LATAM Airlines Group SA (LTM) 2006 Q3 法說會逐字稿

Good day everyone. Welcome to the LAN Airlines third quarter earnings conference call. As a reminder, today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the conference over to Miss. Melanie Carpenter. Please go ahead.

Thank you. Hello, everyone. Thank you very much for joining us today. The LAN Airlines third quarter earnings release was released yesterday. If you didn't receive a copy please contact us in New York at 212 406 3690.

I'd like to point out that certain statements regarding the company's business outlook and anticipated financial and operating results constitute forward-looking statements. These expectations are highly dependent on the economy, the airline industry, the international market and therefore they are subject to change.

At this time, it's my pleasure to turn the call over to Mr. Alejandro de la Fuente, Chief Financial Officer of LAN. So please go ahead, Mr. de la Fuente.

Thank you, Melanie. I am Alejandro de la Fuente, Chief Financial Officer of LAN. And with me are Ernesto Solis, from our International Passenger Division, [Alvaro Varela] from our Cargo division, [Jose Ortiz] from our Domestic Passenger operations, and [Gisela Escobar] our Head of Investor Relations.

Today I will discuss our financial results for the quarter, review three key developments, and comment on our expectation for the rest of 2006 and 2007. Then we will be pleased to answer your questions.

LAN earned $51m in net income for the third quarter, a significant improvement compared to 2005. Strong operating performance was the main driver this quarter. EBITDA reached $143m and EBITDA margins reached 18.8%, eight points above third quarter 2005.

Revenue growth exceeded capacity expansion, driven mainly by higher yields in both the Passenger and Cargo business. The strong financials results, obtained during this quarter, were in spite of higher fuel costs, $22m. This performance highlights the strength of LAN's network and the success we have had dealing with higher fuel prices, and with changing market conditions.

Furthermore, during the third quarter, we advanced in major initiatives aimed at improving LAN's competitive advantages into the future.

The Passenger business, passenger revenue grew 29% on a 12% capacity increase and a 15% improvement in unit revenues. Market conditions remained positive across the board, as demand keeps growing consistently, while competitive activity has increased moderately. In fact, the international market in Chile, Peru and Ecuador all grew at healthy rates year over year, while domestic market in Peru and Argentina expanded slightly.

The main change in our competitive environment this quarter was the start of Gold flight from Brazil to Santiago via Buenos Aires. In response to this, we have increased our flights from Santiago to Buenos Aires from eight to 11 daily frequencies. In addition, we were also prepared for this increased competition, since in July we had already increased our flights from Santiago to Sao Paulo, from two to four delay frequency.

The company permanently managed itineraries in response to dynamic market conditions. As a consequence, this quarter, we transferred capacity from routes to the [Bolivian] and United States to routes to Europe and the South Pacific, as well as for regional routes.

We also worked to maximize revenue efficiency, traded lower load factors for higher yields. This process resulted in a 17% rise in yield due to the combination of higher fares, fuel surcharges and active revenue management. We estimate that, on international routes, the fuel surcharges accounted for 35% of the increase yields. And allow us to recover approximately 70% of higher fuel costs. This fully offsets the 1.1 point reduction in load factors, and led to a 15% increase to unit revenue.

The Cargo business, cargo revenues for the quarter grew 15% into a 3% expansion capacity and an 11% rise in unit revenues. The latter resulted from 6% increase in yields and a 2.9 point rise in load factors. Growth in cargo revenues remained primarily dependent on pricing as the imbalance generated by strong input and weak export continues to restrict our ability to add capacity. While, exports out of Latin America have declined due to strong local currencies, changes in product mixes and higher energy costs. Import has continued to boom thanks to the application of local currencies and weaker price elasticity.

Considering this scenario, we have redesigned our air transportations in order to increase northbound growth. This process has included, adding to [inaudible] to some non stop return trips, for faring airport from airport import destinations to different export markets. We have offset these through improved unit revenues, which have resulted from higher fares on southbound routes, asset growth management and fuel cost pass through mechanism.

Operating costs, although fuel prices have down -- sorry, have shown a downward trend through this month, total cost per ATK were impacted by a 12% increase in average to prices, as compared to the third quarter 2005. This led to $22m in additional expense.

Excluding this affect, unit costs rose 3% during the quarter, mainly because of two main factors. First, higher personnel costs per ATK, per unit personnel expenses grew 4% year-over-year. This was partly driven by increased headcount as a result of growing operations in Argentina, as well as to a slight appreciation of currency in our home markets versus the U.S. dollar.

Second, for rental and landing fees per ATK, which increased 5.5% this was mainly driven by higher airport fees, especially in the United States, Brazil and [abroad]. Finally, the company also saw increased fleet related expenses per ATK of 1.2%. This includes aircraft rentals, [wet] leases and depreciation. The increase is a result of a larger fleet considering both owned and leased aircraft, partly offset by reduced wet leases in the Cargo business.

Overall, elements accounted for the majority of the rise [in excluding] costs. They were partially mitigated by lower commissions to agents and lower passenger service costs.

So key developments, I will now discuss three key developments. First, fleet expansion, as you know LAN is embarking in the most significant fleet expansion program in its history. During the third quarter we received eight new Airbus 319's mostly designated for the domestic operation of LAN Peru.

We also received the third of four new Boeing 737 passenger aircraft, scheduled for delivery this year. Two more aircraft will arrive in the fourth quarter this year. A new Boeing 737 freighter was delivered yesterday, to be followed by one new Boeing 737 passenger aircraft in November.

For 2007 we expect delivery of 16 additional aircraft, more than one aircraft per month. We will receive ten airbuses 318, two Airbus 320, three Boeing 767-200 and one Airbus 340-300.

Update on LAN Argentina. This quarter had various positive developments for the operations of LAN Argentina. On the regulatory front, in August the Argentine Government approved a decrease allowing for the 20% increase in domestic fares for all operators in the market. This decrease also eliminated restrictions in foreign ownership of domestic airlines.

LAN Argentina also advanced in its program to improve its product, continuing to replace its domestic bids of Boeing 737-200 further by a newer Airbus A320. This replacement will allow LAN Argentina to expand its operations, enhance service and reliability standards, and substantially reduce its unit costs. Currently, LAN Argentina operates only one Boeing 737-200 and three Airbus 320 for its domestic operations. The four Airbus 320 will be incorporated into the fleet in November.

This quarter also marked the beginning of LAN Argentina's international operation. On August 15, LAN Argentina began flying weekly frequencies from Buenos Aires to Miami. This flight was increased to a daily flight as of October 10. LAN Argentina's next international route is Buenos Aires to Sao Paulo, which is expected to begin by year-end 2006, with 13 weekly frequencies.

Further steps in the consolidation of LAN Argentina, during the quarter the company completed level negotiations and signed new agreements with its flight attendants, mechanic and pilot unions, which are expected to strengthen the airline's future performance.

Despite the positive outlook of LAN Argentina, operating losses amounted to $9m in the third quarter. This is mainly due to the positive impact of new international operations and higher fares in the domestic markets will only be reflected in future periods. Nevertheless we remain pretty positive and committed to the growth and development of LAN Argentina. And continue to expect this operation to break even by year-end 2007.

Changes in short haul operations. As you know, LAN has been working on a new business model for its short haul operations. The objective of this model is to increase efficiency and improve margins in domestic and regional operations.

One of the main objectives is planned to increase narrow body aircraft utilization to close to 12 hours. This will contribute close to 8% to ASK brought in 2007. The key in achieving this target is the taking out of the existing fleet of Boeing 737-200, in favor of the new Airbus 320 family aircraft. LAN expects to complete this process during 2007. In addition, increased utilization will come from a change in areas, to include more point-to-point and overnight flights.

Another key element is reduction in sales and distribution costs, which will be achieved through higher Internet penetration and lower commissions. We are targeting Internet sales to reach 60% of total sales in domestic flight over the next two years. Overall, this new model is expected to result in a 30% increase in costs per ASK of the domestic operations, reaching levels below $0.4 per ASK ex-fuel.

Together with efficiency gains, LAN expects to reduce average fares on domestic and regional routes. This is expected to result in significant demand stimulation of approximately 40% in two years.

LAN have already launched a pilot program for its new business model, offering nightly flights to two major cities to the South of Chile. These are priced at approximately half the prevailing fare for those routes. This pilot project has shown positive results, with high load factors coming from new demand stimulation. And with no dilution from the regular flights, which have also been positively impacted with new demand. LAN's new business model will be implemented readily throughout the country, and is expected to be fully implemented by year's end 2007.

Oneworld, we would also like to share with you an important event for LAN Ecuador and LAN Argentina. Discussions are very advanced with the members of Oneworld, in order to approve the entry of these two airlines into the alliance. This is an important event for these companies, as they will be able to enhance their offering to customers and benefit from increased con activity worldwide.

Outlook, we had a solid operating performance during the third quarter. And these, together with the attractive conditions, provide an encouraging starting point for the expansions we have planned for the rest of the year. For the Passenger business, we expect the competitive landscape to change moderately with overall activity increasing slightly. In this regard, we expect conditions on the Chile Brazil market to remain volatile, given [uncertainty] about five future plans, and the start of Gold flight from Brazil to Santiago via Buenos Aires.

In general terms, we believe that there a number of attractive opportunities to expand our operations [inaudible]. And, as a consequence, our current plan is to grow total passenger capacity by between 10 and 12% for the full year 2006, with growth accelerating in the fourth quarter.

2007 will be a unique year in term of capacity expansion in the Passenger business. With expected ASK growth between 23 and 25%. Only half of this figure is due to new aircraft being incorporated into the fleet. Approximately 8% capacity growth will be achieved due to higher utilization of the fleet, mainly in short haul operations.

In addition, another 3% will result from increased densification of the fleet, increasing the number of seats per aircraft. The national traffic growth will come, for the most part, from growth in Argentina's international operations, and strengthening the Lima hub with certain additional frequencies.

On the Cargo side, we expect the shifting imbalance of traffic to be somewhat corrected during the fourth quarter, as a result of high season for fruit exports in Chile. For the full year 2006 Cargo capacity is expected to grow between 6 and 8%. And for 2007 we expect growth of between 3 and 5% in 2007.

In addition to capacity growth on the Passenger and Cargo business, we plan to expand margins through cost reduction initiatives. These initiatives will include projects to enhance efficiency on short haul operations, and to reduce commercial expenses.

Although fuel prices haven't been -- have been on a downward trend in current months, they continue to impact LAN's performance. Our strategy regarding fuel will continue to be passed on higher fuel prices to consumer through fuel surcharges mechanisms, in both Cargo and Passenger business.

We'll also continue to use financial hedging as a tool to mitigate the impact of higher fuel prices. We have currently hedged 37% of our exposure for the fourth quarter 2006, at current price levels. We have also hedged 25% for the first quarter 2007, 8% for the second quarter 2007, and 2% for the third quarter 2007. All of our 2007 positions are prices around $1.9 per gallon.

In summary, we believe that our performance, during the third quarter, was positive. And we successfully deal with higher fuel prices and prepared the ground for major improvements in the future. As a consequence, we believe we are in a good position to continue growing revenues, expanding margins and creating value for shareholders.

Now we will be pleased to answer your questions.

Thank you. The question and answer session will be conducted electronically. [OPERATOR INSTRUCTIONS]. And we'll take our first question from [Luis Kemple] with Credit Suisse.

Good morning everyone. My first question is on [UTS]. I just wanted to understand how you see [UTS] for next year, given your strategy of maybe passing through to the consumer's, part of the benefits from the lower commissions that you're paid?

I also wanted to understand better what's happening in the Chilean domestic market, if the low growth there, it's really the market that is not growing, or if it's a result of hard competition?

And just a third point, if you could just give again the impacts you expect on [CASK] from both the high utilization and headcount expenses cut, because I didn't understand well. Thank you.

Yes. This is Jose Ortiz. Actually, in with regards to our domestic operation, the low growth that we've been seeing is going to be compensated with an important growth in demand stimulation that we expect for the next period, more than 40%. And actually, what we've seen so far, it's because the market has been constrained. It hasn't been really because of important competitor movements, because competition hasn't really changed in what we've experienced in our market. So it's been more market driven basically.

And on the CASK side, we expect to have a significant reduction in our cost. We expect something around 30% reduction, and amounting less than $0.4 per ASK once we have the full model implemented.

Regarding your first question about the increase in yield for 2007, for the international operation, we don't see that we have a lot of room in order to increase a lot. Being this year we apply a very aggressive policy in order to pass through the Q, increase in fuel. So we think probably the next year, we are going to maintain the same level that we have in 2006 as [means] increasing 2, 3% yield in international division.

Regarding your question on cost per ASK, what -- the analysis that we did was just dividing plus looking at personnel costs per ATK, and that gives us an increase of 4% third quarter '06 over third quarter '05. And that increase is basically explained by, as Alejandro was saying, increased headcount mainly in our regional operations.

Okay, thank you.

You're welcome.

Our next question comes from Ray Neidl with Calyon Securities.

Hello this is Christine Min standing in for Ray. You've made significant improvement on the cost side this quarter, particularly with reducing the distribution costs. And I understand your new commission structure will be affective in January, but we saw major improvement this quarter. And I was wondering what contributed to that, and how much lower should we expect it go starting in Q1 of '07?

Well, it's true that we are in the process in order to reduce our commissions from -- starting in January 2007. It has been very clear what is going to be the moving. We basically were moved from 6% to 1% in the economy carrying and maintain 6% in the premium business.

Basically, we think these are worldwide trends allowing to pass through these kinds of costs to the final customer. And we think this is an important movement in order to reduce our costs, especially since we will be able to use close to 75% for GSA here in Chile. So we think that should be -- have a huge impact in our numbers for next year.

Okay, so currently it's 75% comes from the agencies?

Yes, it has been.

Okay. Great, thank you.

Our next question comes from Michael Linenberg with Merrill Lynch.

Yes, good morning everyone. A couple of questions. Alejandro, when you were going through the hedging I did not get the fourth quarter hedge percentage. I heard the seven and I wasn't sure if it was 37%. Is that what it is? It's 37%.

Yes. It's 37% for the fourth quarter.

Okay. And then just another nit question here, when I look at their operation you -- I think in your press release you state that 11% or 89% of your traffic is international, 11% is domestic. Is that 11% domestic is that purely Chile, or are you also including the domestic operations within Argentina and Peru etc.?

It's only Chile. We include the domestic operations of Argentina and Peru in the international numbers.

Okay, okay, very good. And then, if I could just jump back to, I think, a point that earlier about the potential demand stimulation, which I heard it was 40% on the traffic side. But I did not hear what the -- maybe what the offset would be on the fare side. Maybe it was 30%, so net-net you're looking at something that's unit revenue positive? I just want to reconfirm that.

Yes, first, let me reinforce, we expect this 40% over a two year period. And that should add from natural growth that we expect was below our tariffs, and also due to the specific measures that we're taking on traffic stimulation. And we don't expect our yields to decrease more than 15 or 16%, so this will have a very positive impact in revenue terms.

Yes, yes, indeed. My last question and this is where this new initiative, from a strategic basis, looks very powerful. Do you have any sense on your cost advantage today vis a vis your other competitors?

And when I say your other competitors I don't want at this point look at a goal, but maybe Sky in Chile or some other carriers up in Peru like TACA Peru. What sort of cost advantage maybe due you have today, if at all although I do think you have a cost advantage?

And with this new operation how much does that gap widen? How much greater is your cost advantage, once you start putting in the larger A320s and the larger A319s and -- in this new, sort of, call it a low cost carrier type operation?

Well, I cannot give you an exact number of our current cost advantage. You would need to look at their numbers, but since these carriers are operating with a very similar fleet than the one that we're using today in Chile. Based on Boeing 737-200, we are pretty confident that we will get, not only from -- we will get a bigger advantage, not only from the change in the fleet. But also from all the process redesign and the itinerary changes, giving a higher utilization of these airports, will give us around a 35% or 40% cost advantage, once we have the full model implemented.

And it's 30 to 40% you said?

That's right.

Okay. Great. Well, thank you and great, great quarter.

Thank you, Mike.

Our next question comes from [Alex Green] with Citigroup.

Hi. Good morning. How are you?

Good morning. Hi.

Hi. I have just three quick questions here. The first one is how should we look at a normalized tax rate for the company going forward?

Today it's 17%.

Okay and that's -- we should just hold that going forward here? Okay.

Second question on the Airbus deliveries, do you have any concerns on the Airbus side, in terms of receiving planes in a timely manner?

No. Everything is expected as per our plan.

Okay. And I also joined the call a little bit late, so I don't know if you already went over the Peruvian operations. If not, could you give me a quick update here on Peru, on any kind of reaction to your moves in that market? And, any sense on one or more of the airlines in that market growing their fleet?

Well, considering we are increasing from this 24% increase in ASK is basically to make stronger the hold we have on Lima. We are increasing, for example, Buenos Aires Lima, to up the daily frequency in December. We are increasing Lima Los Angeles to up the daily also in December.

Probably, yes. It's -- we can expect some kind of movement especially from TACA, because they have their half of Lima. So far nothing in pricing, so probably in the next couple of months we will have some kind of movement from the President.

And also on the domestic market in Peru, we are feeling very strong demand there. And we are also having some pilots for this new operation with night flights, which have given us very positive results, and very strong demand, new demand stimulation.

Okay. Very good. Thank you very much.

You're welcome.

[OPERATOR INSTRUCTIONS]. We will now go to Felipe Mercado with Santander Investments.

Yes, good afternoon. I will quickly say, do you think that the fuel surcharge policy could be somehow not aligned with the new low cost model, especially if oil prices increase unexpectedly? In this sense, are you leveraging the new short model operations on the long haul operations, which you have previously mentioned, but you are already very efficient? Thanks.

Yes, the first part of your question, we don't see a conflict with our fuel surcharge policy, and the new decreasing in fare strategy coming from this low for new model. Actually we portend to keep it. And, on the second part.

Yes, regarding to your second question, we are leveraged this low cost margin to long hauls. International operation, basically, you have the regional factor with basically from South America where we have basically a narrow body fleet.

So, we at this moment are in the process in order to share best practice with what we are doing here in Chile. We are going to have, I would say, a better understanding probably in the short term. In the next six months we are going to do something in the regional [inaudible] zone in order to improve our efficiency. But, in the long haul, flights from six/seven hour only this is not in the short term easy for us to look for some delivery on low cost carrier.

Thank you.

Our next question comes from Rodrigo Goes with UBS.

Well, hi guys, congrats on the great quarter. Just a few questions here, the first one, just with regards to hedges. Sorry to go back to this issue, but the fourth quarter exposure you said was 37% covered, at what price approximately?

It's at current level prices. It's around $1.8 per gallon.

Okay. Great. And the $0.4 CASK decline that you are assuming, that's ex-fuel right?

Yes. Ex-fuel.

Excuse me?

Yes.

Okay. And finally, just with regards to the breakdown of what you're currently doing, can you provide us with an estimate as to what is short haul and what's long haul?

Sorry, in channels of revenues?

I can.

As a percentage of ASKs.

I can carry over, of our total ASKs, about 75% is international. And --.

Yes, but that includes regional flights within South America, no?

Yes.

Done with price -- I would imagine you do Buenos Aires, Santiago with a 320, no?

Our narrow body operation, if that's what you are asking, which includes the domestic and the regional, that's around 25% of our ASKs.

Okay. Perfect. Thanks a lot guys.

You're welcome.

[OPERATOR INSTRUCTIONS]. And there are no further questions. I would like to turn the conference back over to Mr. de la Fuente to close the conference.

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 soon. Thank you very much. Goodbye.

This concludes today's presentation. Thank you for your participation and have a wonderful day.