United states securities and exchange commission

Economic and Demographic Trends

We believe the Mexican airline industry has strong potential for growth, given the country’s young demographics, improving macroeconomic base and growing middle class, which will likely facilitate organic expansion of the airline sector. In addition, the national airline industry is relatively underpenetrated when compared to other countries of similar size and demographic characteristics. These elements combine at a time when the industry is under considerable attrition due in part from some of the legacy operators ceasing operations.

In terms of the macroeconomic environment, GDP growth in Mexico is expected to be 1.5% in 2017 and 2.1% in 2018 according to the Mexican Central Bank. These estimates are lower than the estimates for the United States by 81 and 41 basis points in 2017 and 2018 according to the International Monetary Fund, respectively. This projected GDP growth is expected to result in the continuing growth trend of middle-income homes, having already grown from 12.0 million in 2000 to 15.2 million in 2010, according to information derived from the Mexican Association of Market Research and Public Opinion Agencies ( Asociación Mexicana de Agencias de Investigación de Mercado y Opinión Pública, A.C. ) and the National Statistics and Geography Institute ( Instituto Nacional de Estadística y Geografía ). As of 2015, according to the INEGI intercensal survey, approximately 36% of the Mexican

 

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population was under 20 years of age, which we believe benefits Volaris by providing a strong base of young, potential passengers in the future. This contrasts favorably with more mature aviation markets like the United States, where approximately 27% of the population is currently under 20 years of age. Additionally, the Mexican aviation market is currently underpenetrated, as evidenced by the number of trips per capita. On a global basis the World Bank estimates that there are, on average 0.47 annual trips per capita, whereas in Mexico the number is roughly a portion of that.

The Mexican low-cost airline industry competes with ground transportation alternatives, primarily long-distance bus companies. Given the limited passenger rail services in Mexico, travel by bus has traditionally been the only low-cost option for long-distance travel for a significant portion of the Mexican population. In 2016, bus companies transported over 3.0 billion passengers in Mexico, of which approximately 80 million were executive and luxury passenger segments, as measured in segments which include both long- (five hours or greater) and short-distance travel, according to the Mexican General Direction of Ground Transportation Authority. We believe that just a small shift of bus passengers to air travel would significantly increase the number of airline passengers. We believe that an increased shift in demand from bus to air travel in Mexico presents a significant opportunity as the macroeconomic environment improves and rising demographics take shape across the country. Furthermore, we believe that long-distance bus passengers will continue to shift to airplane travel when certain promotional fares are priced lower than bus fares for similar routes.

In recent years the Mexican government has made a substantial investment in developing Mexico’s airport infrastructure. In 1998, the Mexican government created a program to open Mexico’s airports to private investments. Three private airport operators (Grupo Aeroportuario del Pacífico, S.A.B. de C.V., Grupo Aeroportuario del Centro Norte, S.A.B. de C.V. and Aeropuertos del Sureste de Mexico, S.A.B. de C.V.) were incorporated and granted 50-year concessions to operate airports in Mexico. In the first stage of the privatization process, the Mexican government sold a minority stake to strategic partners. The privatization process culminated in mid-2006, when the Mexican government sold the balance of its holdings to the public via initial public offerings. The Mexican government still manages and operates the Mexico City International Airport (AICM), which it considers strategic, as well as other minor airports in the country. The National Development Plan, published in the Official Gazette of the Federation on May 20, 2013, describes the plans for the airline sector for the years 2013 to 2018. The plan provides for (i) investments in air transportation and airports; (ii) supervision of airlines to ensure safety, efficiency, and quality standards; (iii) the execution of new bilateral air transportation agreements in order to increase the penetration of the Mexican domestic airline industry in international markets; and (iv) the development of airport services for the metropolitan area of Mexico City, as well as regional airports. In addition, on July 15, 2013 the 2013-2018 Investment in Transportation and Communications Infrastructure Program was announced, which is a program with a multi-modal focus, that is intended to improve highways, railroads, ports, airports, and telecommunications through an investment of Ps.4.0 billion. We believe this strong foundational infrastructure, and continued investment and development will result in significant growth potential for the Mexican airline market. In September 2014, the Mexican government announced the construction of a new international airport for Mexico City to replace the current international airport, which is now operating at full capacity at most times of the day. This new international airport is expected to start operations in 2020.

Boeing estimates that the Latin American airline industry will have a higher growth rate than that of the global industry over the next 20 years, with an average passenger to economic growth ratio (RPK/GDP) of 2.0 times. As a result, a GDP growth of 2.9% in the next 20 years could imply an industry growth rate of around 33% by 2021 and over 75% by 2026.

The Mexican aviation industry has undergone a significant transformation due to the emergence of low-cost carriers, including us, Interjet and VivaAerobús, the exit of eight carriers (Aerocalifornia, Aladia, Alma, Aviacsa, Avolar, Azteca, Nova Air and Grupo Mexicana). Changes in the Mexican airline competitive environment have resulted in an important increase in the domestic market load factor for the remaining carriers. While load factor in Mexico has historically lagged more than in developed markets, this positive trend will likely drive greater profitability among the remaining airlines in Mexico. This dramatic capacity reduction and its low-fare strategy allowed Volaris to increase load factor to 85.8% in 2016.

Market Environment

The airline industry is highly competitive. The principal competitive factors in the airline industry include fare pricing, total ticket price, flight schedules, aircraft type, passenger amenities, number of routes/destinations served from a city, customer service, safety record and reputation, code-sharing relationships, frequent flier programs and redemption opportunities. The airline industry is particularly susceptible to price discounting because once a flight is scheduled, airlines incur only nominal incremental costs to provide service to passengers occupying otherwise unsold seats. The expenses of a scheduled aircraft flight do not vary significantly with the number of passengers carried, and, as a result, a relatively small change in the number of passengers or in pricing can have a disproportionate effect on an airline’s operating and financial results. Price competition occurs on a market-by-market basis through price discounts, changes in pricing structures, fare matching, targeted promotions and frequent flier initiatives. Airlines typically use discount fares and other promotions to stimulate traffic during normally slower travel periods to generate cash flow and to maximize revenue per ASM. The prevalence of discount fares can be particularly acute when an airline has excess capacity and is under financial pressure to sell tickets.

 

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In Mexico and the United States the scheduled passenger service market consists of three principal groups of travelers: business travelers, leisure travelers, and travelers visiting friends and relatives, or VFR. Leisure travelers and VFR travelers typically place most of their emphasis on lower fares, whereas business travelers typically place a high emphasis on flight frequency, scheduling flexibility, breadth of network and service enhancements, including loyalty programs and airport lounges, as well as price.

VFR and leisure passengers travel for a number of reasons, including social visits and vacation travel. We believe that VFR and leisure traffic are the most important components of the traffic in the markets we target and serve and are important contributors to our non-ticket revenue production. We believe that VFR and leisure passengers represent a significant percentage of our total passenger volume. As part of our route development strategy, we target markets that will likely appeal to VFR and leisure travels at price points that were previously not available. This strategy allows us to stimulate demand in new markets by encouraging travel by VFR and leisure travelers.

Domestic passenger volumes have grown in Mexico by a CAGR of 6.5% and international volumes have grown by a CAGR of 4.0% from 2006 to 2016 according to the DGAC. The following table sets forth the historical passenger volumes on international and domestic routes in Mexico from 2006 to 2016:

 

Passenger Volumes (millions of segment passengers)		2006				2007				2008				2009				2010				2011				2012				2013				2014							2015							2016
International			27.4				27.2				27.9				24.2				25.8				26.8				28.5				30.9				33.6								37.5								40.5
% growth (decreased)			6.1	%			(0.5	%)			2.5	%			(13.2	%)			6.3	%			4.1	%			6.5	%			8.1	%			9.2		%						11.7		%						8.0		%
Domestic			22.2				27.4				27.6				24.4				24.5				25.5				28.1				30.5				32.9								37.1								41.8
% growth (decreased)			11.8	%			23.6	%			0.9	%			(11.6	%)			0.3	%			3.9	%			10.3	%			8.6	%			8.0		%						12.9		%						12.5		%
Total			49.5				54.6				55.6				48.7				50.3				52.3				56.6				61.4				66.5								74.6								82.3
% growth (decreased)			8.6	%			10.3	%			1.7	%			(12.4	%)			3.3	%			4.0	%			8.4	%			8.5	%			8.3		%						12.3		%						10.2		%