Azul SA (AZUL) 2018 Q4 法說會逐字稿

Hello, everyone, and welcome to Azul's Fourth Quarter 2018 Results Conference Call.

My name is Paola, and I will be your operator for today.

This event is being recorded.

(Operator Instructions)

I would like to turn the presentation over to Andrea Bottcher, Investor Relations Manager.

Please proceed.

Thank you, Paola, and welcome all to Azul's fourth quarter earnings call.

The results that we announced this morning, the audio of this call and the slides that we'll reference are available on our IR website.

Presenting today will be David Neeleman, Azul's Founder and Chairman; and John Rodgerson, CEO.

Alex Malfitani, our CFO; and Abhi Shah, our Chief Revenue Officer, are also here for the Q&A session.

Before I turn the call over to David, I'd like to caution you regarding our forward-looking statements.

Any matters discussed today that are not historical facts, particularly comments regarding the company's future plans, objectives and expected performance, constitute forward-looking statements.

These statements are based on a range of assumptions that the company believes are reasonable but are subject to uncertainties and risks that are discussed in detail in our CVM and SEC filings.

Also during the course of the call, we'll discuss non-IFRS performance measures which should not be considered in isolation and are discussed in detail in our earnings release.

With that, I'll turn the call over to David.

David?

Thanks, Andrea.

Thanks, everybody, for joining us.

December 2018 marked our 10th anniversary.

If you're looking at Slide 3 in the presentation, it is truly amazing when you look at those 2 route networks what we've been able to accomplish in the last 10 years.

When we founded Azul back in 2008, we had a clear mission, to offer our crewmembers the best jobs of their lives because we knew our customers would have the best flight experience of their lives if we took care of our people.

After 10 years, we can clearly see the passion in our crewmembers.

They love their jobs, and our customers love flying us.

We couldn't have better ambassadors for our brand.

Because of this fantastic team, we were able to build an unbelievable network, serving more than 100 cities with a fleet of 125 aircraft.

We have built a solid foundation going forward.

Every next-generation aircraft we add will strengthen our network even more while reducing our costs.

We are now starting to reap the benefits of the network that we have built.

Another huge benefit of having great culture and brand, when difficulties come, like spikes in fuel prices and weakening currency, we have the ability to recapture revenue to offset a significant portion of these costs.

And that's exactly what happened in 2018.

Even though fuel is up 30% and the dollar appreciated against the real 17%, we delivered a record adjusted net income of BRL 704 million in 2018.

We also generated BRL 266 million in free cash flow and ended the year with a total liquidity position of BRL 4 billion, reflecting our commitment to sustainable growth and building long-term value in the company.

You can see some of our amazing crewmembers on Slide 4. Because of them, we continue to rank as the most on-time airline in Brazil in 2018, and we were also recognized as the most on-time LCC in the world.

That's a fantastic achievement considering the size of our network and the diversity of our fleet.

The performance of the 320neos in our network has surpassed all of our expectations.

These aircraft are flying an average of 14 hours a day, improving connectivity across our airline just as we said it would.

At the end of the year, we had 20 A320neos representing 30% of our ASKs, which have a 29% lower unit cost than our current E1s.

Every single one of these next-generation aircraft are desperately needed and will continue to be so for many years to come.

During the second half of the year, we also start receiving the Embraer E2.

And I've talked a lot about that in past calls, and I'm very excited about it.

Now that aircraft has a CASK that is 26% lower than our current E1s and has an impressive trip cost advantage of 20% to even our great neos that we're flying today.

With both of these next-generation aircraft, we are creating a competitive, sustainable advantage that will continue to drive margins higher.

In summary, we ended our first decade confident that we will continue to offer the best job in the lives of our crewmembers, which translates to the best flying experience for our customers, which we believe will continue to drive positive returns for our shareholders.

With that, I will pass it over to John to give you more details on the fourth quarter results.

Thanks, David.

As David looked back on what we built over the last 10 years, I want to say, we're just getting started and the best is still ahead of us.

I also want to thank our crewmembers for all their hard work during the past quarter.

As you look at Slide 5, the core airline drove strong results in a tough macroeconomic environment.

Even with the 37% spike in fuel and the 17% depreciation of the real, we reached an EBIT margin of 11.4% for the quarter and a 31% EBITDAR margin while recording net income of BRL 138 million.

The reduction in net income year-over-year was driven by the onetime gain we had in the fourth quarter of 2017 related to the TAP bond that expired, totaling BRL 154 million.

We grew capacity by 14% in the fourth quarter while also expanding our top line by 14%.

Our RASK adjusted for stage length increased 2.7%.

It's even more impressive that our stage length-adjusted RASK for the whole year increased 7.6% with a 16% increase in capacity.

CASK ex fuel decreased 8.1% as we continue to add more fuel-efficient aircraft to our fleet.

We ended the year with 20 A320neos, representing 30% of our fourth quarter capacity and expect to end 2019 with an industry leading 50% of our capacity coming from next-generation aircraft.

As you can see on Slide 6, fuel and currency had a negative impact of approximately BRL 270 million in our fourth quarter operating results, which represents 12 margin points.

Thanks to our margin expansion strategy, our ability to recapture revenue and reduce costs, we recorded an operating margin of 11.4%, recovering 10 of the 12 margin points during a very challenging macro environment.

Moving on to Slide 7. Our loyalty program, TudoAzul, maintained a strong growth pace during the quarter, reaching 11 million members.

Gross billings ex Azul went up 29% year-over-year.

We now have gross billings share of 18%, up from 16% just 1 year ago and still well below our fair share of this market.

We will continue to focus and grow this business.

On the right side of the slide, you can see that our cargo business continues to perform extremely well.

Revenue increased 57% year-over-year, benefiting from the expansion of our network and fleet.

We have a diversified customer base, including the main retailers, manufacturers and online companies in Brazil who value our reliable and far-reaching logistics solution.

Looking at the balance sheet on Slide 8. I'm proud to report that we ended the quarter with a strong liquidity position, representing 44% of our last 12 months revenue while also reducing our total debt to BRL 3.4 billion.

On Slide 9, we give you a look at the impact of IFRS 16 on our 2018 results.

The new lease standard becomes effective January 2019 and consists of recognizing all aircraft on balance sheet, similar to how finance leases were treated before.

In addition, under this new rule, some maintenance expenses for leased aircraft will also be capitalized.

As a result, our EBIT margin in 2018 would have been 15.1%, 6 percentage points higher than the 8.8 margin point reported under IAS 17.

Under IFRS 16, our EBIT margin is the best in the region.

Our leverage would have been 3, a reduction of 1.2.

Going to Slide 10 and looking at our 2019 guidance.

We expect to grow our total ASK between 18% and 20% in 2019, with most of this growth coming in the domestic market.

As we've been telling you, our domestic capacity growth will be low risk and focused on strengthening our network driven by replacing smaller aircraft with larger aircraft on routes we already serve.

As a result of the acceleration of our fleet transformation plan that we announced earlier this year, we will end the year with approximately 50% of our ASKs coming from next-generation aircraft.

On the cost side, we expect CASK to go down 1% to 3% in 2019.

As you know, we have a multiyear margin expansion strategy, and we expect to grow our EBIT margin every year over the next few years.

Consistent with this strategy, our EBIT guidance for 2019 will be 18% to 20% compared to a margin of 15.1% in 2018.

This estimate does not take into consideration any impact related to aircraft sales transactions or the potential acquisition of selected assets from Avianca Brasil.

Moving on to the last slide.

We've been monitoring Avianca Brasil's judicial recovery process very closely and have identified an opportunity to further strengthen our network and accelerate our fleet transformation plan.

Earlier this week, we announced that we signed a nonbinding agreement with Avianca Brasil to acquire certain assets for $105 million.

These assets consist of Avianca Brasil's operating certificate, 70 slot pairs and approximately 30 Airbus A320s.

It's important to highlight that these assets will be transferred to a new entity, a NewCo, which will be free and clear of all debts and liabilities as provided by the Brazilian bankruptcy law.

Also, the operating lease contracts of the aircraft that will fly at the new company will be all renegotiated to market rates.

The offer is subject to a number of conditions, including the due diligence process, regulatory and credit approvals, final approval from the bankruptcy judge.

We believe this process could take approximately 3 months.

In summary, we're confident about the future of the Brazilian aviation market and our ability to continue expanding margins, all while creating the best experience for our crewmembers and customers.

With that, David, Alex and myself and Abhi are here to answer your questions.

(Operator Instructions) Our first question comes from Savi Syth, Raymond James.

This is Matt on for Savi, actually.

My first one, John, in regard to Avianca Brasil, if it is successful, can you talk a little bit about on how long you think the transition period would last, what the nonrecurring integration costs might be?

And in terms of how much inventory is already sold, how much of that would you really need to honor?

Any color around that would be great.

Yes, Matt.

So I think the process should run pretty quickly as there's a creditors' meeting later this month and the bankruptcy judge is aware of the situation.

I think we can't really can't get behind the scenes of what's happening today, but we believe there's a tremendous amount of upside in how this network could plug into our network.

And so as we look forward, we think we can do it relatively quickly.

They're coming with an operating certificate with pilots that are already flying, flight attendants that are already certified on the aircraft.

And so at this time, we really are not giving any estimate, but we don't believe it is a significant acquisition or a big integration because when it comes into a NewCo, a lot of the typical headaches that you get with a normal acquisition, you don't have to experience.

And so again, we're excited about it.

I think either way, there's going to be less capacity in the market because of this as we're looking at acquiring an airline that's got roughly 30 aircraft in their fleet.

And they had up to 55 aircraft just last year.

And so I think overall, I think this is very positive for their customers, for the crewmembers, certainly for Azul, and I think overall for the industry as well because there's going to be some capacity rationalization that happens as a result of this.

Perfect.

And then also in terms of capacity in the U.S. to Brazil market seems like schedules are showing a fair amount of cuts going into 2Q, and that's before any of all the MAX noise.

So do you think cuts, excluding what's going on with the MAX, is sufficient given the current supply-demand?

Matt, it's Abhi here.

Yes.

You're right.

We are seeing capacity cuts mostly May onwards.

Pretty much everybody is participating, including Azul.

So I think as had been the sentiment on other calls from our colleagues in the region, we'll have some pretty tough comps first 2 quarters.

But 3Q and 4Q, we expect to see an improvement in the international market driven by stability in the currency as well as these capacity cuts.

So the booking curves are longer so we'll kind of see when we get there, but I'm definitely very encouraged by the capacity cuts.

I'm seeing right now U.S.-Brazil nonstop capacity down about 20% May year-over-year from all the players involved.

So that's very encouraging.

And everybody's participating, which is good as well, including Azul.

So I'm encouraged by what I'm seeing.

I'm encouraged by stability in the international bookings going forward.

So we're expecting positive RASM inflection second half of the year.

The next question comes from Mike Linenberg, Deutsche Bank.

Abhi, I just want to go back to the comment that you made about RASM inflection second half of 2019.

Were you specifically referencing international markets?

Are you referencing Azul as a whole?

And could you actually give us some additional color on what you're currently seeing since we've seen kind of the lion's share of the March quarter, give us a sense of maybe what you're seeing and how things are looking into Easter week into the second quarter?

Mike, yes, I was specifically talking about international only.

Just looking at the international booking curve, demand, the capacity cuts.

And also, you got to remember, the comps are pretty tough.

First quarter last year, dollar was BRL 3.25.

Fourth quarter 2017, dollar was BRL 3.25.

And now it's BRL 3.80.

So we have some tough comps.

The industry has tough comps really.

And those will start to turn in the second half of the year together with the capacity cuts.

So for international, I'm expecting positive RASM inflection 3Q and 4Q.

For Azul overall, I think the RASM for the year, if you look at our margin guidance of 15.1% last year, 2018, going to 18% to 20%, 3 points of that is coming from CASK and up to 2 points of that is going to come from RASK.

So that's what you can expect for the whole year.

In terms of breakdown by quarter, I think the largest year-over-year RASK quarters would be 2Q and 3Q, primarily because of the trucker strike in May last year as well as the World Cup.

And so I think that's going to be the most positive.

But I think the other quarters are going to be pretty steady as well.

So I think you'll see first quarter similar in terms of RASM increase and then strong 2Q, a higher 2Q, a higher 3Q and a 4Q also in the 0% to 2% range, again, higher comps.

And remember, we're growing capacity 18% to 20% with larger aircraft.

So to be able to continue to increase RASM like we did last year, to do it again this year with 18% to 20% really shows the strength of the market and the strength of our network.

Okay.

And then, Abhi, that actually just leads me to my second question which is, the 18% to 20%, that presumably is just Azul metal as the plan stands today, the growth plan stands today.

But now all of a sudden, as we assume some assumptions of Avianca Brasil asset, sort of a two-pronged part to that.

One, how does that change the potential growth trajectory?

And I realize I'm probably putting the cart in front of the horse here.

But then the second piece to that is that, how are things trending on Avianca Brasil?

I mean, I realize that you may not have the best information, but the concern would be that you assume a lot of assets and you assume some additional routes that have seen a significant falloff in bookings.

And so in order to get the passenger levels back to where they were before Avianca Brasil filed for bankruptcy, you would have to engage in some stimulative fare activity.

So I realize that's kind of a multipronged question.

However you can answer that.

Yes.

I'll give it a crack, and I'll let John and David jump in if they want.

But in terms of the capacity growth, it already includes some of the A320neos that Avianca voluntarily exited as part of their transformation plan.

So some of these aircraft are already contemplated in this 18% to 20%.

So there's a couple, sort of low single digits worth of aircraft that's already in there and part of what we announced in the fleet acceleration a couple of months ago.

In terms of their bookings, again, I don't know what their bookings are.

I don't have the ability to know what their bookings are.

So it's sort of hard to answer that.

I do think just looking from a commercial perspective that the Azul announcement will allow the market to have confidence in Avianca.

A confidence that they will continue to serve many of their routes.

And I think that should help in bolstering Avianca's bookings.

Again, I don't have access to their numbers.

I cannot have access to their numbers so I can't really answer that in detail.

But I do think the market overall, thanks to our announcement and this partnership, is sensing support and confidence in Avianca and that will and should help their bookings.

Of course, I think, as we mentioned earlier, they had a lot more routes than what we are anticipating putting into the NewCo.

So obviously, we had a pretty good indication of which routes they were doing better on and which ones we were doing worse on.

And so overall, as we said earlier, there's going to be a cut in the capacity in the market no matter how you shake it.

So there'll be less seats flying even with our growth than were flying last year.

So that should help make the transition.

The next question comes from Andressa Varotto, UBS.

I have 2 questions.

First on jet fuel, we saw Azul's jet fuel price expanded 7% quarter-over-quarter while oil Brent price decreased around 10%.

Is this related to a delay in the pass-through of oil price to Azul?

And should we expect a reversion in the next quarter?

Yes.

I'll let Alex kind of walk through the detail, but you have to remember that Brent and WTI fall a lot quicker than we see the benefit because there's a lag in Brazil.

It's about a 45-day lag.

But you want to walk through the -- how it works, Alex?

Yes.

So as John mentioned, there's a 45-day lag.

And that works obviously on the way down and on the way up as well.

So whatever you see on the screen, in general, on average, it takes 45 days for it to start reflecting the fuel price that we actually pay into our planes.

WTI and Brent, first, they have a bigger crack spread to jet fuel.

So we also tend to look more at heating oil because it has a stronger correlation with Jet A, which is what we actually buy, right?

On December 31, these prices were about 20% lower actually than where they are today, but there was a lot of change in prices within Q4.

It was a volatile year overall in 2018, but Q4 was also volatile.

So December 31 was 20% lower than where we are today.

So you can kind of do the math and see how that will reflect into our prices.

We're hedged to the tune of about 30% of our next 12 months.

And our average price, we're a little bit in the money.

Even though we were out of the money in December, today, we're slightly in the money.

So our average price, a little bit better than where you see the market today.

So I think with that info, you can probably kind of figure out where our prices are going to be.

And secondly, we saw a reduction in maintenance expenses in the quarter compared to the historical level.

And is this something that should continue going forward?

And if yes, is it included in EBIT margin guidance?

And how much would represent?

Yes.

So first on Q4, specifically, a couple of factors.

As we've been talking about, we've been investing in spare parts inventory.

We've been investing in in-sourcing some of our maintenance activities.

This all makes sense because we're now bigger.

We have critical mass where it does make sense for us to do that.

Also, we have a lower cost of capital.

Also, in the old accounting policy, IAS 17, we would expense some maintenance on leased aircraft as occurred, right?

So when we had the maintenance event, that's when we would recognize the maintenance expense.

And that creates some lumpiness between quarters, right?

There are quarters with more maintenance expense.

There are quarters with less maintenance expense.

Q4 obviously was a quarter with less maintenance expense, particularly on engines, right?

Going forward, IFRS 16 really changes a lot of this because some of the maintenance expense on leased aircraft that we were recognizing as OpEx will become CapEx, right?

So our maintenance expense overall next year will be lower than this year.

And even if you take into account the fact that we're growing, it would be normal for it to be higher and will be nominally lower than what it was in 2018 mainly because of IFRS 16.

And that's embedded in our CASK guidance of minus 1% to minus 3%.

Our next question comes from Dan Mckenzie, Buckingham Research.

I guess, first question, I'm wondering if you can help us understand how the debt picture changes for Azul under the scenario where it's successful in acquiring Avianca's assets.

So how much debt does Avianca Brasil have today and how much of that would follow under a deal closing?

Yes.

So Dan, as we explained, we're actually acquiring what's called a UPI in Brazil or a new company.

And so all that would go in there is just the operating leases that will need to be renegotiated.

And so there's actually no debt associated with the acquisition.

Okay.

Good.

That's what I was hoping to clarify.

And I guess as you think about deal economics, how does it change CapEx plans for this year or next year?

And as you think about Avianca's working capital needs, does it require more cash on top of what you're proposing at this point?

Dan, I actually think it gives us a lot of flexibility.

What we see with the Avianca Brasil acquisition, assuming it takes place, and we look forward to doing that is, those 30 aircraft, the majority of those aircraft are going to come in on shorter-term leases, which will actually be replaced with our neos that will be coming over the next couple of years.

So it's a way to kind of accelerate a couple of years our growth, but then we can kind of measure our growth going forward.

Hey, do we extend these leases or do we actually just return the leased aircraft and bring in our neos.

And so I think it's a way to reduce the risk going forward as we already get pilots and flight attendants and maintenance technicians already ready to go, that are already trained on the specific aircraft that we're growing over the next couple of years.

And so that's the way we look at it.

And so think of it, it's kind of pulled forward our growth a couple of years.

But then what happens with the neos that come in, most likely the ceos come out as a result.

Understood.

And then if I could just squeeze maybe 1 or 2 more in here, quick ones.

I guess, first off, if you can just help us understand kind of the 2 big risks that acquiring another airline simply is IT and labor.

And I'm just wondering if you can just sort of comment around IT compatibility, lack of IT compatibility, how you're thinking about that labor.

And then just secondly, foreign exchange has been a stubborn headwind here.

And so for those investors that don't know Brazil well, how are you handicapping the potential for economic and fiscal reform later this year?

99% probability the big stuff gets passed?

Is it maybe 50%?

Big picture, how are the initiatives that are critical to Brazil's economic growth being perceived by politicians?

Dan, I'll talk about sort of the IT stuff real quick.

So we obviously have some good experience with this with the TRIP merger.

TRIP at the time had the Sabre reservation system and we, of course, had Navitaire, but we were able to transition that pretty quick.

I think we had the codeshare and the flights in one system within 6 months.

So certainly not -- we've done it before.

Avianca has the Amadeus reservation system, which Azul also has as part of our codeshare and alliances platform.

So we feel confident regarding the IT.

Requires some work, but nothing we haven't done before or don't know how to do.

Dan, from a cultural impact of taking on crewmembers from another airline, Azul is 12,000 strong today and Avianca is significantly smaller than we are.

We, by far and away, have the best product and experience in Brazil.

But I would tell you that Avianca Brasil is a close second.

I think they have fantastic crewmembers and I think they are fantastic.

They put on a great operation.

I think that Azul coming in is probably very welcome.

There's been a lot of uncertainty at that airline over the last 6 months at least and maybe longer.

And so I think that, that's something that we're willing to manage.

And David talked a lot on the call today about, it's got to be the best job of your life.

And I think that's what we have for the majority of our crewmembers.

And we intend to extend that to new members of the family that would come in over the next couple of months.

I think with the TRIP acquisition, you walk through our company today -- and that's what, it's been 5 years -- it's indistinguishable.

You don't know who's Azul and who's TRIP because we've been able to assimilate them into our culture and it's been amazing to watch.

So we don't think that's going to be any different with the crewmembers from Avianca that join our company.

And Dan, back to your other question on reform.

Something's going to get passed.

I think, is it going to be 100% of what everybody wants?

Probably not, but something's going to get passed.

It's all anybody's talking about at the government level.

And I think that the government's hyperfocused on it.

And I think that we're looking forward to the reforms that take place.

And I think you're seeing the military and everybody's kind of onboard in saying that this needs to happen.

I think the states are behind it.

I think most of the political parties are behind it.

Again, I don't want to handicap it because we have to run our business.

And any time you have a business plan that depends on the government, it's not a good business plan.

And so what I would tell you is, we're going to continue to expand margins in light of what happens from a macro perspective, but I couldn't be more optimistic about the changes that are happening in Brazil.

We've gone through a couple of rough years in Brazil.

And so at least the government is focused on the right things right now, and that gets us excited.

The next question comes from Savi Syth, Raymond James.

It's Matt again.

Just a quick one.

You guys gave really good color on the RASM trends throughout 2019.

I was wondering if you'd do that with some of the overall cost trends, how you're thinking about that through the year?

Yes.

Sure.

Sure, Matt.

So as you saw, we gave guidance on continuing our CASK reduction in 2019.

It should go down between 1 to 3 percentage points.

Obviously, that's mainly from our fleet transformation, right?

As you know, and we've mentioned many times, the CASK in the new aircraft goes down between 26% and 29% compared to our current aircraft, right?

It's important to note a couple of specific things about 2019.

First, with IFRS 16, rent and some maintenance, which are dollar-denominated, they are capitalized and depreciated, right?

So that should reduce volatility to FX.

So as you model, you'll see less sensitivity, obviously, in the short term.

And that gets added to the balance sheet and depreciated over time.

Also, this year, we have the payroll tax that had gone away.

It's coming back.

And it's coming back since January 1. And so that adds additional cost to our salary line.

So you'll see that starting Q1, that line is going to be bigger, but that's included in our 1% to 3% CASK guidance, right?

We're going to look for other opportunities beyond the fleet transformation to continue running a more efficient airline and reducing cost and finding any kind of opportunity that we have to take cost out of the company.

Our next question comes from Lucas Laghi, Citibank.

My question is regarding the next steps of the joint venture with Correios after CADE's approval.

When we could see the impact of this JV in Azul's numbers?

Yes.

So we received CADE's approval.

There's another step with government approval.

I think what's kind of slowed this down a bit is we've had 3 different presidents at the Correios in the last 12 months.

And so anytime government changes, there's new leadership in that area.

And so for now we're focused on Azul Cargo, growing that business as quickly as we can, still very optimistic about the opportunity.

But unfortunately, we can't give you much more update at this time because we're now kind of working with the new leadership team on what the new joint venture would look like jointly with them.

And so they need to take some time to get up to speed as well.

That's the latest where we're at.

(Operator Instructions)

Okay.

I guess that's it for the questions.

Again, we'd like to thank everybody for joining us and I look forward to talking to each one of you.

If you have any questions, our team is available, we're always open, but we really are excited about our business.

And we're excited about the direction going forward.

And we'll see next quarter.

And we expect that, hopefully, things will continue to improve and we'll do our part.

So thank you very much, everybody.

Ladies and gentlemen, that does conclude the Azul audio conference for today.

Thank you very much for your participation and have a good day.