Mexico's Volaris touts its differences from US ULCCs

Management at the Mexican ultra-low cost carrier Volaris recently took great effort to deliver a clear message to analysts and investors - "we are different from our US counterparts".

With Frontier Airlines and Spirit Airlines languishing during the past year, driven in part by changing market dynamics, Volaris believes that the elements that have propelled the ultra-low cost sector in Mexico for more than a decade remain intact.

A major driving force for Mexican ULCCs has, and continues to be, immense opportunity to switch bus passengers to air travel. And with a restoration of Mexico's safety rating by the US, capacity rationalisation has emerged in Mexico's domestic market, and has created new opportunities for Volaris in the transborder market.

Another way Volaris has distinguished itself from its peers in the US is the way it has faced headwinds created by issues stemming from the geared turbofan engines powering its Airbus A320neo fleet.

A sizeable portion of Volaris' fleet will remain grounded throughout the remainder of the year, yet Volaris posted a profit in 3Q2024, and expects its revenue for 2024 to inch close to its performance in 2023.

Summary

• The Mexican ULCC Volaris does not face the same challenges as US ultra-low cost carriers.
• Volaris believes it can use its lower costs as a competitive advantage in the US transborder market.
• The Mexican airline has arguably navigated aircraft groundings stemming from issues with geared turbofan engines well.
• Volaris is correct to highlight opportunities for ULCCs in Mexico's aviation market.

Unlike the US, Mexico is still an emerging aviation market

In the US both Frontier and Spirit have faced oversupply in the US market, as well as continued passenger preference for a more upscale experience, and each airline is adapting its products to enhance their competitive offering.

Frontier is touting upside from network and product changes, as well as significant opportunities to bolster loyalty revenue, and has ambitions to post double digit margins by mid-2025, after guiding to a pre-tax margin of 0-2% for 4Q2024.

Although Spirit is also working on product changes, its outlook appears more bleak.

The Fort Lauderdale-based airline is selling aircraft and cutting staff, amid reports about a potential bankruptcy filing.

Volaris hasn't been forced to adapt sweeping changes to its model for numerous reasons. It's one of the largest airlines in Mexico, acquiring a 33% domestic passenger share for the first nine months of 2024 behind fellow ULCC Viva Aerobus' share of 38%, according to data from Mexico's government.

The country's lone full service airline, Aeromexico Group, had a share of 28%. Before facing headwinds during the past year due to Airbus A320neo groundings, stemming from issues with geared turbofan engines, Volaris was the domestic market leader in the country.

Mexico is unique in that its two largest airlines are ultra-low cost carriers. But the reality is that the country remains a developing market, and significant opportunities exist to target passengers switching from bus to air travel.

The country's "unique ability to convert bus passengers and recurring travelers has driven growth in the country's emerging air travel market in the last 15 years", said Volaris CEO Enrique Beltranena during an earnings discussion last month. The airline's position "as an ultra-low cost carrier in Mexico is distinct from that of ultra-low cost carriers in the United States", he explained.

Mexico retains a strong potential to switch passengers from bus to air travel

In an Aug-2024 investor presentation Volaris said that the potential to switch passengers from bus to air travel represented an addressable market of 72 million travellers in the medium term - which is virtually double the size of Mexico's domestic aviation market.

Additionally, the airline explained that buses were the only competition on approximately 55% of its routes. Those market conditions allow the airline to "continue bringing in new flyers without creating excessive capacity growth in key ultra-low cost carrier markets," said Mr Beltranena.

Adding more detail to Mr Beltranena's conclusions, Volaris EVP of airline commercial and operations Holger Blankenstein said that the airline continued to see growing demand from first-time and repeat flyers. That is driving consistent strength in loads, fares and ancillary revenues.

Indeed, Mr Beltranena said that Volaris had kept base fares at 2019 levels over the past 12 months, while increasing ancillary revenues (as a percentage of total operating revenue) from 34% in 2019 to 51%.

Volaris believes it can build on its strength and seize new opportunities in the US market

Volaris believes the strength of its ultra-low cost model will also be a competitive advantage in its ever-growing US transborder market. Mexican airlines were able to resume growth on key US routes in Sep-2023 after the FAA issued a safety upgrade for Mexico (the agency had downgraded Mexico's safety rating in May-2021).

Mr Blankenstein explained that with the restoration of Mexico's safety rating, "we can now allocate capacity based on profitability in any of our markets", he said. Then he added that the airline expected air travel growth in the transborder market, driven by nearshoring: "We could offer low prices that United States competitors can't match," he said.

Opportunities also exist for bus-switching in the transborder market.

Citing Volaris' service from Guadalajara to Reno as an example, Mr Blankenstein described the pairing as a "VFR (visiting friends and relatives) niche route". "Where passengers previously travelled by bus, and now fly with us."

Volaris continues to see opportunities in its core VFR markets to the US, but has also expanded into transborder leisure markets. It has recently launched service from McAllen International airport in Texas to Cancún, and the airline plans to introduce service from Oakland to Cabo next year.

"This marks our first step in expanding our offerings as we leverage our widening cost advantage over North American ULCCs and legacy airlines." Mr Blankenstein said.

Data from CAPA - Centre for Aviation and OAG show that 42% of Volaris Group's capacity is deployed into international markets, the bulk of which is on transborder routes.

Volaris Group: domestic vs international available seat miles (ASMs), as of early Nov-2024

Source: CAPA-Centre for Aviation and OAG.
Note: Volaris Group comprises franchises in Mexico, Costa Rica and El Salvador.

Volaris does a commendable job managing Airbus A320neo groundings

The company's discussions about its distinctions compared with US ULCC counterparts occurs against a backdrop of Volaris managing the grounding of a sizeable portion of its fleet during the past year for inspections of geared turbofan engines.

During the third quarter, the airline had an average of 34 aircraft grounded, and that should improve slightly in the fourth quarter to 32.

Volaris Group: fleet summary, as of early Nov-2024

Source: CAPA Fleet Database.

Putting the grounding into context, Mr Beltranena explained that Volaris' capacity had fallen 11% over the past 12 months, compared with 2023.

He explained that during that time the decrease in revenue passenger miles (RPMs) moved at a slower pace than the drop in available seat miles (ASMs), "...indicating a well calibrated approach to capacity management". For the nine months ending in Sep-2024, Volaris' RPMs decreased 13.7% year-over-year, and ASMs fell 15%.

During the 12 months when engines have been grounded for inspections Volaris has maintained its base fares at 2019 levels, while increasing its ancillary revenues as a percentage of operating revenues from 34% in 2029 to 51%, Mr Beltranena said.

For 3Q2024, Volaris posted a 3Q profit of USD37 million, compared with a loss of USD39 million for the year prior.

Volaris astutely differentiates the market dynamics for ULCCs in Mexico and the US

It is understandable that Volaris opted to point out the differences in the US versus Mexico, with respect to the opportunities for ultra-low cost airlines in each market.

Those differences are formidable, and reflect different realities for ultra-low cost airlines across different markets worldwide.