Pous. They will be discussing the company's quarterly results. Afterward, we will move on to your questions. Please note that this call is for investors and analysts only. Before we begin, please remember that this call may include forward-looking statements within the meaning of applicable securities laws. Forward-looking statements are subject to several factors that could cause the company's results to differ materially from expectations as described in the company's filings with the United States SEC and Mexico's CNBV.

An Airbus single-aisle aircraft overfly a major city, showcasing the airline services of the company. Editorial photo for a financial news article. 8k. --ar 16:9

These statements speak only as of the day they are made. And Volaris undertakes no obligation to update or modify any forward-looking statements. As in our earnings press release, our numbers are in U.S. dollars compared to last year's quarter, unless otherwise noted. And, with that, I will turn the call over to Enrique.

Enrique Beltranena: Thank you, Ricardo, and everyone for joining us today. I want to begin by highlighting the quarterly results compared to last year's figures. In the third quarter, ASMs increased by 10%, total operating revenue by 8%, EBIT by 11% and EBITDAR by 18%. Before we explain in detail the third quarter results, which Holger and Jaime will present, I'll address two key topics. The first one, Pratt & Whitney GTF engines preventive accelerated inspections and the second one is Mexico City International Airport slot restructuring and FAA's Category 1 capacity ramp-up plan. Regarding the first topic, the Pratt & Whitney preventive accelerated inspections, I want to provide a clear and comprehensive overview of our current knowledge of the situation.

This issue affects not only Volaris, but 42 airlines globally, including two in Mexico. Pratt & Whitney's parent company, RTX Corporation, revealed in July and September that the problem with the powder metal in a high-pressure turbine disc will necessitate accelerated inspections of GTF engines on Airbus A320neo family. Approximately 3,000 engines worldwide will undergo inspections from 2023 to 2026. These inspections are mandated by the FAA after a specific number of cycles depending on the engine type. Currently, the FAA has only issued the first service instruction for the initial batch of engines. Volaris's top priority has always been and will continue to be the safety of our ambassadors and customers. Thus, we're diligently following all preventive airworthiness directives.

Our current visibility of the situation is limited to the initial batch as informed by RTX to the operators. The current estimate is that, depending on the work scope, it will take roughly 250 to 300 days on average for these engines to be removed and inspected and then returned to the operator to go back into service. RTX estimates that Pratt & Whitney will take a financial hit of about $6 billion to $7 billion, of which 80% is customer support, namely financial compensation to carriers and the remaining 20% is labor and material costs for the work scope. We are currently negotiating with Pratt & Whitney regarding their initial financial support for Volaris's issues corresponding to this first batch of engines. We expect to reach an agreement with Pratt & Whitney in the next month and will reflect the negotiated compensation and support package on our financial statements once that agreement is in place.

While there is still work to be done to finalize this initial agreement, I must commend Pratt & Whitney for their responsiveness and their acknowledgement for the financial strain on Volaris due to the current engine issues. They have actively collaborated with us to mitigate any significant impact on our financials. Based on guidance from Pratt & Whitney, we expect there will be additional work required on the neo engine lasting into 2024 and 2025 beyond the initial preventive inspections. While we are in discussions with Pratt & Whitney on how best to mitigate these ongoing issues and to ensure appropriate compensation and support to Volaris, we don't expect to have any clarity on the longer-term impact until first quarter of 2024. We will provide subsequent updates as appropriate.

Today, Volaris fleet comprises 126 aircraft, of which 22 A321neos and 51 A320neos may be temporarily affected. Once the initial directive was published, Volaris and Pratt immediately identified the engines requiring preventive accelerated inspections. In September, there was an 8% reduction in ASMs and an estimated revenue impact of $18 million versus the forecast associated with our original published capacity. Thus, on October 10th, we revised our ASM growth for the full year 2023 to be 10% versus our previous guidance of approximately 13%. This translates to a fourth quarter 2023 total capacity remaining virtually flat compared to the fourth quarter of 2022. Despite this capacity reduction in our forecast, we anticipate that our total operating revenue for the year will remain at the low end of this year's annual guidance provided in February, reaching approximately $3.2 billion.

The situation is still evolving, but we anticipate engine inspections will limit capacity deployment from the engines to be inspected until they are completed by 2026. Management is looking for alternative solutions to mitigate the impact and will consider, for example, extending leases and identifying ceo aircraft. It is premature to forecast the potential impact on our 2024 growth plan. But notwithstanding our mitigation initiatives, it is fair to assume that we will be forced to shrink our capacity in 2024 as a result of these engine issues. As we've done in the past, the Volaris management team will again do our best to respond to the challenge. We have designed the mitigation plan to manage changing variables and generate the shareholder value.

As an ultra-low-cost carrier, we are always focused on managing costs. We control and implementing strategic initiatives to offset the impact of those we do not control. In this case, these initiatives include, first, we're optimizing our network by taking advantage of the recovery of Mexico's Cat 1 status, reducing growth to new markets and cutting capacity on underperforming routes. Second, we are maintaining strategies to stimulate demand and enhance ancillary penetration to drive unit revenues. Third, as noted above, we are currently negotiating lease extensions for several ceo aircraft, initially scheduled for redelivery in 2024 and 2025. Fourth, we are implementing additional cost efficiency initiatives, which include reducing redelivery expenses in the short term.

Fifth, on the OEM side, we are maintaining our new Airbus aircraft deliveries for 2024 and 2025, which currently includes 24 already financed aircraft. Additionally, we are actively pursuing further tactical additions in both aircraft and engines. RTX has stated, I quote, we are still able to deliver new engines and spare parts due to the deployment of the angle scan inspection. Moving on to the second key point on Mexico City International Airport and Cat 1. The Mexican Aviation Authority has announced a reduction at the Mexico City Airport from 52 to 43 aircraft slots per hour effective January 8, 2024, after the holiday season ends. As a result of this adjustment, Volaris will have four aircraft lines available for redeployment to other domestic stations, primarily serving routes to the U.S. following the Cat 1 up.

For 2023, our estimated EBITDAR margin is anticipated to achieve approximately 26%. We will continue to execute diligently our mitigation plan in the short term to manage our costs around the reduced operating fleet size, while thoughtfully retaining key personnel, so that we may resume our long run growth trajectory and superior cost profile when the engine inspection situation has passed. I will turn the call over to Holger to discuss our quarterly operating results and go-forward network strategy.

Holger Blankenstein: Thank you, Enrique, and good morning. Let me highlight some critical aspects of Volaris's performance in the third quarter. During the quarter, our RPMs demonstrated robust growth at 9.2%, outpacing ASMs which grew at a rate of 8.2%. ASMs were aligned with our plans in July and August, while RPMs exceeded expectations. The positive momentum in our domestic passenger base highlighted in our second quarter call through mid-July continued throughout the quarter, resulting in solid domestic volumes and load factors. Domestic ASMs finished the quarter 2.2% higher year-over-year. International ASMs increased by 22%, driven by a substantial capacity reallocation to Central America, exceeding last year's levels.

We catalyzed loads in our domestic network during the quarter, achieving outstanding load factors networkwide. Overall, we achieved a total load factor of 86.4% for the whole quarter, surpassing 85.6% recorded in the third quarter of 2022. In July and August, the Pratt situation affected capacity by approximately 3%. However, parking the aircraft affected by the GTF engine issues in September resulted in a 1.9% decrease year-over-year in domestic ASMs, a reduction versus the original plan of 8%. Despite strong demand in the Mexico, U.S. market, we experienced a load factor contraction of about 10 percentage points in Central America. This was mainly due to a substantial 74% year-over-year increase in capacity, a strategic move as part of our preparations for December, positioning us optimally for the upcoming high season.

Notably, demand for VFR travel in the region remains robust. In spite of the challenges posed by the initial round of GTF engine inspections, Volaris demonstrated remarkable resilience in the operational performance and a solid net promoter score throughout the third quarter. This was evident in our strong metrics, including volumes, efficient utilization, and, notably, ancillary revenue penetration. Despite a suboptimal operating environment, we delivered record quarterly aircraft utilization last quarter, a meaningful tailwind to ASM growth. Regarding unit revenue, TRASM for the quarter came in at $8.37 cents, a 2% increase year-over-year, helped by a stronger peso. This result was driven by increased volumes and ancillary revenue per passenger, which grew by 26% year-over-year.

This was partially offset by an average base fare of $48, 13% lower year-on-year as we intentionally kept stimulating demand to maintain loads. Our ancillary strategy has delivered solid results, and we are delighted with its rapid growth. In the third quarter, ancillary revenues reached $49 per passenger, setting a new quarterly record and representing significant progress. We are fully dedicated to emphasizing this strategy, acknowledging its crucial role in enhancing revenue and margins. During the third quarter, ancillary sales represented remarkable 50% of our total operating revenues. Notably, our V Club membership program, including the highly successful Zero Ticket Fare introduced this summer, experienced sustained growth. Passengers with V Club memberships now constitute 18% of our total passengers, reflecting a significant increase from 8% compared to the third quarter of 2022.

In addition to our understanding of bus switching passengers, we are just starting to drive the adoption of ancillary products and encourage repeat service through our loyalty-based programs. Our affinity program with OXXO, the largest retailer in Mexico, is still in its early stages, and we envision it evolving into the largest platform in Mexico with Volaris as one of its cornerstones. Looking into the fourth quarter, we see solid bookings across our network as we approach the holiday season with demand trends largely resembling the ones we saw in the third quarter. Regarding our network, Volaris saw two critical developments in the third quarter with Mexico's recovery of Category 1 status and Pratt & Whitney's GTF engine inspection announcement.

We were pleased to announce the recovery of Category 1 status on September 14th, a significant milestone achieved over two and a half years after the initial downgrade. In the past month, we have diligently pursued regulatory authorizations to increase our flight frequencies between Mexico and the U.S. Additionally, our culture partnership with Frontier is set to resume in December. Although the GTF engine preventative accelerated inspections have affected our ability to reallocate aircraft for U.S. bound routes, more than anticipated, we are on track to introduce four aircraft lines onto Mexico to U.S. routes by December, representing a 19% increase in capacity compared to last year's levels. Our management team is also working to optimize our network for the parked aircraft expected in 2024 by identifying and reducing capacity along ramp-up and underperforming routes.

Looking to the next year, we will focus on prioritizing our most profitable routes. While doing so, we will maintain a prudent approach to protecting Volaris's long term growth prospects. Our commitment involves preserving our leadership in our domestic core markets, while leveraging the Category 1 upgrade for routes to the U.S. Simultaneously, we plan to scale back certain trunk routes. Specifically, we will be reducing capacity on ramp-up routes and at Mexico City International Airport in response to the aircraft movements reduction taking effect on January 8th. I will now turn the call over to Jaime Pous to discuss the financial performance for the quarter.

Jaime Pous: Thank you, Holger. For the third quarter of 2023, Volaris demonstrated financial performance that somewhat tracked behind our expectations. Total operating revenues came in at $848 million, a 10% increase compared to 2022, driven by sound demand across our network and ancillary revenue per passenger, which increased to $49 from $39 the previous year. However, this result was partially restrained by the impact of the preventive accelerated inspections of the GTF engines during September. TRASM was $8.37 cents, up 2% year-over-year. EBITDAR for the quarter totaled $207 million, an 18% increase over the prior year's quarter. EBITDAR margin was 24.4% or an improvement of 1.6 percentage points from the third quarter of last year, favored by lower jet fuel prices and a stronger peso.

Volaris posted an EBIT of $39 million, up 11% for an EBIT margin of 4.6%, flat versus 2022. Our CASM ex-fuel was $4.91 cents, an increase of 21%. The primary factor driving this increase was a strong appreciation of the Mexican peso compared to the prior year. As a reminder, a stronger peso has a net positive impact on our operating margins. Still, it is a headwind for unit cost, given the translation of peso denominated cost into dollars in our consolidated P&L. The appreciation of the peso impacted our unit cost by $0.34 cents in the quarter. Excluding this effect, our CASM ex-fuel only increased 12% versus the third quarter of 2022. We managed cost as effectively as possible to achieve expectation that included cyclical pressures associated with maintenance and redeliveries that we anticipated on our Investor Day last December.

Moving to jet fuel, the average economic fuel cost during the quarter was $3.17 per gallon. While this equates to a 20% decrease year-over-year, given the lapping of last year's historic surge in fuel prices, jet fuel costs have risen rapidly since the second quarter of this year, up 17% sequentially. Given the recent geopolitical global circumstances, we expect to continue to experience volatility in jet fuel prices. During the quarter, we booked delivery cost accruals of $42.4 million and no sale and lease back gains. Total CASM came to $7.98 cents for the third quarter, a 1.7% increase compared to the third quarter of 2022. For the third quarter, the net loss was $39 million. The cash flow provided by operating and financing activities in the third quarter was $145 million and $87 million, respectively.

Cash outflows used in investing were $138 million. CapEx, net of predelivery payments, totaled $63 million in the quarter. Our strategy to maintain operational and reliability drove investment of $11 million in acquiring spare engines. The capitalized measured maintenance events expenses were $37 million for the quarter. Year-to-date, CapEx net of predelivery payments stands at $186 million. For the full year, we continue to expect CapEx of $300 million, net of predelivery payments. Volaris finished the quarter with the liquidity position of $764 million, representing 24% of the last full month's operating revenue. Given the effect of the expected parked aircraft on our capacity and network, it is particularly important to maintain a healthy cash position.

In this sense, we secure financing for ATIS spare engines through finance leases for $109 million. Notably, tied of these leases, are a structure under Japanese operating leases with call options or JOLCOs, representing a milestone for Volaris as this marks our first entry into these finance structures. Additionally, in the third quarter, Volaris successfully issued Mexican trust notes worth MXN1.5 billion or $86 million. This marks our third offering under the program approved by the CNBV and solidifies Volaris as a regular issuer in the Mexican debt capital markets. Overall, our balance sheet remains solid and flexible to comfortably meet our financial commitments for the foreseeable future. At the end of the third quarter, our net debt to EBITDAR ratio remained at 3.5 times.

As of September 30th, our fleet comprised 125 aircraft, up from 113 aircraft a year ago. Seats per departure were 194 in the third quarter, and our fleet had an average age of 5.6 years. We are working diligently on our fleet plan with Airbus and maintaining our regional aircraft delivery plan, which includes 24 aircraft already financed for 2024 and 2025. Our mitigation plan encompasses adjusting certain operating cost in anticipation of the expected reduction in our fleet. However, we must emphasize that we would be cautious in scaling back our operations. While we are committed to cost control, we also focus on long term growth and are mindful of the required resources to support that future. Additionally, we aim to retain the flexibility to increase operations after the engine inspections are completed quickly.

Although our unit costs will likely experience a work pressure due to capacity reductions, our commitment to maintaining world-class cost control remains unwavering. The company's net cost impact for the third quarter, which includes rounding compensation, is forecasted to remain under control. Consequently, for the entire year, we expect the CASM ex-fuel to stay consistent with our original guidance of around $4 point cents. CASM, both including and excluding fuel expenses, will be netted for the compensation received from Pratt & Whitney. However, it is important to note that each line in the P&L statement will continue to reflect the actual cost of the entire fleet, including the non-productive fleet. We updated our full year 2023 guidance two weeks ago to reflect parked aircraft cancellations and higher fuel prices.

As a reminder, our estimates for the full year are as follows: ASM growth of 10%, total operating revenues of $3.2 billion, CASM ex-fuel of $4.8 cents, EBITDAR margin of 26%, CapEx of $300 million net of finance predelivery payments, net debt to EBITDAR ratio of 3.5 times. This outlook assumes an average for the full year foreign exchange rate of approximately MXN17.75 per $1, an average economic field price of approximately $2.80 per gallon. Now, I will turn the call over to Enrique for closing remarks.

Enrique Beltranena: Thank you very much, Jaime. Volaris has managed numerous challenges and regulatory static in recent years, including slot reductions in Mexico City International Airport, a major COVID crisis, a downgrade in the category of the Mexican Aviation Authority, soaring fuel costs well above historical levels, shifts in aviation regulations, including discussions on cabotage, the transition to new airports, significant delays from OEMs, the complex implementation of new engine technologies, et cetera. The Volaris team has consistently responded with agility throughout these challenges, adapting the company effectively and achieving considerable success. At certain moments, in the aviation industry, absolute clarity is impossible to assess.

We firmly believe that the current situation is no exception. We are again prepared and motivated to manage the airline for a successful 2024. We will focus on managing our fleet to the best of our ability, putting safety first, while focusing on profitability. Our operation may be smaller in the short term, but with continuing strong demand against reduced capacity in our markets and appropriate support from Pratt & Whitney, the next year has the potential to deliver an improved performance versus 2023. Thank you very much for listening. Operator, please open the line for questions.

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