Value Investing My pitch on $VLRS, best value investment I’ve ever found, once in a cycle opportunity - coming from a former airlines analyst at a top 5 hedge fund |
| Posted: 05 Sep 2020 02:34 PM PDT Thesis: VLRS is an underfollowed and catalyst-rich potential 10-bagger IF you can swallow the fact that its a levered Mexican airline. A best-in-class operator pre-crisis, VLRS is an immediate and long-term COVID beneficiary that has already doubled market share and almost recovered 2019 traffic levels as primary competitors collapse, creating a sustainable dominant position. Description: VLRS is an ultra-low-cost Mexican airline serving domestic (~70%) and international, mostly US transborder destinations (~30%) with a focus VFR (visiting family and relatives) traffic (45%) and price sensitive leisure travelers (30%). Volaris is a best-in-class ULCC, the largest airline in Mexico and the largest ULCC in Latin America, with the 2nd lowest unit costs in the world. Valuation: Our 2026 price target is MXN204/sh (USD$95/ADR), roughly more than 10x upside - based on a typical high-quality ULCC forward P/E multiple of 14x on FY27 EPS of MXN14. From 2019 through 2027 we expect an ASM CAGR of 10.6%, RASM CAGR of 1% (reflecting depressed pre-COVID environment and ancillary execution), CASM @ -1.5% (reflecting fleet transition and pre-COVID fuel prices). Market Dislocation: 1.) Hairy, foreign listed small-cap airline and trades only 3m USD / day - high discoverability 2.) Poor sell-side coverage - despite significant interim newsflow, including the almost-complete recovery of volumes to pre-COVID levels, US sell-side coverage has not updated models since July. For example, current consensus capacity for 3Q reflects roughly 4,122k ASMs vs. 4,800 based on actuals through Aug and mgmts stated planes for Sep 3.) Sellside and buyside always fails to model the impact of upgauging and fuel efficiency during significant fleet transitions - many sellside models either don't model the fleet or actually apply the wrong number of seats entirely, underestimating growth implied and incremental costs associated 4.) Market anchors to minimum contractual fleet without consideration of significant ability to extend leases or pull forward deliveries if the recovery remains strong, especially if additional capital is raised 5.) IFRS 15 and 16 changes make spot check comparisons messy and the capital structure look worse than reality 6.) Persistent overcapacity in recent years is not reflective of earnings power in a more consolidated market. In 2019, Interjet was discounting aggressively to generate cash in an effort to maintain solvency which depressed fares below rational levels Key Investment Factors: 1.) Accelerating secular growth of Mexican aviation demand – From 2007 to 2018 air trips per capita in Mexico has grown from 0.25 to 0.36 compared to 0.72 for Chile and 0.45 for Brazil. Since VLRS's founding in 2006, the domestic market has grown at a CAGR of 7.6%, international market at 4.9% (US transborder >20%) and total Mexican market 6.2%. Mexico's demographics are supportive, with a young population and an emerging middle class expected to comprise 50% of the population by 2032 2.) Bus switching presents a long runway for sustained growth – Mexico's inter-city bus market is 70x the size of the air market (>3bn bus pax vs. 54m air pax in 2019). 41% of VLRS's routes pre-COVID had only bus competition and VLRS sees buses as the primarily competitor and source of growth. Amazingly, VLRS flights are actually cheaper in many cases than the competing bus trips and VLRS runs ticket giveaways at bus stations to convert first time flyers. First time flyers comprised 6% of 2019 passengers and 82% of passengers surveyed would not travel by bus again. COVID has pulled forward bus switching given the difference in trip duration. 3.) Market share gains from 30%+ reduction of domestic capacity and collapse of primary competitors – a. VLRS has captured ~50% of the growth in the domestic market since its founding and has grown from a 4% in 2006 share to 31.1% in 2019. In July, VLRS held 45% share of the domestic market which is sustainable and could grow further. b. Aeromexico's domestic market share has shrunk from 40% in 2011 to 24% in 2019 as the legacy carrier has basically ceded the domestic market to ULCCs and runs it primarily to feed international travel. Aeromexico is currently in chapter 11 and is expected to reduce its fleet by at least 30%. c. Interjet (19.7% 2019 domestic share) is the 3rd largest ULCC, but is the most important competitor to VLRS since they share Toluca as their main hubs and since Interjet has been aggressively discounting since 2018 in order to manage solvency issues. 60 of Interjet's 66 planes have been repossessed leaving them with a ragtag fleet of six barely operable Russian Sukhoi Superjets. d. Viva Aerobus is another ULCC with 20.2% of the market in 2019, through Viva tends to stay in its lane geographically and focus in different airports than Volaris. Viva will definitely be looking to take their slice of Interjet's and Aeromexico's forfeited routes and slots, though its unlikely they'd be overaggressive with VLRS in an environment of massive undersupply 4.) Expanding and sustainable cost advantage embedded in underappreciated fleet transition – VLRS has the second lowest unit cost in the world and has a RASM lower than Aeromexico's CASM. Airbus NEO (new engine option) are roughly 10% cheaper on a unit cost basis, driven by fuel efficiency (-14% to -16% fuel burn per seat) and increased gauge (operating leverage on per-departure and per aircraft costs like pilot wages, landing fees, etc.). NEO aircraft currently make up 30% of seats in the fleet and the latest fleetplan has that growing to ~60% by 2023 (and >90% by 2026 depending on lease extensions and deferrals), Overall this translates to a ~1% embedded annual reduction in CASM through 2026 assuming no other other cost improvements off of 2019. Said differently, we expect VLRS's average seats per aircraft to grow from 185 today to 198 by 2026. 5.) Upside from price and/or fleet flexibility – VLRS has pushed out 24 neo deliveries from 2020-2022 to 2027-2028 in order to save USD$200m of predelivery payments – if demand recovers more quickly VRLS could reaccelerate those orders and grow the fleet 20%+ in the next three years. VLRS has historically also extended leases beyond the contractual redelivery date, though the published fleet plan only reflects contractual deliveries and redeliveries. VLRS remains nimble and able to accelerate growth and take share if demand is strong or to recover pricing and build cash 6.) Ancillary revenue upside – since 2011 non-ticket revenue per passenger has grown at a ~19% CAGR, and remains below comparable global ULCC peers in absolute value and % of revenue. We'd expect this to grow per management's comments and historical execution, as well as supportive baggage attach rate data through July 7.) Additional growth opportunities from newly-freed slots in previously capacity-constrained Mexico City and expansion into Central America – Historically capacity constrained Mexico City airport has use-it-or-lose-it rules and given the fleet outlook, the incumbents (Aeromexico and Interjet) look as if they will finally lose it, opening the door for VLRS to land-grab valuable slots. VLRS is in the early stages of ramping up subsidiaries in Costa Rica and El Salvador, both of which are high-priced markets with limited ULCCs penetration and significant growth opportunities (watch out CPA) Risks/Mitigants: 1.) Travel recovery - globally, passenger travel has been slow to recover, with some suggesting a structurally lower level of travel as the "new normal". VLRS carries primarily VFR and leisure traffic which is more resilient and quicker to recover than corporate travel, but of course the future is unknown and a second shutdown could increase the risk of a dilutive issuance. 2.) Liquidity - while VLRS is net-positive cash ex-leases and has executed a substantial and impressive liquidity preservation plan (see 2Q20 call and latest investor pres), a second shutdown VLRS would potentially require a further deferral of deliveries, limiting VLRS's ability to fully capitalize on the opportunity market share opportunity. The company said on the 2Q20 call they expect 40-45m USD of monthly cash burn in 3Q20 and that all incremental capacity decisions would be made on the basis of incremental cash contributions - given the capacity recovery since the call we expect the 3Q20 exit rate to be much lower. VLRS is a critical customer to airbus, airports and other suppliers and we would expect further deferrals or negotiations to be successful if travel deteriorates from here 3.) Potential equity or convert issuance - The board has convened an Extraordinary Assembly for 9/18/20 at which they're expected to propose an issuance of debt, converts or shares. The uncertainty creates an overhang, but we believe it is more likely driven by a desire to re-establish a more aggressive fleet plan that was tempered in the depth of the crisis. We would expect that senior debt markets remain open to VLRS. 4.) Uncertain overhang from extended booking period - VLRS extended their booking period out to Oct 2021 and offered 125% flight credits for customers willing to re-book which could be an overhang on unit revenue through 2021, though the does maximize volumes on which to earn ancillary revenue and maximized aircraft utilization. This was a wise move by mgmt to minimize cash outflows from refunds, but with air traffic liability greater than 1/2 of available cash, a second shutdown could reintroduce liquidity risk or extend fare weakness a few quarters into the recover (though we'd expect this to be made up with close in pricing if travel surprises to the upside) 5.) General FX and macro related to Mexico Catalysts: 1.) Consistently improving monthly traffic reports and 3Q earnings to drive positive earnings revisions even if general air traffic recovery is weak 2.) Earnings power in the post-COVID competitive environment to become clear 3.) Removal of overhang form potential capital raise following 9/18 board meeting 4.) Further clarification of Viva and Aeromexico's post-COVID fleet outlooks 5.) Re-launch of Central American expansion and reintroduction of use-it-or-lose provisions in Mexico City, forcing the expected official forfeit by peers of slots temporarily granted to VLRS Management/Holders highlights: 1.) Indigo Partners/Bill Franke: Volaris is backed (15% current stake) by budget-airline guru Bill Franke's firm Indigo Partners, which also has stakes in Eastern-European carrier Wizz (another write-up to follow), Chile's Jetsmart and Frontier (with which Volaris has recently introduced a codeshare agreement with). Collectively, Indigo has an orderbook of 636 Airbus A320-family neo and XLR aircraft. Bill Franke is the former CEO of America West, Chairman of Wizz and Frontier. Indigo also launched and has since exited Spirit Airlines and Singapore's Tiger Air. Doug Parker (AAL CEO) and Scott Kirby (UAL CEO) are among the airline industry leaders originally hired by Bill Franke to America West. Other notable founding Volaris investors include Harry Krensky's Discovery Americas (current stake 2.41%), as well as Latin American business giants Carlos Slim, Emilio Azcárraga (Televisa) and Roberto Kriete (TACA) (current stake 7.6%). 2.) CEO Enrique Beltranena (0.9% holder) has been an aviation fanatic since 8 years old and joined the industry with his home country of Guatemala's Aviateca during privatization in 1988. He became general manager of the Aviateca and was responsible for its merger with, Sahsa, Nica, Lacsa and TACA Peru, forming a Grupo TACA and later serving as COO for the group. In 2003 the TACA boarded asked Beltrarena to develop plans for interconnecting airlines in Latin America – one of the six resulting plans was Volaris. In 2005, Beltranena left the 6,800-employee Grupo TACA founded with Volaris 3.) Enrique is supported by EVP Holger Blankenstein since VLRS's founding, former Bain consultant who heads VLRS's data-intensive approach to everything from network, fares, marketing and labor Catalyst Catalysts: 1.) Consistently improving monthly traffic reports and 3Q earnings to drive positive earnings revisions even if general air traffic recovery is weak 2.) Earnings power in the post-COVID competitive environment to become clear 3.) Removal of overhang form potential capital raise following 9/18 board meeting 4.) Further clarification of Viva and Aeromexico's post-COVID fleet outlooks 5.) Re-launch of Central American expansion and reintroduction of use-it-or-lose provisions in Mexico City, forcing the expected official forfeit by peers of slots temporarily granted to Note: I or others I advise have position in the security discussed in this post. This post represents only my personal opinions and is not meant as investment advice and only serves as supplemental information for your own holistic analysis. [link] [comments]  |
| Tyler Technologies (TYL) write-up Posted: 05 Sep 2020 01:55 PM PDT |
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