Copa Holdings SA (CPA) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Copa Holdings Third Quarter Earnings Call.

(Operator Instructions) As a reminder, this call is being webcast and recorded on November 9, 2017.

Now I will turn the call -- conference call over to Raul Pascual, Director of Investor Relations.

Sir, you may begin.

Thank you, Gigi, and welcome, everyone, to our third quarter earnings call.

Joining us today are Pedro Heilbron, CEO of Copa Holdings; and Jose Montero, our CFO.

First, Pedro will start with our third quarter highlights; followed by Jose, who will discuss our financial results.

Immediately after, we will open up the call for questions from analysts.

Copa Holdings financial reports have been prepared in accordance with International Financial Reporting Standards.

In today's call, we will discuss non-IFRS financial measures.

A reconciliation of non-IFRS to IFRS financial measures can be found in our earnings release, which has been posted on the company's website, copa.com.

Our discussion today will contain forward-looking statements, not limited to historical facts, that reflect the company's current beliefs, expectations and/or intentions regarding future events and results.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially and are based on assumptions that are subject to change.

Many of these risks and uncertainties are discussed in our annual report filed with the SEC.

Now I would like to turn the call over to our CEO, Mr. Pedro Heilbron.

Thank you, Raul.

Good morning to all, and thank you for participating in our third quarter earnings call.

First of all, I want to congratulate all of our coworkers for a very strong quarter.

Their efforts and dedication allowed us to achieve great results and deliver the world-class product that our passengers expect from us.

Over a year ago, while facing a significant economic downturn in Latin America, we shared with you our path to higher margins plan that involves a series of initiatives that we believe would bring the company back to the margins we had delivered in the past.

These initiatives included adjustments to the company's root network and capacity growth, further efficiencies in our cost structure, the expiration of expenses, fuel hedges and several commercial initiatives as was expected improvement in the regional economies.

Although we still continue working for many of these initiatives and where work by no means done, we're happy to report that, as you can see from our Q3 operating margin and preliminary guidance for 2018, we are already realizing the benefits of many of these initiatives.

I'm now encouraged to see that our financial performance and outlook continue to improve.

Operationally, it was a very challenging quarter, as severe weather and natural disasters caused devastation in some of the destinations we fly to.

In our hub in Panama City, a power outage interrupted our operations for several hours, leading to a significant number of delays and flight cancellations.

In total, due to the natural disasters, weather events and disruptions in our hub, we canceled more than 450 flights, approximately 1.5% of flight schedules for the quarter.

This event had a negative impact of approximately $12 million in operating earnings.

In spite of those challenges, the company was able to deliver its highest third quarter operating margin since 2013, all while growing capacity by 13%.

Our main highlights for the quarter: Our passenger traffic grew a solid 15% year-over-year, outpacing our capacity growth of 13%.

This resulted in a strong 85.7% load factor, 1.5 percentage points higher than the third quarter of 2016.

Yields increased 1.3% year-over-year and 2.3% year-over-year when adjusted for length of haul.

Due to our higher load factor and yields, unit revenues, or RASM, improved 2.4% year-over-year to $0.106.

On the cost side, ex fuel unit costs decreased 1.2% to $0.063, amongst the lowest in our industry for a full-service airline.

As a result, our operating margin came in at 18.1%, almost 5 percentage points above the third quarter of 2016.

On the operational front, in spite of the irregular events in the quarter mentioned earlier, Copa earnings delivered an On-Time Performance of 82.9% and a Completion Factor of 98.5%, which is low by Copa standards but still strong for our industry.

We also continued working on several important projects that should configure significantly to our results over the next couple of years, including upgrading our reservation system, which will enable us to make the most of new ancillary revenue opportunity; migrating to a new unit flight MRO solution, which was successfully completed in October and will allow us to more efficiently manage our maintenance programs for both the Boeing and Embraer fleet, resulting in lower costs; and a company-wide project to realize $50 million in recurring savings, most of which should be realized by the end of this year.

Also during the quarter, we continue to invest in our technologies, adding functionalities to our app and website, including TSA PreCheck and ConnectMiles enhancements.

Finally, I'm glad to report that Wingo, although a very small 2% of our revenues, continues to do better than expected, both operationally and financially.

So overall, we had a very strong third quarter.

Turning now to the rest of 2017, we expect the air travel demand environment in our network to remain healthy and are seeing good-looking patterns for both the fourth quarter and the first quarter of 2018.

In terms of fleet, we already received 2 737-800s during the first quarter and expect to return 1 Embraer-190 in the fourth quarter, ending the year with 100 aircraft, one more than at the end of 2016.

In 2018, we will receive 2 737-800s and our first 5 MAX 9s, and we will return 1 Embraer-190 for a net growth of 6 aircraft.

In regards to our network, we are pleased to see strong bookings for our 2 new destinations: Mendoza, Argentina, starting next week on November 15; and Denver, starting in December.

For sure, this will be great and unique additions to our network.

By the end of the year, Copa will provide service to 75 destinations in North, Central, South America and the Caribbean, strengthening its position as the most complete and convenient hub in Latin America.

To summarize, we expect to continue seeing a healthy demand environment during the fourth quarter of 2017 and into 2018.

We continue growing and strengthening our network, the most complete and convenient hub for intra-Latin America travel.

We expect significant challenges in the quarter.

Our team continues to deliver world-class operational performance, while achieving industry-leading unit costs.

And we continue focusing on several cost and revenue initiatives that are aimed at further increasing our margins.

Lastly, we are as confident as ever in our business model and our financial position.

We have the strongest network for travel within the Americas, an extremely flexible fleet plan, the lowest unit costs, a very strong liquidity position with low leverage and a highly committed team.

Now I'll turn it over to Jose who will go over financial results in more detail.

Thank you, Pedro.

Good morning, everyone, and thanks for joining us.

First and foremost, as always, let me begin by joining Pedro and congratulating our entire team for all their efforts and achievements.

More on highlights for the quarter.

We grew capacity by 13% year-over-year, while revenue passenger miles increased 15% year-over-year, which resulted in a consolidated load factor of 85.7%, a 1.5-percentage-point increase versus Q3 of 2016.

Passenger yields came in 1% stronger year-over-year, which combined with a higher load factor, resulted in a unit revenue increase of 2.4% to $0.103 in Q3 2016 to $0.106 in Q3 2017.

When adjusted for length of haul, unit revenues increased 3.3% year-over-year.

Consolidated revenues increased almost 16% to over $657 million.

On the expense side, third quarter operating expenses increased 9.4% year-over-year under 13% capacity growth, which resulted in our cost per available seat mile decreasing 3% to $0.086 as our effective all-in fuel price decreased 8% from $1.98 per gallon in Q3 2016 to $1.82 per gallon in Q3 2017.

Cost per available seat mile excluding fuel, ex fuel CASM, decreased 1% from $0.064 in Q3 2016 to $0.063 in Q3 2017, driven mostly by lower distribution and administrative expenses.

Consolidated operating earnings for the quarter came in at $119 million, resulting in an operating margin of 18.1%, 4.7 percentage points higher than the 13.4% generated in Q3 2016.

Looking at our nonoperating income and expense.

The third quarter generated a net nonoperating expense of $0.9 million, mainly driven by net interest expense related to aircraft debt and a $2.9 million mark-to-market gain of outstanding fuel hedge contracts.

In terms of net results.

Net earnings for the quarter came in at $103.8 million or earnings per share of $2.45.

When excluding extraordinary items, underlying net income for the quarter came in at $100.8 million or earnings per share of $2.38, 82% higher than the underlying net income of $55.3 million or adjusted earnings per share of $1.30 reported in Q3 2016.

Turning to the balance sheet.

We closed the quarter with a very strong financial position as assets totaled $4.2 billion for an increase of over $330 million towards the end of 2016.

Orders equity totaled close to $2 billion.

Debt plus capitalized leases totaled approximately $2 billion, and our adjusted net-debt-to-EBITDA ratio came in at a very strong 1.5x, by far the lowest in our peer group.

We closed the quarter with approximately $1.2 billion in bank debt, more than 60% of which is fixed with a blended rating, including fixed and floating-rate debt of approximately 2.8%.

In regards to cash, short and long-term investments, we closed the quarter with approximately $972 million, about $200 million more than at the end of the third quarter of 2016.

Our cash balance at the end of the quarter represents approximately 40% of last 12 months' revenues.

Finally, this upcoming 15th of December, we will pay out our third quarter dividend in the amount of $0.75 per share to all shareholders of record as of November 30, 2017.

So going back to our results and to recap demand for air travel in our region is expected to remain healthy during the fourth quarter of 2017 and beyond.

We continue in our path to improve our revenues and reduce our costs, including our plan to achieve recurring savings of $50 million per year that should continue contributing to our results during the coming years.

We have one of the strongest balance sheets in the industry, and we continue to return value to our shareholders.

Today, we're also updating our guidance for full year 2017 based on our operating plan and expectations for air travel demand for the year.

We're maintaining our capacity growth in terms of ASMs of approximately 8%.

And even though we're now assuming a higher fuel price for the year, we're narrowing our operating margin to a range of 17% to 18%.

Our 2017 full year guidance is based on the following assumptions.

Load factor of approximately 83%, RASM of approximately $0.105, CASM ex fuel of approximately $0.064 and an effective fuel price per gallon, including into-plane and net of hedges of approximately $1.85.

We're also providing preliminary guidance for 2018 based on our operational plan and expectations for air travel demand.

Keep in mind that our visibility as of now for full year 2018 is very limited.

In terms of capacity, ASMs are expected to grow by approximately 9% and the operating margin for full year 2018 is expected to yield in a range of 17% to 19%.

This assumes an effective price per gallon of approximately $1.85.

So we expect the recovery to continue next year, supported by a healthy demand environment and the many initiatives we have implemented in the last 2 years to strengthen our competitive and financial decision.

Thank you, and with that, we'll open the call to some questions.

(Operator Instructions) And our first question is from Mike Linenberg from Deutsche Bank.

Questions just on your forecast and maybe also you can sort of talk about 2017 as well.

I mean, you talked about the expectations and demand that the backdrop is healthy and that it seems like things are getting better.

The question is, how much of it is macro?

How much is it that the macro backdrop has improved as much as maybe a more disciplined competitive backdrop?

Are you seeing aggressive pricing, for example, across your markets?

Are you seeing less of that as some companies have scaled back or slowed down their capacity growth?

So how much of this macro versus just maybe just better behavior by your competitors?

If you could qualify that, what you're seeing now and as you look to 2018, that would be great.

Yes.

I mean, it's probably a combination of factors, but the economies are improving and we're receiving economic strength in most of our regions.

So that's very important.

There is rational behavior from our competitors.

But that's usually been that way.

I mean, they're always -- there will always be issues in specific markets, but we're usually rational and part of the world in that sense.

So yes, there's that, but there's also growth.

Our competitors are doing better also and not standing still.

So I think the competitive dynamics have not changed that much.

So I would say the big story is the economy's getting stronger.

Yes.

And just to add a little bit to the competitive dynamic, Mike.

For example, in Q3 of this year, we saw competitive growth in the mid-single digits year-over-year.

And we're not seeing anything particularly different for Q4.

It's going to be in that same range, probably a little bit lower than that.

So the competitive dynamic, as Pedro mentioned, is very temporary in the region.

Okay.

Great.

And then just one other question on Wingo.

I think Pedro, in your remarks, you said both operationally and financially, it seems like things are going better than expected.

My sense is that it's still probably not yet profitable on a fully allocated basis.

I think the goal was to get to maybe full breakeven by 2018.

How big is Wingo at this point?

Is it still, I think, the 4 airplanes?

And what do you need to see to start growing that business?

Or does that business, is it more of a steady state, maybe 4 or 5, 6 airplanes that never gets much bigger than that?

Can you talk about that?

Yes.

Well, Wingo is, right now, only 2% of our revenues.

But it used to be -- that same network when operating -- when it was operated by Copa Colombia, the same network was a high percent of our net results in terms of -- in a negative way.

It was producing relatively high losses.

So Wingo has turned that around.

And again, even though it's only 2% of our revenues, we've cut the losses and that network by more than half of what it used to be.

And Wingo is performing much better than what we expected at this point in time, but it will be a negative.

It will lose money for the year.

I think for the year, it should be close to breakeven, if not at breakeven next year.

And in terms of growing beyond the 4 aircraft, it's not an integral part of the reason to be for Wingo, but we will take advantage of opportunities that makes sense for Wingo.

Wingo is not there to -- it's the world.

It's just there to -- it's kind of the Copa philosophy.

We fly what makes sense and what's profitable to do so.

So Wingo will take advantage of profitable opportunities, and we'll go one step at a time.

Our next question is from Savi Syth from Raymond James.

As you look to 2018, I know 2017 is good cost execution on unit cost side and you have the initiative and I think probably a little bit of help from the length of fall.

As we look to next year, as these economies recover, maybe some improvement in the currencies, how should we think about the unit cost of headwinds and tailwinds?

Yes, Savi.

I think in general terms, we feel that there is -- we're working very hard to ensure that our costs continue to improve in terms on a unit basis.

And part of that is our plan to reduce $50 million or more in our yearly cost.

We're about 80% of the lay there with the plan.

And in the 2018 time frame, I think that we'll be able to get more of that.

Remember our next year and more anything looking towards 2019, there's a couple of additional items that will come into play.

The first thing is the introduction with 737 MAX in the second half of 2018.

That should contribute to our unit cost.

And then there are aspect is that we're bringing as part of our plan to achieve savings more maintenance in-house and investing quite a bit on our maintenance capabilities in-house.

So those things should be -- provide tailwinds for our costs, however, having said that, there are some headwinds involved as well, mostly related to overflight fees and landing fees, (inaudible) fees related in some of the airports where we operate in South America that could also some of that.

But we are very confident in terms of our ability to reduce our CASM ex even more than where we are today.

That's helpful, Jose.

And then if I just might ask on the reservation fee, or the ancillary initiative, should have -- which part of it is part of the reservation system?

Any update on the timing of that and how you're feeling about the launch of those initiatives?

Yes, it's Pedro here, Savi.

It's going to be in mid- to second half of 2018.

However, we have found ways to work around with our current systems and already introduced this year a seat functionality where we can monetize the better seats on the aircraft, and that's already producing results ahead of schedule.

And we think we'll be able to also implement some of the other initiatives even before we get to a full implementation of the new CSS system.

Our next question is from Stephen Trent from Citi.

The first is actually just a quick follow-up on Mike Linenberg's question.

When you look at some of the places in South America, Peru, Argentina, Chile where you've got a lot of competition coming in, I mean, I know you guys don't have any domestic service in those markets.

But I'm curious if you've seen any instance that some of these new airlines are trying to do international, affecting your routes or if they're staying more along the domestic market servicing and international trunk routes?

Just curious if you've seen anything from them.

What we're seeing from start-ups is regional or domestic and not something that is affecting or would affect our markets.

Our competition, it's mostly the noncarriers, our peer group that is -- you are very familiar with.

So they're growing in some markets, not much different to what has gone in or what's happened in the past, gone on in the past.

It's very, very similar.

And with stronger economy, there's plenty of business for all.

And again, growth is very rational.

So what we're seeing is rational, not much different to the past and not much affecting us from any start-ups.

Great, Pedro.

And just 2 very quick ones.

One, if you can refresh my memory.

Longer-term, you guys might consider doing third-party servicing with your MRO and generating some revenue on that.

And two, if you could also refresh my memory, what happened with the electric failure in Tocumen.

Okay.

So in terms of our new MRO facility, we could do third-party work eventually.

I don't think it's going to happen in the next 3 years.

We don't see it, so it's not going to be an immediate thing, but it's an opportunity we'll consider in the future.

In terms of the power outage, it's inexcusable.

It's something that should not have happened.

The airport has taken the necessary steps to make sure it doesn't happen again.

They hire a major electrical company in Panama to do a thorough review of their facilities and systems and are implementing the necessary changes, so that they strengthen their systems and it doesn't happen again.

I understand you're also talking to consultants about reviewing their business continuity and disaster recovery plans.

So we trust that they're going to take the necessary measures so that's not repeated, but it was an inexcusable event, one which obviously upset us quite a bit.

Our next question is from Joseph DeNardi from Stifel.

I would like maybe just to ask the outlook question in a different way.

Can you just kind of share with us what the RASM and CASM ex assumptions are kind of embedded on the '18 guidance, at least maybe the CASM part?

Joe, yes.

We have decided just to give you a little preliminary guidance, only keep it at the ASM level and the operating margin estimate, given that it's still very, very preliminary and the visibility of which in 2018 is still limited.

But we have given you the ASM change, the operating margin and the fuel price assumption in there.

Okay.

Fair enough.

And just on the fuel price side, I mean, is there something, maybe, on the hedge book that benefit next year just given that the implied fuel cost in the fourth quarter, why would full year '18 be lower than that?

Yes.

The fuel -- there's no hedges in our fuel book after December of this year.

And for 2018, we still, again, it's a preliminary guidance.

Over the last couple of days, fuel has kind of moved somewhat up.

It's a very recent spike.

But in any event, I think we feel that the $1.85 level that we have is a curve and it's an estimate of where we feel it's going to be in.

And regardless of that, still very, very confident the business model and the ability to flourish even at that end of higher fuel prices, given the economies in the region and the like.

Our next question is from Hunter Keay from Wolfe Research.

This is actually Matt on for Hunter.

So we heard that Air Panama was considering some A330s for European service.

And we just want to get your thoughts on that and if those growth plans may in any way impede your ability to get gates at Tocumen.

Okay.

So this is Pedro here.

We saw that in social media.

And not sure exactly what it is, so I cannot really refer to that, no factual information.

And they are small, not very strong a carrier, so I have my doubts.

In terms of slots and gates at Tocumen, that won't be an issue.

We have no problems there.

Okay.

Great.

And then, I guess, separately, how should we think about the 9% capacity growth in 2018?

Just in regards to how high or how low that could go since 2017 capacity was initially tied to be at 5%, you guys were able to take that up to 8%.

Yes.

I think we're going to be closer to our target next year.

This year, as the economies got stronger, we are up utilization and a lot of our growth this year has been utilization, not additional aircraft.

We will grow, fix that aircraft next year but that happens in the second half.

So we're going to see that effect mostly in 2019.

So I think we're going to be closer to the number we're guiding to in 2018 versus this year.

Our next question is from Duane Pfennigwerth from Evercore ISI.

This is actually Ray Wong on for Duane.

My first one is, excluding the airport market incentives, what is other revenue growth look like in the third quarter?

You're talking about the -- exclude the airport -- the way that we frame it kind of excluding the $12 million earnings impact in the quarter, I mean, I think that the impact on a pure earnings basis is probably going to be a couple of margin points, I would say, related to the operational issues that we had in the quarter.

That's kind of the way that we're looking at it.

Sorry, just to clarify.

I was referring to the other revenue line.

You guys called out a nonrecurring airport marketing incentive that led to like a large...

Yes, yes.

Sorry about that.

It's just simply related to some of the stations that we had opened in the past.

And it's just a nonrecurring item that was there in the base that was not there this year.

(inaudible) marketing funds that we get from some of the new stations that we opened.

Okay.

And following up on Savi's question.

What types of other specific ancillary initiatives could we expect in the second half of '18?

And how much could that contribute?

We don't want refer to the exact initiatives until we are approved and launched, but some of that did already selling seats or realizing value for the most attractive seats in economy.

We have enhanced our upgrade program also where we can sell upgrades when available.

And we are also improving our ConnectMiles revenues.

So all of that is in the mix.

We have guided to eventually a couple of margin points coming from ancillary, and we think we're well on our way to deliver that next year.

The next year and in 2019.

So in both years...

Actually, we are good.

Some of that, given the moves that we've made early in terms of the selling of seats have already been showing up in our performance.

It's...

Yes, that's correct.

All right.

Cool.

And lastly, is your team seeing fuel surcharges returning to market?

And if not, in what level could we see them again?

We're not seeing fuel surcharges returning, and we've kept some from the past, but we haven't been adding to it and I mean, something would have to happen for that to be the case.

There's a recent spike, but we don't think that spike is going to be sustainable, hopefully.

So we don't see them coming back in the near future.

Our next question is from Dan McKenzie from Buckingham Research.

I guess, the first question is just kind of going back at maybe to clarify a couple of earlier ones and that is if we strip out some of the noise here in the third quarter and just kind of tying this to your full year guide, how do we think about the sequential revenue trends between the third and the fourth quarter?

It seems like they're flat to slightly stronger.

I just wondered if you could just sort of help us characterize whether there is potentially a demand inflection here as we head into the fourth quarter.

Yes, Dan.

This is Jose here.

As you can -- I think the implied unit revenue for the fourth quarter is somewhat stronger than what you're seeing in Q3.

Now the one thing also you have to mention is in our cost line, usually the fourth quarter or some timing of expenses come in the latter part of the year.

So therefore, our unit cost should also be somewhat higher for the latter part of the year for the fourth quarter.

So both RASM and CASM, you can -- we're guiding to -- or the implied numbers in the guidance suggest that.

Got it.

And as we look at that stronger fourth quarter here, is this -- would you just sort of characterize this as normal seasonality, Jose?

Or is there potentially some inflection here in business travel or leisure travel?

I think that there is -- it's part.

I mean, the fourth quarter, historically is a strong quarter, but also we are seeing a continuing improvement in terms of the macro environment in the region -- throughout the regions that we're flying.

Got it.

And then if I could squeeze one more in here.

I guess, Jose, for you, one more here.

The 1.5x net debt EBITDA, is that the right leverage metric for Copa, first off?

Or what is the right leverage metric?

And then I guess the second question is would you need to start raising debt to maintain a potential leverage metric that you might be a little bit more comfortable with?

And then what might be the use of cash if you might need to raise some leverage here.

Yes.

So I think that we're very comfortable with the way that we see our balance sheet.

The levels that we have right now are very strong and that, fortunately, given that strength allowed us to concentrate on operations during the downturn that we faced over the last couple of years.

So we are very keen to maintain levels that are very strong.

I think that the board has been very, I think, active in returning value to our shareholders.

You know in the last quarter, they raised the dividend from $0.51 per share to $0.75 per share per quarter.

And so it is -- I think they've proven that even though we have a very strong balance sheet, we have returned that to shareholders.

Having said that, there are uses of cash over the next 18 months, mostly related to the fuel growth that we will have and the orders over that we have and deposits associated with that.

So summarizing, I think that we're comfortable with an adjusted net debt ratio that is lower.

I think we're in a very comfortable position right now.

We will have commitments in terms of aircraft going forward, but the board has also returned value to our shareholders as well.

And I don't think that there's -- it's necessary to lever the business as of now beyond the needs that we have for financing of our aircraft.

Our last question comes from Lucas Barbosa from UBS.

I just wanted to hear your thoughts on the demand recovery that we saw this quarter.

Does it come from a specific region, or is it all around?

So my intention is just to get some visibility per region.

This is Pedro.

I would say most regions, if not all.

Obviously, Brazil came back sooner and stronger than expected in a way we've seen that throughout the year.

And most other regions, they have shown healthy traffic growth and yield improvement.

So I will not "blame one specific region." I think it's throughout Latin America.

I would like to turn the call back over to Pedro Heilbron, CEO, for closing remarks.

Okay.

Thank you all.

This concludes our earnings call.

In fact, thank you for participating, and as always thank you for your continued support.

Have a great day and a great weekend.

Ladies and gentlemen, thank you for your participation.

That concludes the presentation.

You may disconnect and have a wonderful day.