Volaris Aviation (VLRS, Financial) has appreciated almost 40% since I first advised buying the stock back in July. As Volaris is a Mexican low-cost carrier, the company has little coverage and as a result, investors were unaware of its massive potential. Although Volaris has shot up drastically since my call on the stock earlier this year, I think the stock can still inch higher going into 2016. Here’s the reason why.
Cheap oil
After going public in 2013, Volaris was struggling due to high costs and overcapacity in the Mexican aviation industry. However, both the factors that held Volaris back disappeared in 2015, and as a result, the stock has outperformed major U.S. carriers this year. During the time when most aviation stocks are trading sideways, Volaris has managed to grow consistently and should continue its upwards trajectory since crude oil is cheaper.
Being a low-cost carrier, Volaris has benefited significantly from cheaper oil. When oil was priced at over $100 per barrel, fuel expenses accounted for over 33% of Volaris’ revenue. However, the number has come down to 20% and as a result, Volaris’ operational margin has gone up.
The downturn in oil prices is expected to last as there’s no sign of the oversupply ending. After OPEC reiterated its production outlook, it became certain that oil prices will be on their way down. Even legendary short-seller Jim Chanos (Trades, Portfolio) expects oil to go lower and is shorting oil. As oil falls, Volaris should see a continued improvement in its operational margin, which will ultimately push the stock price higher.
Still growing
The company is expanding its presence in both the Mexican and the U.S. market and the continued expansion should help push the stock higher. The company is expanding in the U.S. at a very fast rate, while the condition in its domestic market is also improving. Since both the market that Volaris serves is seeing strong demand, I believe Volaris’ expansion moves will reap fruits in the long term.
Despite the strong growth, Volaris’ stock is relatively cheap and is trading at 11x trailing earnings. With oil prices expected to go lower and demand expected to increase, I will not be surprised if Volaris reaches the $20 mark in the near future. This implies that the stock still has about 15% upside potential. Investing in Volaris right now could prove to be a good decision for long-term investors.
