LATAM Airlines Group SA (LTM) 2006 Q1 法說會逐字稿

Good day, everyone. Welcome to the LAN Airlines first quarter earnings release conference call. Just a reminder, this call is being recorded today. At this time, for opening remarks and introductions, I'd like to turn the call over to Pete Majeski with i-advize Corporate Communications. Mr. Majeski, please go ahead.

Good afternoon, everyone, and welcome to LAN Airlines' first quarter conference call. We thank you very much for joining us today. The LAN Airlines earnings release for the period was released yesterday. If you have not yet received a copy of the release, please contact us immediately at 212-406-3690.

At this time, I'd like to 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're subject to change.

At 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, Pete. I am Alejandro la Fuente, Chief Financial Officer, and with me are Jorge Vilchez (ph) from our international passenger (ph) division, Pedro la racia (ph) from our domestic passenger division, Tomar Silva (ph) from our Cargo Division; Alvel Pucon (ph) from our international Passenger Division and Andres Bianchi from our Investor Relations Department.

Today I will discuss our financial results for the quarter, review three key developments and comment on our expectations for the rest of 2006. Then we will be pleased to answer your questions.

The quarter, we are proud to report that LAN generated net income of $46 million, excluding extraordinary items for the first quarter of 2006, roughly (ph) in line with our performance in 2005. More importantly, our performance was driven by a 21% increase in operating income, thanks to 20% revenue growth and a slight expansion in margin.

The fact that we were able to match that year's net income through higher operating income, despite facing $37 million in additional costs due to higher fuel prices, as extremely significant, as it marks a turning point in our fuel protection strategy.

In the last six months, costs for fuels mechanism have replaced fuel hedging as our primary tool to mitigate high fuel prices. (inaudible) a much more effective long-term approach to address the current demand driven all price (ph) shock.

The Passenger business. Passenger revenue for the quarter grew 18% year over year. This is a 7% increase in capacity and a 10% improvement in (inaudible) revenues. Passenger demand remained strong for most key markets, thanks to a combination of the double-digit (ph) growth, improved customer confidence and a strong currency.

Meanwhile, competitive activity was relatively stable when compared to previous quarters, with the main exceptions being Airlines Cantina's (ph) decision to downsize its operation to Santiago, Lima and Chile. The combination of the strong demand and rational competition generated opportunities which we leverage by careful managing our capacity.

For instance, we transferred capacity from some routes to the United States and the Caribbean to routes to Europe and the South Pacific in order maximize profitability. We also added new frequencies from Lima to Quito (ph), Bogota and Caracas, in order to enhance our regional hop (ph).

Finally, by the end of the quarter, we launched a new Sao Paolo-Lima-Los Angeles service and expanded our operations from Lima to Buenos Aires. We also were actually improving revenue efficiency (ph), taking advantage of the current demand environment to optimize profitability.

Our efforts proved effective, as revenue for ASK grew 10% up to 1.5 point decline (ph). Load factor was offset by a 13% rise in yields, while lower load factors were basically explained by the Easter weekend falling in April and not in March. Yield grew due to improved segmentation to use a new cost (ph) Peru tools and higher premium traffic.

The Cargo business. Cargo revenue for the quarter grew 21%, due to a 11% expansion in capacity and a 9% rise in (inaudible). Cargo demand continues to be impacted by the imbalance between inflows and outflows to the region, while exports out of Latin America have declined, due to stronger local currencies, changes in product mixes and higher energy costs.

Imports have continued to boom, thanks to the appreciation of local currencies and weaker price elasticity. The imbalance poses the major challenge for our cargo operations, since the lack of northbound cargo limits the number of round trips we can perform to key markets such as Chile and Brazil.

The impact of this imbalance was visible in March when the big season for specific export products enabled us to significantly increase total capacity. However, this was a seasonal effect, therefore, we have modified our air confrontations (ph) in response to the current imbalance, using our South American export markets to fill up some of our northbound flights.

The need to fly to these points to pick up cargo negatively impacted our load factors and what the main cost to their (ph) on point to point reduction during the quarter (ph). Nevertheless, low load factors were offset by an 11% rise in yield. This improvement was driven mainly by growth on imports, which usually features much higher yields than exports, and expansion en route to Europe.

Operating costs. Operating costs for the quarter grew 20% as system capacity increased 8%. As a consequence, costs for ATK, which also include net financial expenses, increased 11% year over year. This increase in unit costs is explained almost entirely by three elements; higher fuel prices, higher unit revenues and a stronger Chilean peso.

Average fuel prices rose 26% year over year, leading to more than $7 million in additional costs. That accounted for nearly 60% of the increase in unit costs. In fact, its fuel unit cost rose 4% during the quarter (ph). Higher revenues were another source of higher unit cost, since they generated an increase in commissions for ATK, which in turn accounted for nearly 1.5% points of additional unit costs.

The 10% appreciation of the Chilean peso was another source of additional cost, as (ph) inflated several cost items such as personal expenses in U.S. dollar terms. Excluding these three items, unit costs rose marginally, as careful cost management enabled us to increase efficiency on operations, maintenance and commercial efforts.

Among the main sources (inaudible) we can mention, replacement of adding (ph) capacity for our own .37 freighter, reduction in average age of our fleet, due to the incorporation of newer aircraft, improved maintenance contracts, changes in service standards in the Chilean domestic market, lower sales related expenses from the passenger business, and implementation of a hiring freeze.

As a consequence, our cost structure has gradually become more competitive and we expect that new initiatives will enable us to expand this progress in the future.

Strategic development. I will now discuss three strategic developments. Aircraft orders. During the first quarter, we modified the three delivery plans for our Boeing 727 aircraft by purchasing new aircraft and rescheduling some delivery dates.

On the Boeing 727 67 side, in March we acquired three additional passenger aircraft for delivery in 2007 and 2008. Furthermore, we converted some of our freight orders into passenger versions and, as a consequence, we now plan to receive a total of 11 passenger Boeing 767s and one freighter after 2008.

The passenger planes will be delivered as follows: three during the remainder 2006, three in 2007 and five in 2008. Meanwhile, the remaining freighter is scheduled for delivery in 2006. In addition to our Boeing 727 deliveries, we plan to incorporate 32 Airbus A320 aircraft in 2008, with the first A320s scheduled for delivery on the third quarter of this year.

Exchange in maintenance accounting policies. In early March, we announced that following recommendations from the Company's management and its external auditors, the Board modified our maintenance accounting policies, moving from the provision method to the capitalize and amortize method.

The decision to change was based on the growth LAN has experienced in recent years, which has led to a dramatic increase in operations, as well as on the Company's flip side. From an accounting perspective, the change implied recognizing a one-time pre-tax non-operating gain of $40.3 million, due to the elimination of provisions, most of which exceeded the current value of this corresponding reverb (ph) due to a lower actual cost. The change is also expected to reduce projected maintenance expenses for 2006 by nearly $2 million.

Third, update for LAN Argentina. During the first quarter, LAN Argentina continued consolidating its forcision (ph) under a (inaudible) market, with an average market share of 14% and coordinates (ph) operating losses to $4.8 million.

Capacity expansion was limited even that the Company has decided to accelerate the phase-in of Airbus A320 aircraft. LAN Argentina now plans to move to an all A320 fleet by the end of the year, given its aircraft, strong customer appeal and attractive economics.

LAN Argentina is currently freezing certification process for the first A320, which is scheduled to begin operation during the second quarter, early in the second quarter. This change will continue gradually during the year, with 5 A320s replacing the current five Boeing 737s.

Given the fact that the A320 are larger and can achieve higher utilization rates, this change will enable LAN Argentina to double its domestic capacity with the same number of aircraft. The incremental capacity will be used to increase frequencies, current routes and to add two new domestic destinations by year end.

This plan, together with the start of international flights to Montenegro (ph) and Miami in the second half of '06, is expected to enable LAN Argentina to break even by the end of the year. (inaudible)

We also continue to have a strong liquiditable season (ph), with over $151 million in cash, cash equivalents and committed credit line. As of March 31, total pre-delivery payments amounted to more than $300 million and were near their projected peak (ph), given our aircraft delivery skill (ph).

Since we planned to turn the final (ph) 50% of our aircraft (ph) payment usually amount to 40-50% of the aircraft price, we will start receiving cash after each aircraft delivery before posting our after cash position. In regards to fuel hedging, we have hedged 40% for the second quarter at $1.38 per gallon and finally (ph) less than 15% for the second half at $1.65 per gallon.

Outlook. Based on our first quarter results and on current demand trends, we plan to continue advancing in our development plans owed (ph) on the passenger and cargo areas. Also, we are currently working on initiatives aimed at further improving efficiency by streamlining our operations and enhancing corporate performance.

On the passenger business, forward (ph) booking point to help profit growth and stable pricing. We expect the competitive landscape to change, moderating with overall activity increasing driving (ph). Among the most relevant changes, we can note Lufthansa's pullout from the Santiago-Sao Paolo (inaudible) market and its partial replacement by Swiss.

Meanwhile, Air France has returned to its one-stop flight from Paris in a move we believe is temporary. In the regional market, we expect Gol to start flights to Santiago in the near future, as they have recently received the necessary traffic rights.

In general terms, we believe we have a number of attractive opportunities to expand our operation. As a consequence, our firm plan is to grow total passenger capacity by between 8% and 10% in the second quarter as we add more aircraft to our fleet.

We plan to accelerate capacity growth through the rest of the year, as we plan to grow at an annual rate 12% and 15%. (inaudible) we expect pricing to remain stable, with yields staying at current levels.

Cargo side, we do not expect cargo flows to change dramatically over the course of the year, even that there are no indications of changes in fundamental. As a consequence, we plan to continue using our network to support growth on southbound routes, with return trips from multiple export markets and to leverage our Boeing 727 300 (ph) freighters for increased efficiency.

Cargo capacity is expected to grow between 7 and 9 percent in the second quarter and between 11 and 14% for the full year. In addition, total capacity expansion will compound, resulting revenue growth with initiatives to reduce costs and expand margins further. This initiative includes projects to reduce commercial expenses and has efficiency on (inaudible) operations, and the comprehensive revision of some of our processes.

While at LAN we pride ourselves on being a very good (inaudible) operator, we have already defined areas in which we can improve and that could lead to sizeable (inaudible). We also continue to monitor industry developments across the entire region, since we believe that LAN is well equipped to take advantage of the opportunities that are appearing.

In closing, we believe that our first quarter performance is a solid demonstration of how LAN is able to cope with different challenges and place us on an (inaudible) position for future growth and for continued value creation for shareholders. Now we will be pleased to answer your questions.

[OPERATOR INSTRUCTIONS]

We'll go to Ray Neidl with Calyon Securities first.

Yes. Your passenger growth in the second quarter, I did get ASM growth of 8-10%. I missed what it was for the year?

For the year, it's between 12 and 15%.

Okay, great. Getting to Argentina, very important part of your operations, it sounds like you're optimistic on the progress that you're making. Gol and TAM are benefiting quite a bit in Brazil, from what I understand, from the problems at VARIG, the flagship carrier.

Do you see any upside potential in Argentina as problems continue at the flagship carrier in that country?

Unidentified Company Representative Well, we're expecting-we're already seeing improvements in our revenue efficiency and in load factors between the market from Argentina to Chile and from Argentina to Peru. Basically, all major markets served by Airlineas and they are phasing out in some routes, we're taking advantage of it.

Great, and as far as your plans go for your operation there, no bugs have developed or no unforeseen problems have developed, things are going according to plan?

Unidentified Company Representative Yes, so far, our operations in Argentina continue as planned. There's always some adjustments to that dynamic process, but it's going according to what we had expected.

Okay, and finally, I know you've been able to put through fuel surcharges with the higher fuel prices. This little spike that we've had over the past month or so, how is that affecting you? Have you been able to put through the bulk of those fuel charges or are you absorbing some of those costs?

Unidentified Company Representative Well, we have a clear procedure for fuel surcharges and increases, and we're going to review it at the end of this month, and based on monthly average, we will decide next week if we continue further increasing the surcharge or if we keep the current levels. We'll know that next week.

Great. Thank you, gentlemen.

Moving next to Mike Linenberg with Merrill Lynch.

Mike Linenberg, Analyst, Merrill Lynch: Yes, hi. I know-I think that Ray had asked about some of the impact with Airlineas, which you are seeing on Argentinean traffic. With the problems that VARIG is experiencing, what are you seeing on some of your flows to and from Brazil and even some of the connecting markets, some of your third and fourth freedom markets, like the new route between Sao Paolo through Lima (inaudible)?

Unidentified Company Representative Well, we're taking advantage of it. Actually, our route to Brazil through Santiago and Sao Paolo and Rio, it has always had good load factors and now we're even capturing some of the traffic that VARIG used to have, even though they haven't really cancelled that route, but some people are transferring to us. And, with regards to the Sao Paolo-Lima-Los Angeles route, we're also-it's a little early to say what will happen, actually, because we introduced the route one month ago and we're building on it.

But speaking with the channel and the market in Brazil, there is concern about it and we expect that to grow (ph), so some of the traffic, especially the traffic between Asia and Sao Paolo and between Los Angeles and Sao Paolo.

On a separate question, and I don't know if this should be addressed to Alejandro or whoever, if Enrique's on. I mean, I did see that he-I believe he was quoted earlier, maybe today, saying that he wasn't interested in VARIG.

However, when you look at the foreign ownership restrictions in Brazil, I think it's limited to voting shares, 20% of the vote, but economic, my sense is that I don't think there is a limit. I think you can go quite high. You know, given what's going on at VARIG and the fact that Brazil has always been a market that I think LAN has looked at for many, many years, you know, could we now be closer to an opportunity where LAN could actually do something unique in the Brazilian market?

Unidentified Company Representative It might. We're following the situation in Brazil very closely and seeing maybe there is an opportunity, but there's no-nothing is planned yet. (inaudible) with people, the situation we are very close as (inaudible) but not (inaudible) up to now.

Okay. And then just, last, Alejandro, I think you provided what the quarterly loss was for Airlineas, I think $4.8 million for the quarter. Could you give us a sense of maybe what the revenue base was for the quarter?

Air Argentina had revenues of about $15-20 million on the quarter.

Okay, okay. And the $15-20 million, does that-I know that in the past you've indicated that, you know, that could get up to 3, maybe $400 million, you know, out a couple of years. That's still on plan?

Yes, we're still on plan.

Okay. All right, very good. Nice job.

Thank you, Mike.

From Citigroup, we have Steve Trent with the next question.

Steve Trent, Analyst, Citigroup: Good morning, gentlemen, or good afternoon, rather. Just one or two questions from me. First of all is on the fuel side, you made some comments that you'd be kind of shifting away from doing synthetic hedging and going more towards mitigating fuel expense through surcharges, yet you mentioned that you still have a 40-some-odd percent hedge locked in for 2Q and some hedging locked in synthetically for the second half of the year.

Is this basically the synthetic hedges you have in place sort of stuff that's left over from your prior strategy, before you started looking to do more aggressive fuel surcharges? And my second question is you made comments that you won't expect Air France to stay in your market long, that you expect Air France to kind of pull back from some of their current positions in Latin America, and I was just curious why. Thank you.

Well, in regards to the hedging question, Steve, we have some hedges locked in already for 2Q, 3Q, 4Q, and as you said, those positions were built awhile ago. We don't have-I mean, we don't plan to replace all of our previous hedging policy with the fuel surcharges. We will do some hedging when we see there's an opportunity from a price standpoint. But as you said, those fuel positions were built (ph) a while ago.

Now, going into the Air France question, I think-let me explain this a bit better. What we said on the call was Air France had started operating nonstop between Paris and Santiago on the high season (ph). They have switched back to a one-stop flight, but we don't believe that they are going to continue operating that one-stop flight, but they are going to return to flying some non-stops in the near future.

Super. Thanks.

This is a seasonal adjustment on their behalf, that's our sense, and we believe that back on the high season they're going to have the nonstops again.

Super, thanks, Andres, and just to be clear on the-not to beat a dead horse, but just to be clear on the hedging side, you'll mostly go toward-more towards a fuel-surcharge sort of strategy, but to the extent that the opportunity presents itself from the crude oil curve and back gradation (ph), there might still be some synthetic hedging going forward?

Yes.

Okay, great, and good job on the quarter.

Thank you.

We'll hear next from Rodrigo Martin with Santander Investment.

Rodrigo Martin, Analyst, Santander Investment: How are you doing? (ph) (Inaudible) operations for such a (inaudible) quarter. My question is mainly relating if you can comment on the potential scenario for lining (ph) the Peruvian market (inaudible)

Unidentified Company Representative We have a solid operation in Peru now, a very important domestic business, both to LAN and the country, and we don't envision any problems, neither in domestic nor in the international operation of LAN Peru going forward.

Right. Regarding the fuel hedge, could you remind me, please, what was the price for the (inaudible) for the second half this year?

Unidentified Company Representative The position for the second half of the year, it's $1.65 per gallon.

Great, and you have hedged 50% of the consumption?

Unidentified Company Representative Oh, one-five. Fifteen.

One-five? Okay, 15. Excellent, thank you very much.

You're welcome, Rodrigo.

Next is Ian Crook (ph) with Raymond James.

Ian Crook; Raymond James; Analyst: Hi, guys. Congratulations on your results. A couple of questions. They're kind of technical questions on your balance sheet and on your income statement.

I noticed you posted a few hedge loss for the quarter and that comes after a number of gains, and I'm just wondering if you could, well, explain that to me, whether-well, just explain or talk to me a bit about that loss, and also, I'm noticing that your accounts receivable have gone up somewhat and I'm wondering if there's anything, any change of policy there, or whether it's just explained by greater revenues. I notice that it has exceeded the increase in revenues by some margin, so if there's been any change there?

Unidentified Company Representative Okay. On the hedging side, the loss for the first quarter was explained basically by the differential between the current price and the hedge price. We had hedged ourselves at roughly-we said a point less than 1.9 dollars per gallon for the quarter. The actual price came in lower, at about $1.81, according to average. So that explains the gap, I mean, and that sort of is the driver behind the loss.

Now, all of our hedges right now, as prices have spiked, most of them are on the money. Now, on the balance sheet, (inaudible) basically because of business reasons. There's no change in any of our sort of fundamental going behind the rise in accounts receivable.

Okay.

Unidentified Company Representative The only thing that perhaps can-that sort of one explanation is that increase direct sales are (inaudible) of accounts receivable, but that's basically-

Increased direct sales meaning the wet (ph) sales?

Unidentified Company Representative Right, direct sales are booked at the counter sales (ph) while travel agent sales are paid much more frequently, so they don't get booked at the counter.

Okay. Okay, great. Thank you.

Moving on to Glen Engel with Goldman Sachs.

Glen Engel; Analyst; Goldman Sachs: Good afternoon. Can you go over the 737 200s, how many you plan to have at the end of this year and how many-and when they completely leave your entire fleet, or was that just LAN Argentina you were talking about?

Unidentified Company Representative No. The change on an all 320 fleet refers only to LAN Argentina. We plan to have both of the Peruvian and domestic upon Argentine operations operating a single fleet. The 737s are going to be devoted mainly to the Chilean market in the time being.

We have a dynamic phase-out plan. We're still working on the exact date in which those planes are going to be fully phased out, but it should be between 2008 and 2010.

So, can you give me a rough guess for the entire company how many 737 200s you'll have at the end of this year and the end of next?

Unidentified Company Representative Broadly, we should have near 20 by the end of this year and let's say about, sorry, 25 (inaudible), 23-25 (inaudible) by the end of 2006, 20 by 2007, and between 10 and 14 in 2008, and then they go down, as I said, we're still deciding the exact date in which they're going to be leaving the fleet.

Secondly, if I look at the yield up 13%, can you give me, of that increase, just roughly how much came from-on the passenger side, how much came from better business mix, how much came from fare hikes, how much you think roughly came from currency, just the various things that contributed to that big yield gain?

Unidentified Company Representative Well, the main impact is basically strong demand in most of our markets. We are seeing how that really is having a very good impact and that stronger demand has allowed us to increase yield very strongly in 15, 16%. Yield has really climbed, and also our premium traffic is also increasing much faster than our traffic in economy, and we add all those elements in increasing yield and revenue for ASK, basically.

And can I assume the-you know, on the cargo side, you mentioned by doing more stops that, like the first quarter, I should be seeing lower load factors but good yield gains as a result of that strategy?

Unidentified Company Representative Well, the fact that we need to fly more planes going back from the southern corner, stopping in other markets such as Peru or Uruguay (ph), (inaudible) we need to fly a bit more sort of ferry flights and relocation flights, so you should expect to see load factors coming down slightly and yields improving, given the current fare rate environment.

Now, that should tend to sort of converge to last year's, as this strategy started being implemented since late 2005.

Thank you very much.

Unidentified Company Representative You're welcome.

(Operator Instructions)

And we'll move next to Ben Laidler with Union Bank Switzerland.

Ben Laidler, Analyst, Union Bank Switzerland: Hi, good afternoon. Just two quick questions. Could you just put some numbers on the relative premium traffic rate versus tourism traffic rate, and secondly, what do you think the outlook is in Argentina that the government will allow an increase in prices for the increase in fuel prices?

Unidentified Company Representative Yes, in our passenger figures, premium traffic has grown almost 20%, considering the same quarter in the previous year, while our economy traffic has increased around 5-7% , and also, our net revenues have increased in a much larger number in premium, around 25%, if we consider the same period last year, while economy class has grown much less.

So premium is still growing very fast and we're seeing that some sell-ups also from the economy cabin to the premium cabins, and increasing also are our premium load factors.

Great, and on Argentina, do you think the government will at some point allow a rate (inaudible) because of the increased fuel prices?

Unidentified Company Representative Yes, we expect the government does that in the short term and we hope we will be able to stand up (ph) account for the increasing fuel prices due to that.

And any idea of sort of extending that rise?

Unidentified Company Representative We don't have that predicted.

Okay. Thanks.

Unidentified Company Representative You're welcome.

And we have no further questions. I'll turn the conference back to the speakers for any additional or closing remarks.

Unidentified Company Representative Okay. Thank you again for joining us today and feel free to contact our Investor Relations department if you have any additional questions. We look forward to speaking with you again. Thank you.