Grupo Aeromexico SAB de CV (AERO) 2016 Q2 法說會逐字稿

Good morning and welcome to Grupo Aeromexico's second quarter 2016 earnings results conference call. Before proceeding, I would like to mention that certain comments made during the conference call may constitute forward-looking statements regarding future events or any future financial performance of the Company. These statements are based on the current beliefs and expectations of management and the Company.

Forward-looking statements are based on management's current assumptions and on the information currently available and do not guarantee the Company's performance. The timing of certain events and actual results may differ materially from those projected by forward-looking statements due to a number of factors including, but not limited to those inherent to our industry as well as commercial, economic, and other risks and uncertainties. At this time, all participants are in a listen-only mode. This call is being recorded. I would now like to turn the conference over to Mr. Jonathan Wallden, Senior Vice President of Financial Planning and Investor Relations. Please go ahead.

Good morning and thanks for joining us for our second quarter 2016 results presentation. Speaking on the call from Mexico today are Aeromexico's CEO, Andres Conesa and our CFO, Ricardo Sanchez Baker. Andres will open the call providing insights into our quarterly performance and results and Ricardo will then address our revenue, cost, and cash flow performance. There will be an opportunity for questions at the end of the call. So now, I will turn to our CEO, Andres Conesa.

Good morning, ladies and gentlemen and thank you, Jonathan. It is a pleasure to share with you our results for the second quarter of this year. As in previous quarters, the first six months of the year have been characterized by continued mixed economic conditions specifically the positive impacts of sustained low fuel prices and continued stability in Mexican economic activity have been partially offset by the weakening of the Mexican peso. The peso has depreciated 18.3% against the US dollar in the second quarter compared to same period of last year. The Mexican economy meanwhile has remained stable with average economic growth of 2.4% between January and April of this year.

During this quarter, we achieved an operating margin of 3.1% and for the first half, an operating margin of 4.2%. This is 0.1 points better than the same period last year. With these results, we have delivered positive operating margin every quarter for 25 consecutive quarters. In terms of capacity, we have continued to demonstrate capacity discipline with ASK's increasing 3.8% during the quarter and 6.5% during the first six months of the year. We retain our guidance of growing capacity between 6% and 8% for the whole year supporting our strategy of managing capacity growth in a disciplined manner and taking advantage of greater demand through upgauging our fleet.

During the fourth quarter of this year, we will receive our first 787-9, which will allow us to continue enhancing our customer proposition with a state-of-the-art fleet. Aeromexico continues to focus on offering strength in connectivity through Mexico City airport and our customers from across the Americas increasingly recognize Mexico City airport as a key hub. Indeed, I am delighted that two weeks ago, Aeromexico won the award for Mexico and Central America's leading airline at the World Travel Awards. Aeromexico now offers flights to more destinations from its hub than any other airline in Latin America.

This May, we started direct services from Mexico City to our forward European destination, Amsterdam and we have additionally just increased our frequencies to Santo Domingo. Since the second quarter of last year, we have launched seven new international routes from Mexico City [merging] Panama, Toronto, Boston, Vancouver, Santo Domingo, and Amsterdam. In terms of unit revenue performance, revenue per ASK increased by 5.6% during the quarter supported by increased yields of 4.3%.

Other income increased 43.6% compared to the same period of 2015 mainly due to improvements in our ancillary revenues as our new co-branded card partnership with Santander begins to gain traction with our customers. Since the launch of the program in the first quarter of this year, over 150,000 dual branded cards have been issued. This has been further supported by higher ancillary revenues from additional services such as AM Plus, upgrades, and preferred seating.

Turning to our cost base, cost per ASK in pesos increased 6.6% primarily as a result of continuing peso depreciation while cost per ASK in dollars decreased 9.9% mainly driven by the decrease in fuel prices in dollars and operational efficiencies highlighting Grupo Aeromexico's ongoing focus on optimizing unit costs. We have a strong pipeline of cost reduction initiatives that will continue to improve efficiency. The incorporation of our new modern fleet, operational efficiencies, and our enhanced labor productivity agreements will continue to contribute to optimizing our cost per ASK. We are continually reinforcing Aeromexico's position as Mexico's premium carrier through disciplined capacity growth, innovation in our products, and continued improvements in customer service.

We will carry on investing selectively where we believe we can deliver the greatest returns with e-commerce being a particular focus. During July, we are rolling out our next generation kiosks at Mexico City airport and this together with our new website will enable us to provide an enhanced customer experience. Through both media, we will be offering improved customer choice, including fare and seat selection, upgrades, AM Plus among other services. This will provide Aeromexico with opportunity to drive additional ancillary revenues and improve our cost per ASK.

Turning to our strategic business partner Delta, with regard to our proposed commercial JV, our application for antitrust immunity remains in the process of regulatory approval in the US. In May, we obtained approval to proceed from the Mexican regulators although at the moment the procedure is in the hands of the DOT in the United States. Subject to this approval, we hope to start our new JV later this year. This agreement will allow both companies to align trans-border network and schedules, enhancing our customer benefits with increased frequencies and network expansion.

Finally, with regard to Delta's proposed investment to acquire up to 49% of Grupo Aeromexico's stock, we expect the transaction to be completed once the ATI application gets resolved. This concludes my remarks. I would now like to hand over to Ricardo, who will provide more detail on the financial results of this quarter. Thank you for your confidence and Ricardo, please go ahead.

Thank you, Andres. Good morning, everyone and thanks for joining us today. We delivered a strong quarter with a slight improvement in operating profit compared to the second quarter of 2015. This is our 25th consecutive quarter of operating profit as Andres mentioned. Beginning with our topline, we achieved revenues of MXN12.4 billion, a 9.7% year-on-year increase. This increase was mainly due to an 8.4% increase in passenger revenues and 11.4% increase in cargo revenues and it is important to mention that this is the 11th consecutive quarter in which we have had a year-on-year increase in cargo revenues driven by improvements in our commercial strategy and customer service as well as the Boeing 787's extra cargo capacity.

We also had a 43.6% increase in other revenues driven by the new co-branded card partnership with Santander, launched during the first quarter of 2016 as well as higher ancillary revenues from additional services such as upgrades and preferred seating. These increases were partially offset by a decrease of 26.6% in charter revenue as the Company focuses on its core scheduled business. Our international passenger revenue amounted to 54.1% of total passenger revenues, creating a better hedge against exchange rate fluctuation, which is increasingly important in light of continued exchange rate volatility.

In the meantime, our domestic passenger revenue amounted to 45.9% of passenger revenues. As in previous quarters, two macroeconomic factors have impacted our cost structure again this quarter, fuel prices and exchange rates. Fuel prices in dollars fell compared to the second quarter of 2015 resulting in a 11.9% reduction in our total fuel costs for the quarter.

The benefit obtained from lower fuel prices is not fully proportional to the reduction in international market fuel prices due to the fact that the Mexican peso depreciated 18.3% against the US dollar during the second quarter of 2016. We are well positioned to capture the benefits of market fuel price reductions thanks to our hedging policy. With around 50% of the next year's fuel requirements hedged using a mix of coal and coal spread options with a strike price starting at $1.83 per gallon.

The positive impact of this hedging policy has been reflected in Grupo Aeromexico's financial results since the Company benefited from reductions in market prices of fuel while maintaining the maximum loss of the hedging policy capped to the value of the premiums paid for said options. Secondly, regarding exchange rate, the Mexican peso depreciation mentioned before increased several operating costs such as aircraft leases, maintenance expenses, reservation expenses, and communication and traffic expenses among others. We estimate that during the second quarter of 2016, the 18.3% exchange depreciation contributed to a year-on-year increase in [dollar of MXN0.9 billion] in operating costs excluding fuel. Including fuel, the exchange rate depreciation contributed to a year-on-year increase in the order of MXN1.3 billion in our costs.

With a depreciating peso, it has been critical to continue our focus on managing our cost base. During the second quarter, we continued to obtain positive results on the cost side. Our second quarter total cost per ASK expressed in dollars decreased by approximately 10% versus the same period of 2015 while our cost per ASKs in dollars excluding fuel decreased by 3%.

Moving to our bottom line, second quarter operating profit reached MXN385 million, a 0.7% increase compared to the operating profit registered during the second quarter of 2015. Operating margin reached 3.1%. During the quarter, Grupo Aeromexico registered a positive foreign exchange impact of MXN129 million, based on the revaluation of US dollar denominated assets. This is due to the fact that we used the US dollar as our functional currency while the peso is used for registration and reporting. As part of the foreign exchange impact during the quarter, we recorded a negative foreign exchange impact of MXN60 million on our cash position in [bolivars] as we have suspended operations to Venezuela and we are in the process of closing our financial position. The Company also reported a positive impact of MXN3 million due to mark-to-market gains on our fuel hedging positions.

Second quarter net income reached MXN28 million with a 0.2% margin. Year-over-year, our balance sheet continued to improve. Despite the significant impact of exchange rate depreciation on our debt, our strength in financial performance allowed us to decrease our adjusted financial [net debt-to-EBITDA ratio], which includes capitalized leases to 4.8 times, below the 4.9 times registered at the end of 2015. At constant exchange, our ratio would have been approximately 3.9 times [EBITDAR]. Cash flow generation also remained strong. During the second three months of the year, net generation of cash resources derived from operating activities amounted to MXN3.6 billion. Cash to revenue at the end of June was 14.9%.

We closed the second quarter of 2016 with 128 operating aircrafts including 64 Embraer aircraft, 51 Boeing narrow-body aircraft, and 13 Boeing wide-body aircraft, comprising four 777s and nine 787s. We continued to pursue our strategy of upgauging our fleet and retaining our guidance to close the year with 131 aircrafts. This concludes my remarks. Thank you once again for joining us on today's call and we would like now to answer any questions that you may have. Thanks.

(Operator instructions) Michael Linenberg.

Good morning Jon and this is actually Katie O'Brien filling in for Mike. Just a couple questions here. Regarding the large increase you saw in other revenue, could you give us a breakout of how much of that was driven by your new credit card agreement versus growth in your other ancillary revenue items and just this update on your new kiosk coming on in July and the new website, how much potential do you think that has to grow your ancillary products. Thank you.

Thank you, well, most of the ancillary revenues are linked to other concepts, other than these ones. So roughly probably, I will say that around MXN100 million are linked to these new agreements, but again most of the ancillaries have to do with the traditional concepts of excess luggage, AM Plus upgrades. That's the bulk of it and I think we have lots of room to improve there because even though this concept grew 43%, we are relatively low in terms of ancillary to total revenues compared with our peers.

So, I think there is, again a significant opportunity to grow. In terms of kiosks, we launched them a couple of weeks ago. If they are working really good, this will give us also additional opportunities for ancillaries because it has compared to the other ones, the possibility to capture additional revenue. They are at the final check-in point of the passengers. So, again its soon, but we're very happy with the performance with the new webpage that we plan to launch next week and the complete version in the first week of August.

We've been growing significantly in our direct sales to total sales, but this will give us an additional boost. So again, it's a sign also to cater and attract more ancillary revenues. So, we are very confident that it will help us in supporting that strategy and also to improve the service that we offer to our customers to a more friendly way of booking and paying. Thank you.

Great, thanks. And then if I could just ask one more. In the US right now, most network carriers are noting the decline in business travel yields, but seeing that, there's continued strength on the leisure side. How's that compare to the trends you're seeing in Mexico right now?

I would say that in terms of our main business markets, they are relatively flat. I mean they haven't been declining. We've changed a little bit our strategy in the second quarter and compared to what we were thinking at the beginning of the year, we added a little bit more capacity in the domestic market versus international and also for example Ricardo mentioned when we canceled the Venezuela flight, we [were using that plane] to have a combination of business markets like Monterrey and also some leisure markets like Los Cabos.

So in terms of -- yields are holding domestically relatively well although as you mentioned probably, right now in the summer and that's clear, the leisure markets has done slightly better. Well, for the rest of the year, we remain positive in the sense that the aviation market within Mexico, the domestic market will continue to perform as it has been in the first six months of the year, which has been better than the first six months of 2015.

Ravi Jain.

So, I have two quick questions, the first one is, how have you see the competitive landscape change on the trans-border routes after the aviation agreement between Mexico and US? Are you seeing additional competition? How you are seeing the yields internationally between Mexico and the US? And the second question is, can you give us a little bit more color on the cost efficiency initiatives or what kind of benefit should we expect in the second half and going into 2017? Thank you.

Regarding the competitive landscape, with the new bilateral agreement between Mexico and the US, we are expecting additional seat capacity between the two markets. In fact, you've already seen that, seen although in the first six months of the year -- we've seen not only from us but from our competitors some additional frequencies in key markets. In our case, we've added some important in capacity markets like LA, in New York, a little bit some additional flying in the summer between certain leisure places in Mexico and you will see this. So, we expect that to continue. What I think that with the JV that we are asking and as I mentioned, it's in the process of being approved on the US side will help us to offer not only additional seats, but a better product together. I [don't mention Delta] by connecting better, we expect that we will be able again to offer a much better product at a more competitive scenario and that [will help] as we mentioned in the previous conference call in an additional increase probably between today and in the next five years of around 20% more flying altogether compared to what we are flying today. And Ricardo will answer the second question.

Regarding the cost efficiency initiatives, the main initiatives that we are pursuing continue to be fleet upgauging of course. That is certainly one of the most important initiatives that we have to gain efficiency in our unit cost and we will continue to do that. We will continue to phase out some of the Embraer 145s and bring some additional 190s in the second half of the year, that's important.

The other important initiative of course is related to labor as we also continue to rely more on our productivity enhanced labor contract, but we are working also on other initiatives. As usual, reviewing processes and improving, but one important initiative that will kick in mostly by the end of the year is a new IT system for maintenance and supply chain. We are implementing a new maintenance system. I will say this is like the third big wave of IT investment in the Company after the reservation system, the back office, and then this is the operational part on maintenance and supply chain and this will allow us to make a much more efficient maintenance plan and also a more efficient response from our supply chain area to the maintenance needs. So this is an assistant that will certainly streamline the operating part of the airline and that should be ready by November/December of this year.

Perfect. Thank you. That's really helpful. One quick follow-up if I may be on the Delta antitrust immunity and the tender offer after that. As of today, in your expectations, do you think that -- when do you expect to get the approval for the antitrust immunity? Should we look at it more towards the end of the third quarter or more closer to the end of the fourth quarter just to gauge as of today your thoughts?

Yes, I would say probably the end of the third quarter or early fourth quarter. So that's more or less what we are expecting along those two couple of months. It been a process that you know -- has lasted, we applied for it in May of last year. So it's been already 14 months. So we are seeing probably the light at the end of the tunnel soon.

[Francisco Rodriguez].

I have two questions if I may. The first one is regarding to Delta's offer of acquisition. We understand that the agreement is not binding. Is there any possibility that this could be revised?

Well. That question should be answered by Delta, but we have a great working relationship. We have been working together for many years. As you know, they already are important investors in the Company. So again, the process probably has taken more than what we expected these 14 months that I mentioned, but in our view, we do not see any clouds in the horizon that could translate into what you mentioned, but obviously, it's something that Delta would need to answer.

Okay, understood. The second question is related to maintenance expenses, which have surged significantly lately. Could you give us more color on what's the reason behind this? Is it FX or something else? And what do we expect looking forward?

Thank you, Francisco. This is Ricardo. Regarding maintenance expenses, I mean when you compare the second quarter expenses to the expenses in the second quarter of last year, we have an increase, a significant increase, but however, if you normalize last year's expenses and let's say you take the total annual expenses and divide them by four, you would see that the variation then is really reflecting the foreign exchange movements.

So, really what we have here is a combination of two factors. One is the seasonality of the maintenance plan that we have in 2015. Our maintenance plan was heavy loaded for the second half of the year. This year what we have done is basically, we have been smoothing that process to have maintenance expenses relatively flat during the year and therefore the variation versus last year overall mostly reflects exchange rate and the seasonality effect. Once we get to the second half, you will see a much lower variation basically just coming from foreign exchange movements.

Victor Mizusaki.

Actually, I have two follow-up questions. The first one, you said that you want to replace E145. So the idea is to replace all of them in the second half or can we expect something for 2017. And the second question I think about capacity you said I think the second quarter, you changed a little bit your strategy and then you deploy more capacity into the domestic market. Is this something related to the impact of the sales depreciation and what can expect in the second half, I mean given that [petroleum cost depreciation could] basically affect demand for international travel.

Thank you, Victor. In terms of replacing the 145s that Ricardo mentioned, in the plan that we have for the second half, we have some E145s going out of the fleet and 190s arriving. We expect to keep probably between 10 and 15 145s until probably 2018. They will be still flying in 2017, but one thing for sure is that they will not be flying next year in Mexico City. All of them will be particularly in the Monterrey hub and some flying in other regions.

So again, we will keep them probably for another couple of years, but outside Mexico City. In terms of capacity, yes what we saw is that there were some yield pressure outside Mexico in some international flying, that's why we decided -- and also we have been very conservative in adding capacity in the domestic market. It has been for two or three consecutive quarters relatively flat growing 1% to 2%. So, we felt that that was not enough.

For the remainder of the year, as I mentioned, our guidance is to grow between 6% and 8% and if you look at the narrow-body fleet, it will be evenly distributed between flying in Mexico domestic and flying outside. Probably you will see higher ASK growth because as we receive the 787-9s, we know we are adding additional capacity on wide-bodies, all of that flying is outside. So that's probably, the skill will be [typical] of that, but if you look at the rest of the fleet, it will be evenly distributed between domestic and international. As of the second quarter, I want to highlight, two-thirds of our flying is international. 66% of our ASKs are outside Mexico and one-third is within Mexico.

Okay, can you give any guidance in terms of EBIT margin for the full year?

No, it's difficult to say. As you say, obviously the depreciation of the peso obviously has an impact on demand although we are seeing strong volumes and good support of yields for the summer. So, it will depend a lot how the rest of the month and [Nagos] turns out, but so far what we are seeing again compared to last year is positive momentum. So, in that sense, traffic and yields look good, but on the cost side, depending on the movement of the pesos, it was explained during the second quarter, it could have an impact on the P&L.

Renato Salomone.

Yes, thanks for taking my question. For the past few quarters, Aeromexico has been purely focusing on maximizing unit revenues through yields, but with the peso devaluation and the growth of ultra-low-cost carriers in the domestic market, how sustainable is this strategy of protecting yields at the expense of volume and consequently market share?

Thank you, Renato. Actually, if I would characterize second Q, obviously, revenue per ASK, the performance was good although there as you know, as we have lots of international flying that reflects also some of the depreciation of the peso. So, if you look also, revenue per ASK in dollars, it's still in negative territory. So there have been in the industry and that has happened in many regions across the world, some pressure on yields measured in dollars. We continue to be competitive and if I would characterize -- that we share in the second Q, the improvement was a combination of both volume and yields. Actually, if you look at our traffic figures for April and May, they were relatively flat and for June, we posted a significant increase. So, June in terms of volume was very important and we are seeing that same trend for July and August. So again, it's a combination of volume and yields, not only yields.

Mauricio Arellano.

You guys mentioned earlier, your ancillary revenues, you're saying as a percentage of total revenue, it's below the average for your peers. More or less, is there any guidance that you can give us as to what percentage of total revenue you would like that bigger to be? That would be it.

Well, that depends on the business model of course. I mean some carriers rely more ancillaries versus the base rate, but what I can say is the growth that we have been experiencing of 43% -- I think, our idea is to maintain, double-digit rates of growth and at least for that we have another two to three years to catch up. So, we are relatively still far away from where we want to be and again, the investments that we're doing particularly in e-commerce with a new page, an offering what we've concentrated not only strengthening ancillary revenues by charging more, but offering new products to the customer. So it's upselling. So adding value, nothing that inhibits the customer experience. We are going to be very careful on that and that's the balance that we want to -- now be cautious going forward.

Mauricio Martinez.

Good morning, and thanks for taking my question and congratulations on the report. I was wondering if you can share with us your expectations in terms of yields for the second half of the year and if you see [sustainable percent] increase that we saw this quarter is sustainable?

Hi, Mauricio. Yes, I think we can -- our expectation -- we can keep the trend that we're seeing, which was recovering in the second Q versus the first Q, in terms of yields versus revenue per ASK. We expect that at least for the third Q to continue. Going forward, again for the fourth Q and beyond, it's difficult to say because it will depend a lot on the behavior of the exchange rate. There are some events that can have an impact on the exchange rate in the second half of this year. So it's difficult to forecast, but what we are seeing, again as I mentioned in my previous answer is that we will again continue to drive these by a combination of volume loss, revenue management. So the pick-up is positive. Again comparing the trend is good and we are going to work and very hard to make sure, but it continues going forward.

Michael Linenberg.

Just one more quick question on the JV with Delta. I believe you said that you expected to close sometime towards the end of the fourth quarter, beginning of first quarter next year possibly and I was just wondering, after that closes, have you been working maybe kind of behind the scenes that you can turn on the switch to cooperate once that agreement is approved. Like for instance, how quickly would you be able to co-market to your corporate customers on both sides once you get that approval?

We expect the approval to take place by the end of the third Q or [early 4Q] this year. That's the base case scenario. So, we expect to have in place and we cannot start working until we have that approval, but we expect to relatively fast be able to start offering the benefits to the clients for the two airlines, really relatively fast. I would say probably not more than a quarter. So if we get the approval this year, we will be able to start working together probably early first Q of next year. So it will not be too much time between the two events.

And then just one quick clarification question on my question earlier actually. I believe you said that MXN100 million of the year-over-year improvement, that was the credit card, did I get that right?

Yes.

So the credit card was half of the year-over-year improvement. The other half was just the ancillary products.

Right, improvement, but the bulk of the ancillaries are related to these other products, yes.

(inaudible).

So, two questions here. So the first one, how do you compare the profitability of your Embraer fleet compared to your Boeing fleet? And since you're in this upgauging strategy, would that make sense at some point to replace for example the E190 for Boeing 737s if you continue to upgauge further?

Well, really it's difficult to measure and characterize between Boeing and Embraer because that also depends where you're flying. So that can affect and its a decision based on the size of the markets, affect the profitability number and that wouldn't mean that one airplane is much better than the other. As you know, we have two carriers, one Aeromexico and one Aeromexico Connect. So, we have a clause that limits the number of seats up to 100 in Aeromexico Connect. So, we are not thinking in replacing as long as we know and the idea is to keep flying the two airlines. What we are definitely looking in the next decade, what we're going to do with our original fleet and obviously one option is to continue working with Embraer and the other one, there are other possibilities and we are -- the case analyzing everything on a day-to-day basis. We're not taking that decision soon, not this year, but in the future, again we need to make sure that 2020 going forward what will be the product that we will be offering on our regional airline in Aeromexico Connect.

Okay, and a second point, so related to your financial liquidity. So today it's around 15% right, cash position as a percentage of last 12 months revenue. So, do you think that's a comfortable level for you or do you plan to raise that further and if you have any plans for that?

Thank you, [Leander]. We think this is a comfortable level. Definitely, we think a ratio between 12% and 15% is reasonable and in any case what we would prefer is to decrease leverage by decreasing debt directly more than having additional cash balance. So, we feel comfortable with this ratio of cash to revenue.

And also just to complement what Ricardo mentioned. This good performance and this good cash generation has been in the context of a significant CapEx expansion. So this here, between non-PDPs and PDPs, we will be investing [close to $1 billion] between aircraft and operating investment. So the possibility of having both, the ability to generate cash and strengthen the liquidity position together with making these investments that will help us in the future, I think it's important.

At this time, I would like to turn it back over to our speakers for any closing comments or remarks.

Just to thank everybody for joining the call and we look forward to seeing you for the summer results again, which we will work very hard to be very, very positive and if something important, write us in between, we will obviously touch base with you. Thank you for joining the call, bye.

We'd like to thank everybody for their participation on today's conference call. Please feel free to disconnect your line at any time.