LATAM Airlines Group SA (LTM) 2005 Q3 法說會逐字稿

[OPERATOR INSTRUCTIONS] Welcome to the LAN Airlines conference call. I would like to turn the cover over to Maria Barona.

Thank you, good morning, everyone, welcome to LAN Airlines third quarter conference call. We thank you very much for joining us today. The LAN Airlines earnings release for the period was distributed today. If you have not received it, please contact us immediately in New York at 212-406-3690.

At this time, I'd like to point out that statements regarding the Companies business outlook and anticipated financial and operating results constitutes forward-looking comments. These expectations are highly dependent on the economy, the airline industry and international markets. Therefore, they're subject to change. At this time, it is my pleasure to turn the call over to Mr. Alejandro de la Fuente, Chief Financial Office of LAN Airlines. Mr. de la Fuente Goic, please begin.

Thank you, Maria. I am Alejandro de la Fuente, Chief Financial Officer and with me are [Ale Buchor] and Jorge [Vilches] from our Passenger Division, Thomas Silva from our Cargo Division and [INAUDIBLE] from our Investor Relations Department.

Today, I will discuss our financial results for the quarter, review full recent developments and comment on our expectations for the rest of 2005 and 2006. Then, we'll be pleased to answer your questions. The quarter, LAN earned $24 million in net income for the third quarter compared to $36 million the year before. We consider this to be a positive result during this quarter we face $54 million in additional costs that we were able to offset partially through $24 million in [true hedging] gains.

Furthermore, we're also impacted by the cost associated with the launch of LAN Argentina and [INAUDIBLE]. The passenger business had a successful quarter. Revenues grew 24% as capacity grew 11% and unit revenues improved more than 11%, thanks to a two-point increase in load factors and an 8% rise in yield. The passenger business performance this quarter was driven by strong demand, solid market shares despite increased competition and irrational pricing environment.

Overall, market conditions have remained favorable with the money in Chile and Argentina growing solidly and Ecuador recovering from a weak comparison base. This positive demand environment has generated multiple opportunities for us on domestic regional and local markets. And we have decided to focus on those of highest strategic long-term value such as growing our regional network or expanding our operations in Argentina. Because of capacity limitations, we have been enabled to grow in other markets and this has enabled smaller carriers in Chile to increase their market shares at our expense.

Operating conditions on regional and local markets remain fairly stable, and we have been able to hold or increase our market share on most routes despite active competition. The main exceptions to this stable environment has been the Latin America/ Europe market. In particular, in Chile/ Spain market, we have started to compete with [INAUDIBLE] which has obtained sizable market share based on the first accumulation and pent-up demand.

Meanwhile, on the Ecuador/Europe market, we have benefited from strong demand and from the decision to pull out from the market. We have actively managed our capacity response to these conditions in order to leverage strong demand, capitalize competitive opportunities and optimize aircraft and network utilization. In terms of pricing, yields have increased due to higher average fares, improved segmentation, higher business traffic, and impact of the stronger Chilean peso on domestic revenues. In this regard, it is important to know that LAN has gradually positioned itself as price leader in all its main markets, as was recently proven by the successful launch of our passenger fuel surcharge.

The cargo business. Cargo had a tough quarter, as we faced weak demand that ultimately led to flat traffic. As a consequence, the only source of revenue growth was the 7.5% increase in yield since we were unable to cut capacity rapidly enough, load factors fell 4.3 points and this led to modest 1% expansion in revenues per [ATK.] Cargo traffic has lost momentum mainly because of lower than expected demand on northbound routes due to two main factors. The fall in Chilean [INAUDIBLE] and the slowdown on export [INAUDIBLE] in Argentina due to stronger local currencies and wider availability of seat transports.

On the positive side import demands into Latin America which is composed mainly of higher value added goods continue to strength during the quarter. This has led to strong flow imbalance which in turn has generated [INAUDIBLE] pressure on [INAUDIBLE]. On the competitive front conditions have improved slightly as capacity cuts by one of the major US operator to the region. Where partially counter balanced by the entrance of new one aircraft operator in the Chilean market.

We have responded to this changing environment by adjusting aircraft rotation in order to optimize capacity locations and by replacing [INAUDIBLE] capacity with our new more profitable Boeing [INAUDIBLE] Freight. Thanks to these adjustments and also due to a slight recover on northbound non perishable exports, both cargo traffic and margins improved in September. Operating cost for the quarter grew 26% [INAUDIBLE] increase 9%. As a consequence, cost for ADK which also include net financial expenses and our operating revenues increase 50% year-over-year. Cost increases were mainly driven by higher crude prices, which led to $47 million in additional expenses and account for almost of 70% of the unit cost increase. The remaining 30% was mainly accounted for by the impact of the stronger Chilean Peso which only include personnel cost, accounted for nearly $10 million in additional expenses.

Excluding this two impact unit cost increase marginally as were partially able to accept the impact of shorter trip length, higher per unit commercial cost due to higher unit revenues and launch of LAN Argentina. Through the re-negotiation of maintenance contracts, the replacement of lease capacity of our new freighter, lower fuel burn rates and improved acid utilization.

[INAUDIBLE] developments: First, LAN Argentina. LAN Argentina continues to grow and completed its full -- its first full quarter of operations ahead of expectations. It is important to note that LAN Argentina posted a $5 million loss for the quarter. Mainly because LAN and its local partners have chosen to expense its start-up cost rather than capitalize and amortization them over 20 years. Customer response has been very positive and load factors for the quarter exceeded 80% enabling LAN Argentina to start improving its yields gradually.

LAN Argentina is expected to continue growing aggressively and will start international operations on December 1, with daily service between Buenos Aires and Miami. By the end of 2006, LAN Argentina expects to serve 10 destinations with 14 aircraft, some of which will be new Airbus [INAUDIBLE] aircraft. It also plans to add a domestic and international destinations. [INAUDIBLE] LAN Argentina is expected to break even in 2006 with annual revenues of around $300 million.

Airbus A220 order, in October, we finalize our order for Airbus A220 family aircraft, which combined with our A319 backlog means we will receive three two-narrow bodies between 2006 and 2008. Under the current delivery schedule, we will take delivery of eight - A319's in 2006; ten -A318's in 2007; ten-A318's and four-A320's in 2008. The vast majority of these aircraft, together with the two A319's we received last week, will be used to expand our operations both in regional routes and domestic markets of Chile, Peru and Argentina. We are confident that these aircraft will enhance our competitive advantages as they will help us improve customer satisfaction, reduce operating costs, and cautiously they [INAUDIBLE] with the fleet in each of its core markets.

Labor negotiations. Earlier in the year, Chile's Labor regulator rules. Earlier in the year, Chile's labor regulator rules that all collected contracts in Chile should be adjusted to conform to the four-year term limit set on the Labor Reform Law of 2001. Since a number of our contracts has been signed prior to the reform, and had longer terms, we have had to re-negotiate eight contracts with unions and employees' group. And so far, we have signed agreements with all but two of them. We are currently negotiating with one of our pilot unions and with the union of [INAUDIBLE] employees which includes back office personnel and some airport person in Chile. At this point, we believe we will be able to reach agreements with both unions before the legal deadline in late November.

Fuel price management. During the third quarter, we actually worked on a number of initiatives to mediate the impact that high fuel prices have had on our profitability. This includes operational adjustments aimed at reducing fuel burn, changes in our fuel hedging policy, adjustment on our cargo fuel surcharge and implementation of new passenger fuel surcharge. I will only discuss our strategy in the passenger fuel surcharge. In regard to fuel hedging in July we decided to hedge higher than usual portions of our total consumption and as a consequence, we were fully hedged for both August and September at roughly $1.6 per gallon.

As part of this policy, we have also hedged 65% of our needs for the full quarter at $1.80 per gallon and 50% of our [INAUDIBLE] consumption for the first quarter of 2006 at $1.90 per gallon. In September, we implemented a passenger fuel surcharge that will vary in line with changes on international oil prices, effectively hedging nearly 80% of the incremental fuel costs. Since this is a rule-based system, we believe it will minimize the impact perception customers tend to have on this type of fuel increases as it will insure passenger that fare will be fall as oil prices decrease. This measure has been widely followed by our competitors, positioning us as price leader on our main markets. We expect the passenger fuel surcharge and some changes to our cargo fuel surcharge, to generate incremental revenues of $7 to $9 million per month.

The future. Despite record fuel prices, and other challenges, LAN has continued to post positive results and we believe that the adjustments we have implemented should lead improvements in both our short-term and long-term outlook. We believe this is supported by the advance made to protect our performance from higher fuel prices brought by recovery of our cargo business and by a series of commercial developments on the passenger side.

On the passenger business, we expect passenger demand on our main markets to continue to grow and competition to remain fairly stable. More importantly, we expect our competitive position to improve for a number of reasons. First, the DOT, recently granted LAN Peru, an American Airlines antitrust immunity, enabled them to corporate closely and consolidate as LAN Peru's as Peru's most important airline. Second, LAN Argentina, Buenos Aires to Miami service will significantly enhance our valuable position to Argentine customers and position it as the main international player in the Argentine market. Third, the arrival of seven of Boeing 737s on short-term lease contracts as well as our new Airbus 319s will help us expand capacity on domestic and regional markets. And, four, the incorporation of Boeing 77 aircraft will allow us to tackle growth opportunities on long-hold markets. Overall, we plan to grow total ASK by 8% to 10% on the four quarter and 15% to 17% in 2006. Yield should increase due to higher fare on the passenger fuel surcharge. On the cargo business, we do not expect major changes on current demand, trends, nor in competition because of this, we have adjusted our capacity plan to respond to lower than expected growth. As a consequence, we will use our 2005 freighter deliveries to replace wet lease capacities and as a consequence, at the capacity share of total freight capacity will come down from 30% this year to nearly 10% in 2006. Since we estimate our own freighter to be 10 to 15% more efficient that wet lease freighter, this move should lead to higher cargo margins.

Overall, total cargo capacity is expected to grow close to 5% on the four quarter and between 10% and 12% next year. Meanwhile, unit cargo revenues are expected to improve slightly thanks to improved southbound fares and new commercial strategies. In summary, although we remain concerned about fuel prices, we are optimistic about the short -- about the short and midterm outlook since we have implemented effective measures to contain high fuel prices and the cargo business starting to recover.

At the same time, LAN Argentina is adding aircraft and expanding its itinerary, to position itself as a very strong competitor on the Argentine market. More importantly, the long-term outlook remains solid as we are bound to roll out several projects that should reinforce our competitive advantages on areas such as efficiency, service, and network, enable us to strengthen our competitive advantages and positions as the leading airline in the region. Now, we will be pleased to answer your questions.

[OPERATOR INSTRUCTION] Our first question of the day will come from Steve Trent with Citigroup

Good morning, gentlemen. Just two quick questions for me. The first question I was wondering. Thank you, first of all, for the your expectations on ASK and ATK growth for the fourth quarter. I'm wondering to what degree you've built in the impact of Hurricane Wilma? Miami's not exactly back to normal right now. And I know LAN's Cargo headquarter in Miami. I also realize you have limited capacity going to Cancun, both directly and through some Euro-Mexico code shares, so I was wondering what are your expectations on that level? And my second question, basically refers to, your price leadership by what time period do you think you guys will also be the price leaders in the Argentina market? Thanks very much.

In regard to hurricane, the cargo business and impact of Hurricane Wilma, Mexico will not have any impact because it was the hurricane was in another region of our operations and in Miami the impact is basically two days of operations. The airport was closed for a little bit more than 24 hours and we had troubles getting the cargo into Miami.

Basically from the export business out of North America -- sorry out of South America and also, there's been a delay of about 12 hours, 12 to 24 hours in the reception of cargo in Miami for southbound cargo. Okay. Were evaluating the impact in terms of revenue but it shouldn't be important because we should make up for that in the next ten days. On the passenger side, our impact on Wilma was minor. We had to cancel two flights. The exact days the hurricane was over Cancun but the situation we have been talking and in constant communication with the authorities and our people onsite and we expect that the end come will minor since we have a combine operation with Havana in Cuba. In the future, in the next quarter were going to be changing some traffic from Cancun to Havana and to Punta Cana in Demonic Republic. So we expect our impact to be minor until Cancun gets back in places.

Great and just a quick comment as well in terms of what you guys are thinking in the Argentine market and if and when you'll achieve price leadership in that market.

Well, regarding the Argentine market we are very, very pleased with the development that we are seeing both in our low factors and in our yield as well. It' definitely better than that we expected at the beginning. And well this is hard to tell the exact date that we expect to be leading prices in Argentina but we expect a year or even less to be really leader in this point.

Okay. That great, thanks very much guys.

Our next question will come from Margaret Kalvar with Harding Loevner Management.

Hi, I was curious about what the exact split on Domestic International on the passenger side was at this point and if you could elaborate on the competitive environment in the domestic market and whether long-term you see you strategy moving away from domestic and to more of inter- regional carrier position?

Margaret, basically the split between international on domestic on the passenger side is about should account for less than 18%. And we are expanding it leans towards international development. That we see this as a comprehensive product involving all the markets in which we operate.

Could you also elaborate a little bit about the routes to Spain and the competitive situation in that particular area?

Yes, regarding the route to Spain which is a important route in between Chile and Europe, we failed a new intern which is Air Madrid, a couple months ago. They started with pulling prices down aggressively as they have done in the Peruvian market and the Ecuador market and other markets between South American and Europe.

But [APEX] has been much minor than we expected because we have been able to compensate some of the traffic between Chile and Spain with simular yields or most about similar yields traffic between Chile and other destination in Spain and in other places in Europe because Air Madrid doesn't have a good distribution system in Europe and other parts of Spain. So we've been able to compensate that traffic and maintain very high load factors and high yields.

Okay, thank you.

[OPERATOR INSTRUCTIONS] Mike Linenberg with Merrill Lynch has a question.

Yes, I have a quick bilateral question here. When you look at recently the agreement between Peru and Argentina is increasing the number of weekly frequencies and I want to say it's like 20 or 28. Is LAN both , Argentina and Peru, even though you could say the influence of those two carriers are influenced by a single entity. Can both actually apply as if their represented from the two different regions? Any clarification on that would be fine.

In legal terms, since LAN Argentina is an Argentina company and LAN Peru is an Peruvian company and the rights have been increased on both sides they could perfectly apply on each side. We don't know exactly if that's the perfect strategy that should be followed in that case but we know that we're going to expand operation on this route mostly coming from our operations in Peru. Mostly from LAN Peru.

Okay. Thank very much.

Ricardo Fernandez with ING is next.

Good afternoon. The first question I have is on basically pricing. I'm looking at, if I'm correct basically about a 1% drop quarter-for-quarter in terms of the yield for passenger revenue. On the cost side I think basically, the numbers were pretty much in line, I was expecting but is that drop in yield obviously, the reason for the, in my opinion lower margins, again then expected. Because of Argentina or was there the inability to pass through pricing across the market? That's the first question.

Yes, actually the -- that drop in yield that you are mentioning is only based on the normal seasonality of the business sense. On the second quarter are main traffic, southbound, northbound they have a lower load factors, and lower yield. Is basically a [INAUDIBLE] effect.

But if you look at last year there was a drop, a similar drop in yields because of seasonality but at the same time your facing a big increase cost, basically fuel. Which you weren't able to pass through.

Now you weren't able to pass through it because of the seasonality or because of competition because Argentina you were more aggressive in pricing. I'm trying to get a feel for, the key to Airline is obviously pricing because cost are sort of given to you. What hold you back from improving that yield in face of a rising cost environment?

Ricardo, basically to answer your question is a passenger fuel sur-charge. The passenger fuel sur-charge was implemented on late September. And it's going to be the main means in which were going to pass on that incremental fuel cost to our customers. Basically you look at from the rising cost perspective vis-a-vis increasing revenues, its related to the fact that we [INAUDIBLE] late on the quarter.

Okay. So basically fourth quarter, you add your increase in prices because of the season obviously, and then also add on the fuel surcharge and we should have a basically pretty good increase in yield average prices as to cover, if oil stays where it is today, the rise in oil in the third quarter. Is that a fair statement?

Right.

Then the other subject is basically Argentina, as you probable know gold is going to be aggressively moving or starting service international from -- Brazil to Argentina and various other cities. Your going to be going from Buenos Aires , North. Do you have a sense as to the success, the -- any problems -- or what's your sense in terms of Argentina, Brazil traffic. Which is I think probable relatively heavy, in terms of Argentina overall international, if I'm not mistake.

Right. The traffic between Brazil and Argentina, especially Sao Paulo and Buenos Aires. It's important in the region and goal is it's been operating recently in that market and we should do that we should work on that market in the future and in LAN Argentina.

But we are not very concerned about the impact of gold because we are targeting different market segments. Since the industry is very big considering the offer, the capacity that each carrier has in this market, we are very comfortable in knowing that were going to keep on targeting the marker segments that we already cover in Argentina, by the time that we go to the Brazilian market and this is the corporate segment and high yield market.

Okay. Has LAN Argentina already launch a frequent flyer service? Is it, I guess LAN Pass card, right?

Right. Exactly. It's -- It was already operating when before LAN Argentina, but know it is getting much stronger due to traffic increase.

Okay. So if I'm in Buenos Aires I'm a business person in Buenos Aires, I want to go to Sao Paulo, why should I take LAN Argentina versus [Lena Aires], [Go, Vague or Tamp]?

Well, that's a easy question. If you only travel to Sao Paulo, then -- you could be in the dilemma of which carrier should I use? First, we have the biggest network in South AMerica and most of the travelers in Argentina they don't only go to Brazil they move around a lot in the region so sense you want to take advantage of the traffic most of corporate travelers, in this case, they have already gone with the LAN Pass Card which gives them a higher offer. And also it's a matter of service, Gold is a low cost a low cost carrier. That implies a lower service carrier and a high yield and corporate markets they want a better service and that's why we are very comfortable in that matter.

Okay, but how about versus [INAUDIBLE], they have good service, why would I chose LAN Argentina versus [INAUDIBLE] for example, in the group.

Yes, it's basically the network. It is the network in South America. But [INAUDIBLE].

Would you consider doing Coach Air, to improve, I guess the Argentina/Brazil traffic?

We haven't consider that yet.

No, okay. Argentina, LAN Argentina International was basically focused for the Argentinians going abroad not for southbound traffic from either Brazil or any where else; is that correct?

Well, it's also thinking of the important southbound traffic Argentina's and other people living gin Europe and the United States. Not that much from traffic inside South America, even though there's a different traffic regional but also the United States and Europe, Yes.

Okay. Because longer-term, think three, five years out it's going to be the international Argentine service is going to provide the bulk of the revenue for you versus domestic; correct?

Des it's going to be very, very, important on the international operation going to led the operation.

Okay. Thanks, I appreciate your time.

Next we'll hear from Ray Needham with Caylon Securities.

Good morning. I got on the call late so I apologize if you talk about this before, but I was just interested in your Brazil goals. I know at one time you were looking at trying to go internally domestically in Brazil and the Brazilian government was very protective. I am just wondering if you gave up on those goals or if still working on something to get into that big market?

No, we don't have plans. For going to the Sicilian market right now. We are in the process of developing the LAN Argentina. The Brazil market is very protective for foreign investor. Right now we are very active in the cargo business. We are working with the [INAUDIBLE]. Which is a Brazilian freighter carrier. Not for the moment we are not following any investments in Brazil.

Okay. How about Mexico? There's a lot of changes going on in Mexico, which is a big domestic market as well, and I understand some of the parties up there may be looking for an outside partner of investor. Is there opportunities within Mexico for a LAN.

No, No we are not considering Old New Mexico. In the near term because we want to be the most important company in the southern part of South America. Mexico is very far, and it's not part of our study to invest there in the passenger business. In the cargo business we have investments, we own [INAUDIBLE], which is a cargo company. In passenger were not interested in investing.

Okay. Thank you very much.

Your welcome.

[OPERATOR INSTRUCTIONS] Glenn Engel with Goldman Sachs has our nest question.

Good afternoon. A question on the unit cost side, please. Even if I stripped out fuel and currency it would still look like the non-fuel unit coast were up about 3 or 4% and unit labor cost were up even more than that. What is driving the unit wedge -- the unit cost increases and -- can you get that back down to -- are you expecting to bring that back down to flat in 2006?

Glenn, basically if you look at the unit cost they were up 15%. If you exclude fuel that's about close to 4, 4.4%. If you isolate the currency affect your left without 2% increase on unit cost overall. The main reason for that were basically the fact that we operated short-term trip lengths as you know that drive up unit cost some what. Also the fact that commercial cost, I mean in commission increased faster than capacity. They were up 16%, again a 9% increase in capacity.

Therefore they have a higher weight on the unit cost, on the total unit cost. In regards to the fuel, oh sorry on the personal element. Indeed wage and benefits were up much more than capacity, part of it comes from the currency affect that I just explained. The remainder of it comes from basically increasing headcount. Those increases in headcount are basically related to the requirement to hire personnel Argentina. We are running right now in operation that for a smaller that for what it will be in the next two to three months. Therefore we should those start operating, we increase capacity there. We will take advantage of that personnel. So that should help us decelerate growth on the unit labor cost.

Okay. Are the labor cost running through the consolidated statements?

Yes.

Thank you very much.

Your welcome.

[Pablo Gabaren] with Lucite Research has a question.

Hi, I would like to know how much LAN Argentina, what sort of a target your looking in terms of revenue contribution? Like what's your target for LAN Air -- Argentina, to contribute to the top line. What sort of a time frame are you looking at?

Basically as we said previously the target '06 on an annualize basis is $300 million. That should increase obviously overtime as we work capacity in routes. But for '06 which is sort of we can have good visibility on the project it's about $300 million a year.

Initially you mentioned that on the passenger revenue break down you said 80% of the passenger revenue comes from Chilean operations.

No, Sorry it's more than 80% is international revenue.

I see, I see, International revenue. So the three hundred will part of the LAN Argentina contribution. What is it right now? How much was it ball park number?

Ball Park number is Argentina is growing significantly over the last month or so. It's about $50 million.

Okay. Thank you very much.

[OPERATOR INSTRUCTIONS] Next we will hear a follow up from Ricardo Fernandez with ING.

Yes, Quick question on the fuel surcharge is that going to be past through as passenger revenue or will that be a separate non other revenue item? What's the accounting over that?

[INAUDIBLE]

Okay. We'll see right in yield?

Yes.

Okay. Thanks.

There are no more questions in the queue. I will now turn the conference to Mr. Alejandro de la Fuente for any closing or additional remarks.

Okay. Thank you again for doing this today. Please feel free to contact our investor relations department if you have any additional questions. We look forward to speaking with you again. Thank you very and goodbye.

And that does conclude our conference call. Thank you for joining us today.