LATAM Airlines Group SA ADR LFL
Q4 2012 Earnings Call Transcript
Transcript Call Date 03/20/2013

Operator: Good day, ladies and gentlemen and welcome to the Fourth Quarter 2012 LATAM Airlines Group's Earnings Conference Call. My name is Shaquana and I will be coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference.

I would now like to turn the presentation over to your host for today's call Mr. Alejandro de la Fuente. Please proceed, sir.

Alejandro de la Fuente Goic - CFO: Thank you very much for joining us today. This is Alejandro de la Fuente and with me on the call are, Claudia Sender from our Domestic Brazil Operations; (indiscernible) from our International Passenger Division; (Alvaro Carril) from our Cargo business; Andres del Valle from our Corporate Finance Department; and Gisela Escobar, our Investor Relations Officer.

We hope that you have all received the press release and have been able to access the webcast presentation on our website for the better understanding of our consolidated results at LATAM Airline Group during the fourth quarter 2012.

Please turn to Slide 3, as you can see total revenues in the fourth quarter 2012 reached $3.5 billion, passenger revenues decreased 0.7% and cargo revenues decreased 3.1% as compared to pro forma 2011 revenues.

Operating revenues this quarter are impacted by the negative effect of the 14% depreciation on the Brazilian reais on passenger and cargo revenues denominated in real. The challenging operating environment in international passenger businesses continued weak market demand in the cargo business and the change in land reservation and inventory systems to a anew system provided by Saber which took place in September 2012 although it is difficult to measure the exact impact. We estimate decreased revenue of approximately $25 million to $40 million during the quarter.

Net income reached $8.5 million in fourth quarter 2012 excluding special items. Special items include, a $21.9 million of merger cost and a one-time charge of $52.7 million related to the sale of LAN A318 and the redelivery cost of LAN Colombia-8. Excluding these items, operating income reached $119 million in fourth quarter 2012, the 61% decrease compared to pro forma operating income of $307 million in the fourth quarter 2011. This resulted in 3.4% operating margin compared to an 8.8$ pro forma margin in the fourth quarter 2011.

Turning to Slide 4 you can see more details the evaluation in our operating margins for the fourth quarter 2012. The main impact during this quarter was a decline in passenger and cargo yields. This impact excludes the negative effect of the depreciation of the Brazilian reais. The yield decline was partially offset by an increase in passenger load factors especially from the domestic passenger operations in Brazil.

Fuel costs increased 8.7% compared to fourth quarter 2011. This increase was in line with a 3.3% increase in consumption and with the 4.8% in the average fuel prices per gallon, excluding fuel and specialized in unit costs per ASK declined 4.1% as compared to fourth quarter 2011.

Taking a closer look at passenger operations on Slide 5, you can see detailed evolution of the business during the quarter. Total passenger traffic from LATAM Airline Group grew 10.7% while capacity increased 6.7%. Subsequently load factors reached 72.3% an increase of almost 3 points. Passenger yields declined 10.3% and as a result revenues per ASK declined 7%, as sequentially the base.

We see different dynamics in different parts of our passenger network. On Slide 6, you can see the detail of our capacity expansion by markets. Passenger capacity expansion this quarter was mainly focused on domestic routes in LAN's Spanish speaking countries as well as all international routes. During the fourth quarter of 2012 we faced challenging environment in our international passenger operation. We have seen significant pressure from international competitors adding capacity to South America. This has led to downward pressure on fare as well as aggressive commercial conditions offered through distribution channels.

As a result the market in general has suffered from lower yields and load factors. Within this context and considering our recent merger both LAN and TAM have also made significant increases in capacity, with total international capacity for the group increasing by 13.2% in the quarter. This increase has come from increased routes from LAN's (indiscernible) as well as strong increases on routes between Brazil and the U.S. The new capacity is on routes that are strategic and profitable for the longer term. However and especially considering the current market environment, competitive pressure resulted in a two-point decline in load factors as well as lower yields in this business unit.

Considering the current situation we have decreased our capacity growth estimate for international operations for 2013 and are evaluating alternatives to rationalize our fleet plan. We have already seen certain improvements and expect a solid recovery over the coming quarters, especially after the low season in the second quarter of this year. As you know, the International Passenger business unit was also one of the main areas of synergy generation for LATAM post-merger. Overall, we'll remain confident that these identified synergy opportunities exist.

In certain cases, the process of achieving these synergies has been delayed as a result of certain regulatory and government approvals that are required. For example, in order to obtain the necessary slots to better connect our network and enhance our itineraries. Also the implementation of the announced co-chair agreement between TAM and American Airlines has been delayed as a result of the additional regulatory approvals required in Brazil from carry for example in Brazil.

On Slide 7, we're going to take a closer look at the Brazilian Domestic Passenger Operations. We have made significant progress in the turnaround of this business unit. We continued to focus on capacity discipline with a 4.2% reduction in the ASK during the fourth quarter 2012 as compared to the fourth quarter 2011. We are also focused on improving market segmentation and revenue management in order to offer the right conditions to each type of passenger and stimulate demand with the more price sensitive clients.

As a result we are happy to see solid load factors that are consistently at least 10 points higher than last year. Also, we have seen double-digit improvements in revenue per ASK as measured in the reais. Results in U.S. dollars were impacted during the fourth quarter by 14% depreciation of the Brazilian currency.

We remain convinced that capacity discipline and adequate segmentation of the market will provide basis for continued healthy load factors as significant improvement in operating results in 2013. We have also announced the capacity reduction of between 5% and 7% in ASKs for the domestic Brazil operations during full year 2013.

Please turn to Slide 8 for an overview of LATAM's cargo operations. The cargo business continues to face the challenging environment reflecting a slowdown in global trade momentum which is reflected in the 1.5% decline in cargo world traffic during 2012 and 1.2% decline in Latin America cargo traffic as a whole during last year.

The decline in cargo traffic for LATAM Airline Group was driven mainly by weaker imports into Latin America especially Brazil. This was partially offset by strong demand for commodities from South America including fresh salmon, asparagus and berries. At the same time both regional and international competitors continue to be active in the region.

LATAM cargo traffic decreased 1.5% during the fourth quarter. Although we saw a decline in international cargo traffic, the Company was able to adjust capacity in its freighter fleet in line with lower demand. The capacity increase from the new Boeing 777 freighter during the quarter was offset by capacity adjustment in the freighter fleet and the reduction of ACMI leases.

Total capacity increased 3% mainly due to additional billing capacity in long-haul passenger operations. The yield decline of 1.6% -- the yield decline of 1.6% was mainly the result of the deprecation of the Brazilian reais on the domestic Brazil cargo revenue. During the fourth quarter LATAM obtained the second (mail) route in Brazil. With this we already have two Boeing 767 freighters operating mail routes within Brazil.

Please turn to Slide 9 for an update on the expected synergies from the merge. We remain confident in our synergy target of between 600 million and 700 million to be fully achieved by the full year after the merger June 2016. During the second half of 2012 LATAM recognized an estimated 72 million in merger synergies. We expect an additional $250 million to $300 million to be achieved during 2015. These figures are before merger related expenses which we expect to continue to incur as the result of the integration process over the coming quarters.

LATAM Airline Group estimates one-time cost associated with the merger and realization of synergies of between $150 million and $200 million most of which are expected to be incurred in the first 12 months after the completion of the merger. For 2012, the total amount of the merger cost reached $41.4 million. These costs are mainly related to consultant and legal fees as well as the implementation cost. In addition to this direct cost, we expect to incur indirect costs related to operational challenges in the implementation of the integration process. These costs are much more difficult to quantify and predict. Finally, we also expect additional investments required to achieve certain merger synergies.

On Slide 10 we can take a closer look to the initiatives we have generated and that will continue to generate our estimated synergies. Regarding the international passenger operations, the Company has already established (fare compatibility) cross-selling and code shares on all of its domestic routes, and in almost all of its international routes such as Santiago-Orlando, Santiago-Madrid, and Santiago-London. Both TAM and LAN have aligned the fare strategy implementing new fare classes as well as sharing revenue management best practices. In addition LAN and TAM have published new operations on regional routes as well as new agreements with international carriers.

December TAM signed a new agreement with American Airlines, which enabled the Company to have higher availability in American Airlines. Flights this agreement will be enhanced once the Brazilian authorities approve the culture between the two carriers. Another important milestone in our integration process was achieved during March with the announcement of the election of One World as the global alliance for LATAM Airlines Group. In the Second quarter of 2014, TAM will join One World, the leading alliance for flights within Latin America and from the region to both the United States and Europe.

In July 2012, the Cargo division of LAN and TAM were integrated taking advantage of the highly complementary nature of the operations. As of today, international cargo operations have completed their integration, incorporating TAM's extensive passenger network with coverage in over 40 destinations, the LAN Cargo operations. All domestic and international cargo operations in Brazil, including belly capacity on freighter aircraft are being commercialized under the TAM Cargo brand, which is well-positioned in the Brazilian market.

During this period, in which cargo traffic has been impacted by macroeconomic conditions, the implementation of connections in the (indiscernible) Guayaquil airports has been key to consolidate cargo traffic from the region to the U.S. and Europe. Strong exports mainly of perishable goods in the northern routes have been able to mitigate the impact of the weakness in southern routes. The ability to consolidate cargo at these airports and better fill TAM's belly capacity to the U.S. and Europe is an opportunity that we did not have prior to the integration of the Cargo business.

Please turn to Slide 11. We're also on track to achieve the cost synergies projected for the Group. LATAM has successfully completed fuel negotiations in all regional airports, as well as achieving efficiencies in terms of engine inventory and insurance negotiations among other initiatives. Continued sharing of best practices has allowed us to streamline operational processes in airports maintenance and on-board procedures, which have led to the achievement of considerable efficiency.

In terms of fuel, we have also achieved important fuel savings with the implementation of the lean fuel program in TAM. This program resulted in more than 1 million gallon of saves as of December 2012 and we target that in 2013 the savings will reach to approximately 6 million gallons.

Please turn to Slide 12 to see our estimates, ASK and ATK growth for 2013. Regarding passenger operations, we expect capacity growth of between 2% and 4% for the group. The change in our passenger capacity estimate is mainly driven by a change in our strategy in the long haul business. For 2013, we expect to see the relatively moderate increase in this business in order to adjust capacity to market conditions.

In terms of domestic passenger, ASK in the Brazilian market are expected to decrease between 5% and 7% during the year in line with the company's strategy to adjust capacity in this market. We will continue to see strong growth in our domestic operations outside Brazil.

Regarding cargo operations, LATAM expects cargo ATK growth between 2% and 4%. The reduction in our estimated capacity expansion for cargo is in line with the adjustment made in the long haul passenger business for 2013.

On Slide 13, you can see our fleet plan for the coming years. We ended 2012 with the fleet of 227 aircrafts the largest in Latin America. LATAM is in the process of adjusting its fleet plan in order to match its capacity expansion plans to the expected competitive and macroeconomic environment on international and domestic Brazil passenger market.

LATAM's current fleet plan shows a decrease of $1.2 billion in the expected capital expenditure for 2013 to 2015. We continue to allow its alternatives to rationalize fleet orders. During the fourth quarter 2012 LATAM successfully issued Ex-Im Bank guaranteed bonds for an amount of $640 million partially replaced existing Ex-Im Bank guarantee debt and to pre-fund certain fourth quarter 2012 aircraft deliveries.

The rate of these issuances was fixed at 156% in U.S. dollars. These financings were for the companies 2012 aircraft deliveries which in full a total amount of approximately $2.7 billion for a total of 40 aircraft. Additionally 2012 November LATAM issued an Ex-Im Bank guaranteed bonds for an amount of $212 million to refinance three Boeing aircrafts which were delivered in the second half of 2011. This bond was issued with the floating rate. The spread was set at 33 basis points over LIBOR three months. With this, the weighted average cost of debt as of December is around 4%.

On Slide 14 you can see our consolidated fuel hedge position for the upcoming quarters. Our financial hedging strategy in addition to our fuel surcharge policy applies in most passenger and cargo operations, which allow us to recover a significant percentage of higher fuel costs. In the closing of the transaction, the hedging function is centralized for both LAN and TAM. As you see on the slide we have hedged 56% of the estimated fuel consumption for the first quarters of '15 and 11% of the estimated fuel consumption for the next three quarters of 2013.

In closing I can say that the past quarters have been challenging as we work through the integration between LAN and TAM in a difficult competitive environment where we are dealing with a variety of external pressures in our different markets. Nevertheless we have made significant progress in terms of harmonizing internal processes, integrating the business units, and defining the long-term strategy for the Group. More importantly we remain absolutely convinced that the strategic rationale behind the merger of these two important airlines and of the value of creating a Latin American leader we are confident that we will see the results of this strategy over the coming quarters.

Now we will be pleased to answer your questions.

Transcript Call Date 03/20/2013

Operator: Jim Parker, Raymond James.

James Parker - Raymond James: I have a couple questions. Your synergies, merger synergies you say are $72 million in 2012. Is that an annual run rate or the actual amount in the calendar year 2012?

Gisela Escobar - Director, IR: That's the actual amount. It's not the run rate. The $250 million to $300 million estimate for 2013 is also the actual amount.

James Parker - Raymond James: My second question has to do with LAN Colombia. What was the loss in the fourth quarter, and in which quarter do you think you're going to get into the black with this operation this year?

Alejandro de la Fuente Goic - CFO: LAN Colombia in the fourth quarter was breakeven and we expect it to be profitable year for 2013. We're not providing any more details on Colombia. It's a part of the network plan, but the operation is in a well condition and improving every month.

Operator: Ricardo Alves, Morgan Stanley.

Ricardo Alves - Morgan Stanley: I have one question regarding the declining yields we saw, you mentioned that one of the reasons was softer international operations. Could you give us more color on which international operation is struggling more here. I guess I think that international out of Brazil would be healthier, but wanting to your hear your thoughts on this maybe main routes that are been affected by this increasing competition you mentioned. And then my second question quick one – I apologize if you mentioned this in the presentation, but we saw this $22 million merger related cost this quarter. Could you just give us a sense or maybe remind us what do you expect for this transaction related cost for this year if you do have an estimate on that? That’s it. Thank you.

Unidentified Company Speaker: This is (indiscernible) from the International Business Unit. Regarding your first question on declining yields, yes we saw mainly this downward trend in yields focused mainly on TAM operation, because of excess capacity that was put in the market from LATAM and also by our competitors if as I'm sure you follow American and United added together 6 weekly frequencies to Brazil and we added 20% in additional capacities. So, this forced all the carriers to be aggressive also in the commercial conditions to the channels and lowering fares and that's why all the industry suffered this declining yields. What we are very confident is that all our additional capacity was focused on build routes that we know in the future are going to be fairly profitable which are Sao Paulo Miami and Sao Paulo New York. We'll focus our interest on those routes and we're confident that from the third quarter on we're going to see a good result in this additional capacity.

Ricardo Alves - Morgan Stanley: Thanks for that, it was very clear. If you have any color on the second.

Alejandro de la Fuente Goic - CFO: In the third quarter we had a $20 million (course) on the second quarter $22 million that's totalized $42 million and we expect in total around $150 million.

Operator: Stephen Trent, Citi.

Stephen Trent - Citi: Just one or two questions for me. I wanted to get your thinking as to what are your thoughts on your let's say medium to long-term goals of obtaining the investment grade credit rating that have been enjoyed by your predecessor carrier?

Alejandro de la Fuente Goic - CFO: As you know we're convinced with what we have in investment grade and that a solid balance sheet is important competitive landscape in this industry. We're adopting the best way to improve our balance sheet indicators, clearly (we have already) improving cash flow generation of the Company and improving margins. There is no decision right now regarding the capital increase, but we are also reevaluating our fleet plan and CapEx required for the coming year. That's what we can say at the moment.

Stephen Trent - Citi: And just one other question and I'll let someone else to ask. When I think about the domestic Brazil market, you're not cutting capacity as aggressively as your main rival. And at the same time maybe the domestic unit revenue movement hasn't yielded the same result. I'm wondering how you guys are also thinking about domestic passenger flow and how you're balancing people purchasing tickets directly versus people purchasing tickets via Multiplus points and what kind of impact that could have on your yield?

Claudia Sender - VP Domestic Brazil Passenger Operations: This is Claudia Sender from the Domestic Brazil business unit. I apologize we dropped the line and I don’t think I heard your full question. If you don’t mind repeating it, so I could answer it correctly.

Stephen Trent - Citi: I was just curious in the domestic Brazil market, I was curious as to how you're thinking about your unit revenue strategy as you're not cutting capacity quite as aggressively as your main domestic competitor? And along those lines, how is the Company thinking about balancing customers that purchase tickets directly versus customers that are purchasing domestic flights using Multiplus loyalty points?

Claudia Sender - VP Domestic Brazil Passenger Operations: Alright. So, regarding our revenue strategy, we have a strategy where we believe that our passengers can be very clearly segmented between the corporate and leisure passengers. Therefore, we have maximized – we're focusing on maximizing the revenues and not necessarily just maximizing (yields loads). So we're looking at a very relevant raft increase in the fourth quarter and maintaining this trend in the first quarter of 2013 and projecting a double-digit raft increase for 2013. Regarding capacity cuts, it's very relevant to remember that our key competitor has shut down an operation that's why there was a very significant capacity cut in the fourth quarter. However, we already see some capacity maintenance in balance for the first quarter 2013. Our strategy is very focused on capacity discipline and we believe that this is key for regaining profitability for the – here in Brazil. Regarding the balance between Multiplus and passenger money purchase, let me put it this way. Multiplus is a very relevant client for us not only because it brings the frequent flier passengers, but also all the alliance of clients that Multiplus – the coalition clients that Multiplus has through its other coalition partners. We have not seen an increase in the participation of Multiplus in our total passengers. So, the participation of Multiplus versus purchase passengers remains pretty much like the previous year. We have announced 1st of March this year, a change in the program which we believe will have a very positive impact in our flexibility, but also will be very beneficial for our frequent flier customers.

Operator: (Irwin Rodnick, CHG).

Irwin Rodnick - CHG: My question is related about your cash positions, considering your fleet plan and your estimated CapEx for around $4 billion in next two years, I'd like to know if you feel comfortable with your cash position right now and is you are considering alternatives of increasing the cash such as capital increase?

Unidentified Company Speaker: Mr. la Fuente responded to that question, on liquidity yes, we are as of the end of our last year, we ended up over the total cash balance something like $1.1 billion. On top of that we have committed for LANs of $200 million and we are currently working a future flows deal which is under way. We expect to go to market sometime in May, in the region of $400 million to $500 million which will increase our liquidity. Talking about the CapEx we have reduced a bit the CapEx for this year rather than being $2.3 billion it will be in region of $2 billion. We are also financing a higher percentage of the total CapEx. For the next year and even for this year improved margin which will be more in line with the CapEx plan.

Operator: Bianca Faiwichow, GBM.

Bianca Faiwichow - GBM: You mentioned in the report that the RACs in Brazil increased in reais and that yields in U.S. dollars dropped. I'm just curious to know what happened with yields during the quarter I mean I know you, you're doing the segmentation between leisure and business passengers but I just would like to know what happened in the consolidated yields in the Brazil domestic in reais?

Claudia Sender - VP Domestic Brazil Passenger Operations: Yes, as we mentioned our RAC has increased double-digits in the fourth quarter last year and this trend remains for the first quarter of this year. However, we would not disclose the exact figures for yields and RAC.

Bianca Faiwichow - GBM: Perfect and just another question, you said that you expect double-digit increase in RACs for 2013. So can we expect this coming from increase in load factors or we can have something coming from yields and this double-digit is in U.S. dollars or in reais?

Claudia Sender - VP Domestic Brazil Passenger Operations: Well, if you remember correctly the first quarter last year we were still operating below two reais per dollar exchange rate and so we will still have some exchange rate impact for the first quarter. However for the remainder of the year we do not expect to have that much of an impact coming from the exchange rate. Also during the first semester 2012, TAM operated in the domestic market at what we consider significantly low load factors, and we expect to have some gain coming from load factors also from yield recovery. But mainly in the second semester this year we expect very – we were already operating at high load factors last year, so we might have some gain in the second semester on load factor, but most of it should come from yield recovery.

Bianca Faiwichow - GBM: And my next question is actually regarding the investment grade one more time and how does (much of those) capital increase helps you in recovering the investment grade, I mean with the purchase of airline tickets?

Alejandro de la Fuente Goic - CFO: On a consolidated basis we're improving our (indiscernible) position, but we are far away from recovering the investment grade. As I mentioned, we are working right now in improving our balance sheet through cash flow generation and improving margin. That's the best way for recovering the investment grade and to prove to the investment rating agencies that we're on the track to recovering investment grade.

Operator: (Indiscernible), BCI.

Unidentified Analyst - BCI: (As you were saying) before the two Brazilian government regulation process we are seeing difficulties in achieving synergies. Has it been more difficult than expected?

Gisela Escobar - Director, IR: We have seen regarding the synergies that in certain areas the synergies are being achieved faster than we expected and in certain areas we have seen some delays with achieving the milestone. So, specifically, in the case, for example, of the frequent – of the code share agreement between TAM and American Airlines, we require approval in Brazil from CADE, which means that there is going to be still a delay of a few months before this code share can be implemented, but on the other hand there are other cost synergies and especially synergies related to the integration of the cargo businesses that have advanced as planned and some even faster than planned. So, overall, we are able to reconfirm our original synergy estimates.

Unidentified Company Speaker: This is (indiscernible). If you allow me regarding what Gisela was just mentioning before we got dropped out of the conference, I was going to add on this regard of American code share, this is one very significant element of our strategy for connecting U.S. and Brazil for the next years. If you see our network, until now TAM didn't have a significant penetration in the beyond Miami or beyond New York markets in the (indiscernible) U.S., and with this strategy, with this new code share, we're going to be able to penetrate; one, which is the biggest market connecting U.S. and Brazil that we were not participating yet. So, this is a very important tool that we're going to make use once we have the co-chair agreement signed.

Operator: (Ranapo Salion)

Ranapo Salion: My question regards to the upcoming changes in the schedule of almost the entire international operation in Lima and I wanted to know if this is part of a wider – broader plan for this hub and if you could give us some details on what are your plans for this hub and if it's possible to improve connectivity within South America through Lima?

Alejandro de la Fuente Goic - CFO: As you have seen in the last year, we've been increasing our presence and strengthening our Lima hub. And what we are doing now is making a change in the times that we connect flights from the south and from the north that will allow us to have a bi-directional hub that we didn't have to be. Today we are only connected in one direction and now we are going to be able to connect in both directions, going south and going north. And this is also going to allow us to have a better connection with significant market as Brazil and from the southern markets that are important in our fleeting strategy which are Argentina, at Cordoba and Mendoza and Chile. So, yes this is a very important element of our interconnection strategy for South America with North America that we're doing now.

Operator: At this time there are no further audio questions.

Alejandro de la Fuente Goic - CFO: 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 soon. Thank you very much and good bye.

Operator: Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.