International Consolidated Airlines : Q3 Presentation 2018 Conference Call Transcript

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EDITED TRANSCRIPT

Q3 2018 International Consolidated Airlines Group SA Earnings Call

EVENT DATE/TIME: OCTOBER 26, 2018 / 8:00AM GMT

CORPORATE PARTICIPANTS

Enrique Dupuy de Lôme ChávarriInternational Consolidated Airlines Group, S.A. - CFO & Executive DirectorWilliam Matthew WalshInternational Consolidated Airlines Group, S.A. - CEO & Executive Director

CONFERENCE CALL PARTICIPANTS

Alex PatersonInvestec Bank plc, Research Division - Analyst

Andrew LobbenbergHSBC, Research Division - Head of the European Transport TeamDamian BrewerRBC Capital Markets, LLC, Research Division - Analyst

Daniel RoeskaSanford C. Bernstein & Co., LLC., Research Division - Research AnalystJaime Bann RowbothamDeutsche Bank AG, Research Division - Research Analyst

James Edward Brazier HollinsExane BNP Paribas, Research Division - Senior Transport Analyst

Jarrod CastleUBS Investment Bank, Research Division - MD, Head of the Travel and Leisure Sector, and Co-Head of the Global Transport Sector Team

Mark A. SimpsonGoodbody Stockbrokers, Research Division - AnalystMichael KuhnSociete Generale Cross Asset Research - Equity analyst

Neil GlynnCrédit Suisse AG, Research Division - Head of the European Transport Team and Global Transport Sector CoordinatorPenelope Jane ButcherMorgan Stanley, Research Division - MD

Rishika Dipak SavjaniBarclays Bank PLC, Research Division - Assistant VP

Savanthi Nipunika SythRaymond James & Associates, Inc., Research Division - Airlines AnalystStephen FurlongDavy, Research Division - Transport and Logistics Analyst

PRESENTATION

Operator

Good day, and welcome to the Q3 2018 International Consolidated Airlines Group S.A. Earnings Conference Call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Willie Walsh, Chief Executive Officer. Please go ahead, sir.

William Matthew WalshInternational Consolidated Airlines Group, S.A. - CEO & Executive Director

Thank you very much. And good morning, everyone. Thank you for joining us.

We're pleased to report a good set of results for the third quarter. And I think this is particularly the case when you look at the significant foreign exchange and fuel headwinds we faced or EUR 111 million of foreign exchange and EUR 268 million of fuel. Of course, some of that fuel bill increase was a result of increased activity.

Operating profit of EUR 1.46 billion, that's an operating margin of 20.4%. Good results in all of the airlines. And the figures that we released today actually absorbed the costs of the startup operations of LEVEL at Paris and at Vienna. If you look at 9 months, our pre-exceptional net income grew by over 9% versus a year ago. And we see continuing strong return on invested capital, trailing 4 quarters, at 16.1%. And Enrique will take you through the details of that in his presentation in a few moments.

You will have seen yesterday or the day before we reported that we had completed the second EUR 500 million share buyback program. That was 65 million, nearly 66 million ordinary shares, representing 3.2% of share capital. And the board yesterday approved a interim dividend of EUR 0.145 per share.

And looking at the full year, you may have seen our guidance. We're now saying that at current fuel prices and exchange rates IAG expects its operating profit before exceptional items for 2018 to show an increase year-on-year of around EUR 200 million from a 2017 base of EUR 2.95 billion. And both passenger unit revenue and non-fuel unit costs are expected to improve at constant currency for the full year.

Going to hand over to Enrique now, who'll take you through the detailed financial presentation. And I'll come back then after he's done that to finish up and give you an opportunity to ask questions.

Enrique Dupuy de Lôme ChávarriInternational Consolidated Airlines Group, S.A. - CFO & Executive Director

Thank you, Willie. Good morning for all of you.

As Willie has just said, our operating profit for Q3 this year has reached EUR 1.46bn, which is EUR 10 million better than last year. And we're proud of our performance basically because this result has been done on significantly challenging circumstances, which you basically all know. So we are talking about higher fuel prices significantly higher than the same period last year; also this headwind that we were mentioning on the ForEx type of impact which is very much related to the volatility of the dollar against both the euro and the sterling, so weaker in the first part of the year and also Q2 and then stronger through Q3 and basically end of the quarter, so generating opposite impacts both in the revenue side and on the cost side. And other challenges have been coming from ATC disruption, which you have been hearing about. We've been very vocal about it; and the way it has been penalizing our company, especially Vueling, as you well know. Also, engine problems have been creating disruptions for us, as for other competitors. So as a whole, the quarter has been challenging, but we have been able to improve our operating profit figures in constant currency terms in EUR 121 million. And this is basically on a strong performance on passenger unit revenues, which has been basically following the trends of Q2 and the guidance that we were giving to you in this last couple of quarters. And as we will insist, Q4 is looking similar in terms of our basic trends.

So it's worth to note that total unit revenues are higher than passenger unit revenues. And this is because of our non-ASK-related businesses as Iberia MRO activities for third parties but also British Airways Holidays. Even the cargo business have been strong for the quarter. And we feel this strength is going to be also flowing into Q4. So 2.4% passenger, total 2.7%, both figures in constant currency terms. Capacity has been high, 6.6%, slightly lower than our plans for more in a range of 7%. And this shows that we are following and monitoring very closely capacity versus demand, load factors and unit revenue contribution. And that's something that we will continue to do in through Q4 and into the next year.

Non-fuel unit costs constant currency figure that we are publishing is 0.7%, but then if we take into consideration the increase in revenues and then costs, of course, on this non-ASK-related activities, so basically we are talking about the other revenue business and activities, the underlying figure will be closer to 2.3% negative, so saving. And that's a very strong saving figure. Of course, we have to be transparent, saying that it includes compensation that we have been receiving, as other companies, on the engine manufacturer issues.

So basically, we can follow the next page trying to understand the bridge that leads us from last year figure into this year figure in operating profit terms. As we have been mentioning, this headwind coming from ForEx, which has impacted negatively our figures by EUR 111 million, and again it has to do with how the dollar has been affecting both revenues that were booked on the early part of the year at lower dollar rates and then costs that have been basically affecting our Q3 performance and our "end of the quarter" working capital position. So that's why there is this big figure that probably will be getting smoothed through the remainder of the year.

Second big message is growth and the contribution coming from our growth which is close to EUR 100 million of additional margin in relation with last year, good figure. And then the 3 other columns have to do with the fuel cost impact and the way we've been recovering this negative cost impact through increased revenues, both passenger revenues and non-passenger revenues. So we have been offsetting practically 100% of the negative fuel cost. And passengers have been taking into account 75% of this offsetting exercise, which is a high figure in absolute terms but also in relative terms against what has been the story, our story, in previous years. Finally, our non-fuel cost performance has been positive, adding another EUR 30 million to the performance of the quarter and allow us to reach this EUR 1.46bn operating profit results for Q3.

So more flavor on -- as usual, on growth and RASK. As you see in here in the chart, basically, in terms of unit revenues all our sectors have been producing improvements against last year, with the exception of Latin America. And this, you need to frame it into a significant growth pattern across-the-board. So basically, starting with North Atlantic and South Atlantic, you have seen there capacity increases in the range of 10% or 8.3%, talking about the North Atlantic and the South Atlantic markets. In respect of the North Atlantic, we have to say, British Airways has a strong participation in this 10%, it's in the range of 6; and also Aer Lingus, which is close to 3. A relevant fact around how we have been producing this capacity growth has to do with the split in terms of new routes, which represent basically half of this growth. New routes will be taking into account half of the 10%. The other half is basically on routes that we have already been operating.

So in terms of unit revenues, North Atlantic has been positive, slightly positive; and better than last quarter. And basically, this performance has to do with the split of tools that we have been using to execute this capacity growth. Of course, it's British Airways. It's British Airways, both Heathrow but significantly Gatwick. It's Dublin. It's also LEVEL network expanding. And so this in some way is showing the relation between capacity and unit revenues, average unit revenues, that we are achieving.

If we talk about the short haul markets. I think good data, good set of data. So strong capacity growth because the demand is there; and then unit revenues been improved very significantly, 4.5% and 4.2%, talking about domestic and Europe. And it's basically across all our companies and basically most of the market that we are operating, some very strong performance in domestic market in Spain but also in Spain to Europe and also in Ireland to Central Europe in the same way.

If we talk now about Asia Pacific. There capacity has been basically left freezed. And there has been an improvement in terms of unit revenues against the previous quarters, and the improvement is coming basically on all the routes. Worth to mention improvements on Tokyo and Hong Kong, which were routes that were a little bit of the laggards, as we saw them in Q2.

Africa, Middle East and Asia. And a little bit of a lower level of growth, of course, has to do with the discontinuation of Tehran. And a significant improvement in unit revenues. And I would be mentioning basically here the African routes. So South Africa, Nairobi, Lagos and others have been taking the lead in terms of unit revenue improvements.

Latin America, high growth and lower unit revenue performance all negative for the first time in this year and in quite a bit of consequent quarters. And it's very much related to recent weakness that we have been noting, of course, in Argentina and also Brazil; and that we have to say are not getting worse, through the data that we have on the fourth quarter of this year. So apparently, there has been, of course, a step-down because of the devaluation, but we don't feel the step-down is heading south in this moment in time.

So as a whole, good improvement with a RASK of 2.4%, which is a strong one, on a capacity growth which is 6.6%, which is also an ambitious one.

If we get into now the non-fuel unit cost performance. We have seen -- and the fuel. We have seen fuel increasing in constant currency basis and unit terms by 15%. We are going to be talking more about fuel on the following slide. And non-fuel costs, good results in terms of labor costs, employee costs with a minus 4.7%, of course very much related to, on one side, productivity improvements, and productivity improvements strong against last year, third quarter, up 4.6% in terms of ASK per employee; but also the underlying improvement that we've been achieving both through Athens project in British Airways, Plan de Futuro II in Iberia and other measures in the rest of the companies. Very significant again, the improvement in pension fund costs that was achieved through the significant deal that was agreed, by the end of the second quarter, in British Airways with pension fund trustees.

Supplier costs, the figure that appears here is negative, but I think we need to filter it down. We need to qualify it. Of course, it's affected by disruption, especially in Vueling again; and other matters, as selling costs, for example. But also, this line of costs is being affected by the increased activity in non-passenger-related revenues. As I've been talking to you before, the improvement and increase in activity in both British Airways Holidays but also Iberia MRO have been dragging this line of costs as well but also creating additional revenues and margins. Ownership cost increases in constant currency terms. And this is, of course, having to do with higher CapEx this year, the pace of the renewal of our fleet, new aircraft, also accelerated depreciation of our old 747 fleet. And again we need to mention disruption. And here it comes with additional wet lease contracts that we've had to deal with having to do with basically ATC and engine manufacturers disruption.

So as a whole, the non-fuel is coming at minus 0.7%. In reality and making this adjustment on costs that are basically related to other activities, the underlying one is minus 2.3%. And again, this minus 2.3% is positively affected by the compensations that we have been receiving on our agreements with engine manufacturers through the summer.

And then let's talk a little bit more about fuel. As you see, the chart, the same chart that we reproduce each quarter, is showing our expectations for future unit fuel cost evolution in the following quarters. It's done at $770. Today, we are at $740, so really this has been adifficult chart to complete because fuel prices in the market have been so volatile that it was difficult to determine a specific reference to be able to produce a reliable one. Again, this is basically in the range -- on the higher end of the range of the prices that we are seeing today. What it's showing is, remember, Q3 '18 has been up 15%, so we are seeing the following quarters at this level of prices having probably a similar range of performance in terms of increases in constant currency basis. We are talking about ranges between 14% and 16% in the following quarters. And my message here again is this is going to be a challenge in the following future, in the next year. It appears at -- this level of prices is not going to be representing an additional challenge, an increased challenge to the one that we are basically managing, I would say, successfully through Q3. The level of hedging that we have for the next quarters is expressed in the chart. As you see, for Q4, basically it's close to 100%, 92%. So it appears as that fuel bill for the quarter is now quite certain.

And then again the message for next year is we see fuel costs and prices coming up at rates that probably are not going to be dissimilar to the ones that we are going to be seeing in this last part of the year.

And then ROIC. So in terms of ROIC, what we are seeing is a very smooth pattern of evolution. So ROIC for the last 4 quarters has been for the group 16.1%. The last figure that we disclosed you end of June was 16.2%, so as you see, it's becoming stable figures. And when we come to the different companies of the group, again, stability. So we are seeing, for example, Aer Lingus at very high 27.9%. And last quarter, the similar figure was 27.8%, so sustaining, as you have been seeing, a very high level of ROIC in Aer Lingus. In Iberia, it has been again slightly improving, so 12.3% against 12.2% the last set of figures that we were showing. The same for Vueling. It was 13.1%, and now it's coming up to 13.4%. The slight reduction is coming in the case of British Airways. It was 16.9%, and now it has been getting down to 16.7%. And this basically has to do with the pace of CapEx and the new deliveries of new-generation aircraft that we are receiving through the group. As you'll remember, 2018 for IAG is a high-CapEx year, and that's basically increasing the size of our asset base. ForEx negative impact has not been helping those numbers either in this specific quarter, but the trends, the underlying trends, really are keeping in the path that we were expecting.

So finally leverage. And I've resumed the picture of our balance sheet. So as you see, gross debt has been increasing, and that has to do basically with the new fleet deliveries through the year. Cash has been kept at figures in the range of EUR 7 billion. Again, there is a reduction in respect of September last year, but this has to do with the investments that we've been doing through the last 4 quarters and the relationship between the investments and the borrowing that we have been raising; also very much related to specific outflows that we've been producing, of course, has to do with the normal dividend payments. It has to do with the completion of our share buyback, EUR 500 million, that we have just completed a couple of days ago. It has to do with an extraordinary repayment, early repayment, of British Airways preferred shares that we have in the marketplace around EUR 200 million. So we've been efficiently allocating our free cash flow generation through these last quarters.

As a whole, we are still very comfortable because our level of leverage adjusted net debt-to-EBITDAR is being kept at 1.4x, which is I would say a very comfortable level; the same with the level of absolute adjusted debt, which is just EUR 7.5 billion with an asset base which is in the range of EUR 20 billion, okay?

So this is my last page of reference, and I'm passing back the floor to Willie.

William Matthew WalshInternational Consolidated Airlines Group, S.A. - CEO & Executive Director

Okay, thank you, Enrique.

If we just look now at the forecast growth for the year and for the fourth quarter. We're now saying 6.2% ASK growth for the year. And if you remember, back in February, we had expected to grow by about 6.7% in the year. And we said 8.4% in the quarter, but the profile of the growth is actually very different to what we had first set out. And there are a couple of things in the fourth quarter that weren't in the base, and I'll just highlight some of those. We have now reflected in this fourth quarter -- the Aer Lingus wet lease operation of 2 aircraft on London City-Dublin, which was not in the base and not in our original plans, also not in the original plans, with some growth on the transatlantic by Aer Lingus. So they've gone to a daily service on Los Angeles and 5 flights a week to Toronto. And you may have seen that Ethiopian, who were selling Dublin-Los Angeles on their tech-stop at Dublin have now stopped selling Dublin-L.A. Also in the fourth quarter of this year and that wasn't in the plan or the base was the LEVEL operation at Vienna with the 4 A321s that we're operating there.