LATAM Airlines Group SA (LTM) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to the LAN Airlines conference call. As a reminder today's call is being recorded. At this time I would like to turn the conference over to Maria Barona. Please go ahead.

Good morning, everyone, and welcome to LAN Airlines fourth quarter conference call. We thank you very much for joining us today. The LAN Airlines earnings release for the fourth period and 12 months ending December 31, 2005 was released yesterday. If you have not received it, please contact us immediately at 212-406-3690. At this time I would like point out that statements regarding the Company's business outlook and anticipated financial and operating results constitute forward-looking comments. These expectations are highly dependent on the economy, the airline industry, the international markets, therefore, they are subject to change. A this time it is my pleasure to turn the call over to Mr. Alejandro de la Fuente, Chief Financial Officer of LAN. Mr de La Fuente, please begin.

Thank you, Maria. I'm Alejandro de la Fuente, Chief Financial Officer, and with me are [INAUDIBLE], from our International Passenger Division, [INAUDIBLE], from our Domestic Passenger Division, [Almero Garril], from our Cargo Division, and Andres Bianchi, from our Investor Relations Department. Today I will discuss our financial results for the quarter, review six recent developments and comment on our expectations for the rest of 2006. Then we'll be pleased to answer your questions. The quarter. LAN earned $49 million net income for the fourth quarter compared to $47 million the year before, a significant improvement considering that we continue to face extremely high fuel prices and the cost associated with the launch of LAN Argentina. This performance is even more impressive considering that comparable net income grew close to 20% as last year's result included a 6 million one-time tax benefit.

More importantly, our bottom-line improved [greatly] by a significant rise in operating income, which increased 34% to $59 million, as the revenue grew 16% and operating margin expanded 2.8 points to 8.4%. The passenger business. The passenger business had a successful quarter as revenues grew 23% due to a 16% improvement in unit revenues and a 6% expansion in capacity. Unit revenues grew as load factors improved 2.7 points and yields rose 12%, but highlight the success we have had in managing strong demand and competitive opportunities. Demand growed in our home market, Chile, Peru, Argentina and Ecuador, continued at the strong pace supported by economy growth, improved customer confidence and a stronger local currencies.

This attractive environment has motivated a moderate increase in competitive activity, but we maintain healthy market share across the board thanks to both careful capacity management and a solid brand position. The only exception to this was the Chile [paying] market in which Air Madrid's low fares generated significant market stimulation and enabled it to capture sizable market share. Strong demand generated interest in investing growth opportunities for us. And we focused on those with the high [INAUDIBLE], long-term value, such as expanding operations to South Pacific, consolidating our regional network and growing domestic operations in Argentina. In term of pricing, [INAUDIBLE] improvement, primarily driven by cost pass-through initiatives, the stronger Chilean peso and improved segmentation.

It is important to highlight that the passenger fuel surcharge exceeded our expectations, as demand proved to be less elastic to price than anticipated, therefore leading to higher than expected actual pass-through. The cargo business. Slight improvements in the cargo environment, plus the actions taken to adopt our operations to different market conditions, enable our cargo business to deliver a positive performance in the final part of the year. During the fourth quarter we change our capacity expansion plan in order to better match the current environment of strong imports and weaker than usual exports. Export volumes have weakened due to lower fresh salmon shipments out of Chile and slow down on export shipments from [Brazil] Argentina due to stronger local currencies and wider availabilities of sea transport. On the other hand, import demand into Latin America, which is composed mainly of high value-added goods, continue to strengthen during the quarter due to economic growth and strong local currencies.

It is important to know that, given their nature, southbound shipments allow for higher unit revenue after yields fully offset their lower rate. The changes we made in our freight mix were aimed at increasing profitability by maximizing the contribution of our Boeing 767 freighters make to total capacity. This decision was based on the [INAUDIBLE] ability to perform well on both long and short rotations, as well as on its strong cost advantage over all the wet-leased aircraft. In addition to actively managing capacity, we have also worked on pricing, raising rates on southbound routes in the face of strong demand, while cutting rates on northbound routes in order to stimulate demand. As a consequence, total revenues grew 9% as capacity grew 2%. Load factors remain stable and yields increase 6%. Operating costs. Operating costs for the quarter grew 12%, as [season] capacity increased 3%. As a consequence, cost were 80K, which also include net financial expanses increase 11% year-over-year.

This increase in unit cost is explained almost entirely by two factors, higher trip prices and a stronger Chilean peso. Our ex-fuel prices rose 37% year-over-year, leading to more than $2 million in addition costs. That explains nearly 85% of the increasing unit costs. In fact, ex-fuel unit costs rose 1.7% during the quarter. The rise is, in turn, fully explained by appreciation of Latin American currencies and, in particular, that of the Chilean peso. The Chilean peso rose nearly 10% year-over-year, inflating several cost items, such as [special] expenses in U.S. dollar terms. In fact, the impact the appreciation of the Chilean peso had in our personnel cost, explains the remainder of the unit cost increase. Excluding these two items, unit cost rose marginally as careful cost management enabled us to increase efficiency in operations, maintenance and commercial efforts.

Among the main sources of saving we can measure, replacement of ACMI capacity from our own Boeing 767 freighters. Reduction in our age of our fleet, due to incorporation of newer aircraft, the negotiation of maintenance contracts, changes in service standard in the Chilean domestic market, lower sales related expenses, implementation of the hiring freeze, and lower variable wages. In summary, during the quarter we were able to effectively mitigate extended cost pressures through various initiatives that will we believe will continue delivering positive results in the future. Strategic developments. First LAN Argentina. LAN Argentina had a mixed fourth quarter, as good news on the domestic market were offset by the postponement of the launch of its international operations. Domestically LAN Argentina continues to beat expectations. During the quarter load factors remain close to 75% despite the fact that capacity grew close to 50% compared to the third quarter.

This positive performance has enabled LAN Argentina to achieve a domestic market share of 12% in December, that is well ahead of our initial expectations. Financially LAN Argentina reported a $6 million loss during the quarter. Mainly because LAN and it's local partners have chosen to expense it's start-up cast rather than capitalize and amortize them over 20 years. On the international side, we were forced to postpone the launch of our Buenos Aires-Miami service after the FAA upgraded the Argentina's safety rating, dramatically modifying the parameters under which LAN Argentina operations had been defined. Before this service can be launched LAN Argentina is to complete another certification process, which we expect will be finalized during the second quarter, thus enable the Buenos Aires-Miami operations to start in June. Despite this set-back, we continue to be committed to Argentina market and estimate that by the end of 2006, LAN Argentina will be serving 10 designations with 12 aircraft, including new Airbus A320 family aircraft and a couple of Boeing 767s.

Over all, LAN Argentina is expected to breakeven in late 2006 with annual revenues of around 300 million. Airbus deliveries. In the fourth quarter LAN incorporated seven aircraft to it's fleet, including: One leased passenger Boeing 767; One leased Airbus A320; Two new owned Airbus A319; two leased Boeing 737; and one new owned Boeing 767 freighter. It's important to note that except for the A320, none of the leased aircraft actually flew during the quarter, as they were completing their delivery [tests]. In term of future deliveries during 2006, we expect to receive four new owned passenger Boeing 767, eight new owned Airbus A319s, five used, leased Boeing 737s, and one new owned Boeing 767 freighter. The vast majority of the [service] we believe will expand our operations, especially on local routes to the U.S. and the South Pacific in regional routes and on the domestic markets of Chile and Argentina. Aircraft financing and liquidity.

Since our last conference call we have made significant advances in aircraft financing. We have now secured the financing for all of our Boeing 767s delivered through 2008 at sub-LIBOR rates. Furthermore, in November we have seen it fixing the rates of all of the [INAUDIBLE] at an average rate of approximating 4.7%. Last week we secured the financing of our other outstanding aircraft order of 32 Airbus A320 family aircraft. This new $770 million facility will be used to finance 85% of our new aircraft, also at a sub-LIBOR rate. We also continue to have a strong liquidity position with over $260 million in cash, cash equivalents and committed credit lines. Our cash and equivalents fell from 305 million in 2004 to 159 million in 2005. Given our decision to fully fund aircraft pre-delivery payment and used committed credit lines to reach our internal liquidity targets.

As of December, total pre-delivery payments amounted to more than $280 million and we're near their projected peak given our aircraft deliveries channel. Since we plan to internally finance 15% of our aircraft and delivery repayments usually amount to 40 to 50% of the aircraft prices, we will start receiving cash after each aircraft delivery before boosting our actual cash position. New long-haul product. In December, we announced the launch of a new long-haul product that includes the new premium business class with full-flat seats and leading-edge in-flight entertainment system, improved economy-class seats and new aircraft interiors. We plan to retrofit all of our Boeing 767 to this standard, in a process that will take a total of approximately 18 months and require an investment of nearly $90 million. In this period one of our Boeing 767s will remain grounded while it undergoes refit. We expect [products], which will be used primarily on routes to the United States, will further enhance LAN Atlantic/Latin America, especially on premium classes as no similar products are currently available on these markets.

Short haul adjustments. In December we implemented the first batch of changes in the Chilean domestic service that included cutting the number of flight attendants on this flight from four to three and reducing catering standards. The measures will be followed in 2006 by the re-configuration of our A320 family aircraft in order to increase seating capacity by approximately 5%. These changes are likely to be followed by additional ones that are currently under consideration and that should enable us to enhance customer satisfaction while reducing costs. LAN cargo investigation. On mid-February, we received an information request from the United States Government and European authorities in connection with global antitrust investigation involving the worlds' main cargo companies. We have cooperated fully with U.S. and European authorities in this matter and hope it will be resolved as soon as possible. Given the fact that this is an on-going investigation, we are not in position to make any further comments on the matter at this time.

The future. Our fourth quarter performance proves that the adjustments we made to address the challenges faced were effective. We believe that this, together with positive developments on both passenger and cargo areas, and additional service and efficiency related initiatives enhances our short-term and long-term outlook. On the passenger business demand continues to be strong as proven by high passenger traffic during the summer season and continued strength in forward bookings. Although several carriers, such as America, Delta, Copa and Air France have increased capacity, improved demand has limited the impact this has had on our [Company]. We currently expect total [each] case to grow between 6% and 8% during the first quarter. Load factors to decrease slightly and yield to grow over 9%. For the full year, we expect capacity to rise between 15 and 18%, supported by the addition of at least 17 passenger aircraft.

In the cargo business we do not expect major changes on current demand, trends, nor competition. Because of this, we have adjusted our capacity plans to respond to lower than expected growth on northbound routes, which are the ones that typically require extra [lift] capacity under [full] we'll use our Boeing 737 to provide most of our capacity. As a consequence, ACMI capacities share of total freight capacity will come down from 30% in 2005 to nearly 10% in 2006. Since we estimate our own freighters to be 10 to 15% more efficient than wet-leased freighters, this move should lead to higher cargo markets. Overall, total cargo capacity is expected to grow close to 5% on the first quarter and between 8 and 10% for the full year. Meanwhile unit cargo revenues are expected to improve slightly thanks to improved [INAUDIBLE] and new commercial studies. In regard to fuel hedging, we have hit 50% of our total requirements for the first quarter, slightly below $1.9 per gallon of jet fuel, 40% for the second quarter at $1.8 per gallon, and 50% for the second half at $1.55 per gallon.

In closing, we believe that we are moving in the right direction and our fourth quarter results provide strong evidence about this. We are determined to continue growing expanding into new markets serving our customers better and by advancing on efficiency initiatives. We expect that during 2006 we will continue to advance, as initiatives currently in progress start to mature and new ones start delivering positive results. Although it's likely that first quarter results will be below last year's, we expect full year results to improve relatively to the south of 5, this enable us to continue creating value for shareholders. Now we will be pleased to answer your questions.

[OPERATOR INSTRUCTIONS] Our first question today will come from Raymond Neidl with Calyon Securities.

Good morning. Good results, congratulations.

Thank you.

Just to kind of reverify some of the things that you were talking about on the cost area. You are achieving very good parameters on your cost controls, by buying new aircraft, your new maintenance contracts, and by replacing the wet-leased aircraft. Going forward has all of the easy fruit been picked? Do you see other ways of further reducing your unit costs? And if so, are there any big items on the agenda that you can share with us?

Yes. We are working hard on that subject and we currently are doing a complete analysis on alternatives. But some of the complete items that we're working on is adding of new seats on the same aircraft without decreasing the space between rows and so that will be an additional 5% for this year on less cost.

Okay. And as a result of this, and your fuel hedging protections and so forth, just for our modeling purposes, do you think that you can expand operating margins in 2006 versus 2005? What is the probability of that happening?

Well, in regards to your previous question, Ray. One more comment and we can expand further in a second on that. But we are also working on reducing our commercial costs following the global trend in that direction. Now going to your question about operating margins, it is probably likely that they will expand during 2006. Especially considering the changes we have made which have been noticeable on the fourth quarter in terms of improving customer pass-through on similar-cost items.

Yes, you were very good on the fuel surcharges. In the U.S. what is happening now is [RAZM] numbers are going up very strongly, of course, over a weak base, so domestically we're seeing strong RAZM increases. Are you seeing the same trends in your territory in South America?

In terms yields?

In terms of yields, yes.

Yes. Actually we're very pleased with the results we are achieving with our fuel surcharge. And due to the strong increase in demand, we haven't really seen any major impact in elasticity. And so this is allowing us to really have a strong results in margins based on these good results on the surcharge.

Okay. Great. In the cargo area, I think your last guidance was you saw that area growing 10 to 12%. I don't know if you brushed upon that in detail. But is that pretty much still good guidance?

Yes. If I understand correctly your question about where goes our increasing capacity? Increasing capacity is very much related to the stronger southbound demand, especially to refuel, so we're going to add frequencies to different points in Brazil. We are currently fly from the U.S. to eight different points in Brazil. So we are going to be adding frequencies to most of these destinations. And also we're going to start around April a new operation between Brazil and Europe, connecting directly Europe to Brazil. This is going to be a [INAUDIBLE] style operation with connecting, as I say, Brazil and Europe.

Do you have the ability -- I know you said you want to expand your Miami cargo hub. Do you have the ability, the rights to fly cargo planes from Europe to Miami to South America.

Yes, we do. In fact we're doing that currently. We have five frequencies between Europe and South America via Miami.

Okay. And that will increase, I assume?

Not at the moment. We recently increased from three to five frequencies, this is in November when we received a 767 freighter. In November we increased from three to five and the extra flights are going to be direct flights between Europe and Brazil, as I explained, two frequencies a week.

Okay, great. And did you give a CapEx number for this year, maintenance CapEx? In other words CapEx ex what is financeable?

For 2006?

Yes.

We currently expect our CapEx for 2006 to be around $800 million.

Okay.

Based on our aircraft delivery schedule plus the maintenance required to improve our business classes plus class maintenance CapEx, that's all in 800 million.

Now most of that is financeable, is that correct?

Of the aircraft CapEx?

Right.

85% of it is financed and the rest of it it's financed internally.

So net CapEx will be for the company for the year will be what? About 100 million? 80 million?

Of CapEx aside from the aircraft?

From the aircraft, yes.

It's probably going to be around that on the internal CapEx and the fraction of the aircraft.

Okay, great. And my last question concerns with Argentina. I know that's a big challenge for LAN, there's a big opportunity there. Could you just, again, go over what is developing there? What kind of progress you are making in an environment where the other airlines are having labor problems?

Well, actually we're very glad regarding our results and achievements in the Argentina market so far. We started operation not long ago and we have achieved already 12% in market share. And the best of all is that we are achieving very high load factors and we are improving, increasing our yields through all of these months. So we're really very optimistic on the future to come in the Argentina market. And once we start our international operation from Argentina, also bringing foreigners and putting in contact the domestic market with international market, we really expect it even to be better.

Great. Thank you very much, gentlemen.

Thanks, Ray.

Our next question will come from Helane Becker with Benchmark.

Thank you very much, operator. I just have one question. In your remarks you were talking about segmenting out the passenger market. And I was just wondering if you could expand on what you were doing to segment the market? And if you are finding that in doing so, you're improving your business mix so much so that your revenues are increasing more than they otherwise would have? Thank you.

Yes. Actually segmentation is something that we are focusing a lot on this last months. We are being able to really work on segmentation throughout all of our markets. And there are some reasons in supporting that. One is the strong demand that we are proceeding even in lower season, what typically are our lower seasons, we are seeing a stronger demand, which is allowing us to do a better revenue management. And also, we're increasing our capacity and the number of frequencies we have in a strategic market inside Latin America and connecting to Europe and to Australia. And that is really allowing us to go into the corporate market better, since we have a better product now.

Okay.

Excuse me. Also on the domestic operation, we changed slightly the policy that we were using for a high system demand, allowing us to improve the segmentation that we were doing in the previous years.

Great. Okay. Thank you for your help.

You're welcome.

Glenn Engel with Goldman Sachs has a question.

Couple of questions, please. One is did those capacity numbers was inclusive of LAN Argentina?

Capacity projection numbers includes LAN Argentina.

It does include it?

It does include it.

Two is is that with the changes you are making, would you expect unit cost in 2007 to be relatively flat? I mean in 6, to be relatively flat?

Ex-fuel unit costs should go slightly down because of the higher density on the fleet and because of the cost initiatives that we mentioned.

When you look at the passenger manned by region, is it pretty much strong across all board or are there certain markets that are stronger and certain markets that are a bit softer?

Actually, we can say that it is across the board a very strong demand in basically all markets.

And is business mix also still higher premium class also contributing to the yield increase?

Pardon me? Can you repeat that.

When I look at the yield increases that you are having, how much of it is fares, how much of it is yield management, how much of it is greater premium travel?

Well--

Or it is all?

I cannot tell you the exact figure, but I can tell you that, for example, regarding, this is also related to the previous question, the growth in our premium passengers has been three times higher than the growth in our economy passenger, and that I can tell you is throughout our network and that is a significant part of it. But also I would say the higher load factors is also been a very important factor in the increasing yields.

That's pretty impressive. And finally on the wet-leasing. You said it's going from 30% to 10%. How many dollars does that save?

We cannot go into that. It's more confidential.

Okay. Thank you.

One additional comment, Ray, regarding the yields. It's also-- one thing it's FX rates on the domestic market. As you know, FX rates are going down. We have a natural hedge between revenues and costs given that most of the Chilean domestic revenues are [INAUDIBLE] eliminated.. So part of the yield increase was also related to the fact that we are seeing stronger peso and therefore higher U.S. dollar revenues.

And overall how much has currency boosted yields? Because I guess that's true for the other Latin demand as well.

It's probably had a contributed about 10% of the total yield increase. So of the total yield increase that you are seeing, probably 10% of that number it's sustained by FX rates.

Thank you very much.

You are welcome.

Our next question will come from Michael Linenberg with Merrill Lynch.

Good morning, gentlemen, this is Lily on behalf of Michael. I have two quick questions. The first one, you talked about the details of the short-haul adjustment you made on the plane, reducing the flight attendants, et cetera. How much savings did you get for that, if you can share that number?

We are budgeting $2.5 million in savings due to that change.

A justified attendant change, right?

Sorry?

Just due to the flight attendant change? The number of flight attendants go down?

The two things together, flight attendants and catering.

And catering, okay. My second question, and I think maybe, Andres, you talked about this very briefly, is regarding commission costs. We sort of heard it from a lot of other airlines about ways that they are going to reduce commissions. What is LAN doing about it and if you can share some savings target, that would be great too.

Okay. [INAUDIBLE] is here. Actually we're following, as Andres mentioned earlier, we are following the world trend to optimize our cost restructure, and this is a very important part of it in the commercial side. And our distribution costs, they are different cost items, but it's not really our target. We're just following on what the main competitors are doing in their markets and trying to optimize and optimize the whole process regarding the commercial side and our commercial partners in the distribution side. But that's not really our current target now.

Right. I'm just curious, a follow-up on that. I assume you're talking more about working with your GDS system. Or are you planning to push more on the direct sales channel trying to get more customers and tel-agents to go directly to, say, LAN.com. A little bit more color on that would be really helpful.

Actually both. We are trying to optimize our GBS distribution cost, trying to focus it more on high value. And also regarding the direct channel, we want to expand our direct sales channel, LAN.com, and call centers and our CPUs. But also we are trying to focus and work together with a distribution channel in optimizing their service to the final clients, and focusing on the high value-added and the low-value added we can serve it through our direct channels and that will definitely decrease our cost. And also we're following the trends in reducing, in some cases, standard commissions and try to focus more on incentives.

Sure. Thank you. And last one, can you just tell me what percentage of your sales going through the direct channels right now?

Pardon me?

What is the percentage of sales that is going through the direct channels right now?

Channel? Yes, it's around 15%. It depends on the different markets. In Chile the average domestic and international sales is about 35% in terms of tickets. And in other countries, the amount is lower. But what is the most amazing thing is how big has been the change in dot-com sales and we're forecasting a very big change, in the order of doubling the result of a year [INAUDIBLE].

Okay. Thank you very much, gentlemen.

Thanks.

[OPERATOR INSTRUCTIONS] Next we'll hear from Margaret Kalvar with Harding Loevner Management.

Yes, hi. I had a question if you could elaborate a little bit more about the competitive environment in both the domestic and international passenger markets.

Okay, domestic. Yes, in domestic markets we, since last year, we have two competitors in Chile, who are adding them up they have 25% market share. They have been performing in the same fashion in the last 12 months. They haven't done a very aggressive market campaign.

Okay.

And we feel that we have a strong position mainly due to the brand and the quality of our itinerary.

Okay. Is that 25% for the two of them or each one with 25.

No, the two of them.

Two of them.

They have the same 25% and adding them up and they have been focusing on markets that are long distant markets, but not business markets.

Okay.

So they haven't been-- they task very well, in my opinion.

Okay. How about internationally?

Okay. On the international market, I can tell you, for example, an important competitor in the region, Aerolíneas Argentinas.

Okay.

They have reduced their offer between South America and Australia and we have been able to capture a big part of that market. Also they have been reducing their capacity between Argentina and Peru.

Okay.

And that is also good for us, and Lima and Mexico, so we are trying to expand there. Other carriers, like, for example, Coba, they are strong in the Caribbean, connecting South America to the Caribbean, and they are expanding their operations through their Panama hub. And other carriers, like American or Delta, they continue their seasonal strategies, increasing their offer in the high season and expecting to reduce that offer in the low season.

Right.

Also it's important to mention Air Madrid, that they have become an important player in the Europe - Chile market. But we have been able to compensate that with other European markets going to Chile and we maintain high-low factors, so we're not really very much concerned about them right now.

Okay. Thank you very much.

[OPERATOR INSTRUCTIONS] Next we'll hear from Ian Crook, Raymond James.

Hi, yes, it's Ian Crook. I'm calling from Raymond James Argentina. Congratulations on those results. My question is really about LAN Argentina. I know it's a very regulated market and I know that government regulators are currently adjudicating new routes and frequencies within Argentina and have received bids from all local operators. And I know that LAN Argentina placed their bids for those routes a few months ago. Can you tell me when you expect them to decide-- maybe they have already decided, but I don't think they have, so can you tell me when they expect to decide and adjudicate those frequencies and routes? And what level of uncertainty do the regulators kind of contribute in terms of expanding our operations in Argentina?

Okay. First of all as you mentioned, Ian, it's a regulator market. There's fair regulations in our operators on routes. Some of the routes have been assigned, others at this point probably some operators from that, but it's not to mention that we can't comment on due to the fact that we haven't see actual capacity additions. As in all regulated markets, there is a varying degree of discretion in the parts of authorities and that certain uncertainty on what it going to happen in terms of relations going forward. But that is usual with most regulated markets.

Okay. So can you share any ideas of expected market share one year from now?

One year from now, our goal we have 12% market share in December. We expect to have between 20 and 30 by the end of the year, probably on the high-end of that, and [before] it's going to be aided by the fact that we aren't going to have international connections feeding traffic into the domestic.

Okay. Great. Thanks a lot, Andres.

Thanks, again.

At this time there are no questions in the queue, I will now turn the conference back over to Mr. Alejandro de la Fuente for additional closing or additional remarks.

Okay. Thank you again for joining us today. Please feel free to contact our investor relations department if you have any additional questions. We look forward to speaking with you again. Thanks very much.

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