Volaris Stock Surges: What Is Next? (NYSE:VLRS)

In October 2023, I analyzed Volaris (NYSE:VLRS). The review of the rating for Volaris stock and its price target was sparked by the anticipated capacity reductions driven by the geared turbofan issues that P&W, part of RTX (RTX), is facing. I maintained my buy rating for Volaris stock, but significantly lowered the price target. Since my buy rating, the stock price has significantly appreciated, and while Volaris has yet to share its fourth quarter 2023 and full year 2023 results, the company did issue guidance for the first quarter of 2024 as well as full year 2024. In this report, I will be analyzing whether the stock price changes and the issued guidance are reason to alter my view on Volaris stock.

Volaris Stock Price Drop Offered A Valuable Opportunity

Since I reiterated my buy rating for Volaris stock, the stock has done very well, appreciating 32.7% compared to 17.4% for the broader market displaying strong profitable potential for investors who could stomach the risk and averaged down. Admittedly, we made the buy call at the bottom for which I could take credit but that is also partially luck of course. Either way, helped by an analysis of the numbers and projections we were able to uncover a rewarding entry point.

Volaris Provides Guidance For 2024

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^{(1) For convenience purposes, actual reported figures for 1Q’23 are included.}

For the first quarter, we see that capacity will decline 16% to 18% which is steeper than the 9% capacity reduction expected by fellow Seeking Alpha contributor Ricardo Fernandez. At the same time we do see that unit revenues are expected to be up around 11.5% at the midpoint and unit costs excluding fuel will be up 20%, which likely is partially driven by the capacity reduction. A tailwind is that the average jet fuel prices during the quarter will be lower year-over-year. All of this results in EBITDAR margins of 25 to 27%.

We don’t know to what extent EBITDAR margins for the quarter are positively affected by the compensation that Volaris has agreed in connection with grounded airplanes and lease extensions but it’s clear that this will be the case. In the release for the November 2023 traffic figures, Volaris’ President and CEO said the following:

Looking forward, it is noteworthy that we have reached an agreement with P&W that contemplates compensation for each GTF engine removed from our fleet. The agreement will help address fixed costs associated with the engines during inspections, supplementing the mitigation initiatives outlined in our recent earnings call.

In the press release issuing the full-year guidance for 2024, the company also pointed out that the outlook for Q1 and the full year include GTF engine removal compensations. So, the strong EBITDAR margins likely are driven by a combination of lower fuel costs and a strong compensation package negotiated by Volaris management.

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For the full year, capacity is expected to be down 16% to 18% which is the same reduction as seen in Q1 202 and EBITDAR margins are expected to expand five to seven percentage points partially driven by lower fuel costs.

It’s going to be interesting to see what comment management can and will provide on the capacity reduction while executing a better EBITDAR margin in 2024, but I also do expect that the company will not be willing to split out how much of it is driven by the GTF compensation package. Nevertheless, the company seems to be navigating the issues the best it can and as expected the company is rotating some domestic capacity into the US market after Mexico regained its Category 1 safety rating allowing Mexican carriers to expand capacity in the US market again. That prudent capacity allocation likely also contributes to the better TRASM expected in 2024.

Volaris Stock Has The Potential To Fly Higher

I have processed the numbers for Volaris and I believe that even after the 32% surge in recent months, the stock still offers significant upside potential. Both the current EV/EBITDA for airlines and the median EV/EBITDA for Volaris show around 75% upside which would put the price target at around $14.

Wall Street analysts have a Strong Buy rating for Volaris with a $13.37 price target and 65% upside, so I feel quite comfortable with my $14 price target for 2023 and allow this to be the valuation on a one-year delayed valuation principle to account for any risk involved.

Conclusion: Volaris Is Navigating The Headwinds Rather Well

I believe that Volaris is handling the GTF grounding issues rather well and its EBITDAR margins for 2024 are looking strong. The company also is prudently deploying capacity with some capacity shifts from the weaker domestic market to US-Mexican routes which I believe bring better unit revenues. Considering the revised EBITDA and FCF, which came down another 1% for both metrics and 8% for EBITEDA compared to before the GTF issues I still believe that there is plenty of upside for Volaris stock even after the >30% surge in recent months.