International Consolidated Airlines : Q4 Presentation 2018 Conference Call Transcript

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EDITED TRANSCRIPT

Full Year 2018 International Consolidated Airlines Group SA Earnings Call

EVENT DATE/TIME: FEBRUARY 28, 2019 / 8:45AM GMT

CORPORATE PARTICIPANTS

Alejandro Cruz de LlanoInternational Consolidated Airlines Group, S.A. - British Airways Chairman and CEOAndrew James LightInternational Consolidated Airlines Group, S.A. - Head of IR

Antonio Vázquez RomeroInternational Consolidated Airlines Group, S.A. - ChairmanEnrique Dupuy de Lôme ChávarriInternational Consolidated Airlines Group, S.A. - CFO

William 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 & Leisure Sector and Co-Head of the Global Transport Sector Team

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

Savi SythRaymond James - Analyst

PRESENTATION

Antonio Vázquez RomeroInternational Consolidated Airlines Group, S.A. - Chairman

All right. Good morning, ladies and gentlemen. And I'm glad to welcome you jointly with the management; and the Senior Independent Director of the Board of IAG, Patrick Cescau. And welcome to the IAG results presentation 2018.

I'm really glad, another year to be here reporting quite a good result and despite of the headwinds, fuel price up by 30%; the worst air traffic control environment in Europe in the recent history; and the impact of ForEx, a change in the -- in our result, EUR 129 million. So despite of all these headwinds, we have been able to report EUR 3,230 million operating profit, which is 9.5% up versus last year and with an increase in our adjusted EPS of 15.1%. Based on those airlines that have reported so far, we are the only major airline group on either side of Atlantic to have reported a high operating profit and a higher margin on 2018 compared to 2017. So the management team, led by Willie, deserve a very deep and very strong recognition.

As far as the shareholders' return is concerned, at the results presentation of the third quarter 2018, we announced an interim dividend of EUR 0.145 per share. I'm pleased to announce right now that the Board of Director has recommended a final dividend of EUR 0.165 per share. This makes a total dividend for 2018 of EUR 0.31 per share, which is 50% -- 15% higher than the -- than for 2017, and it is in line with the increase in the EPS -- with EPS growth. This demonstrates the Board of Director confidence in IAG financial strength, IAG strategy and the outlook.

I'm also pleased that the board yesterday approved a special dividend of EUR 0.35 per share, approximately EUR 700 million of additional return to shareholder. Total cash returned to shareholders in respect to 2018 will therefore be just over EUR 1.3 billion, which will be around EUR 260 million more than previous year's. Including this final special dividend, we will have returned a total of almost EUR 3.8 billion since 2015. We're glad with this figure and looking forward to continue returning our shareholders.

I hand over to the management, led by Willie.

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

Thank you, Antonio, and good morning, everybody. Thank you for joining us.

And I have to say, as you would expect, I'm very pleased with the performance of the group in 2018 not just from a financial point of view but clearly making good progress on our strategic objectives as well. We've continued to invest in our brands and our customer proposition, strengthening the brands and our network. You've seen the expansion of LEVEL at Barcelona and the launch of LEVEL at Paris and then exploiting the LEVEL brand to launch a short-haul operation at Vienna. And we'll do more of that in 2019.

We've seen a very significant improvement in the British Airways Net Promoter Score and, in fact, very strong Net Promoter Score for all of our airlines, with the exception of Vueling. And as you know, Vueling was disproportionately impacted by the air traffic control environment in Europe in 2018. So not only were they hit by the en route ATC delays, but Barcelona was one of the most impacted airports on the European network. So we operate about 201 flights, I think, in 2018 from Barcelona. 19% of all flights in Barcelona were delayed by ATC. And the average delay on flights operating out of Barcelona was 19 minutes -- roughly 19 minutes. That's across the whole airport. So when you consider the business model that Vueling has, similar to other low-cost airlines where quick turnaround times are a feature of the business, what the delay statistics don't show you is that a lot of the problems were caused not just by ATC but to --the reaction to those ATC delays, which are not embedded in the ATC statistics. So if they delayed a flight on the outbound leg and the flight remains delayed on the return leg, they don't count the return as being an ATC delay. So that clearly had a big impact on the Vueling NPS. We've taken measures to try and counteract what we believe will be a difficult ATC environment in 2019, and I'll talk about that again later on.

In terms of our leadership position across our network, I know some of you last year expressed concerns about our growth plans. We had announced this time last year that we were planning to increase ASKs by 6.7%. We actually finished the year with 6.1% doing what we said we would do, which was to look to trim capacity as we went through the year. I think that capacity has been justified, particularly when you look at our unit revenue performance, which showed at constant currency a 2.4% improvement versus last year.

We had 8% capacity growth on the transatlantic. It's represents 30% of our capacity across the network. In Latin America, which is about 16.5% of our capacity, 9%. And the Latin American market was a bit more challenging than I think we probably expected given the devaluation in Argentina and the economic environment in Brazil. I think our assessment is that it has bottomed out. So it's an important part of our network, as I said, about 16% -- or 16.5% of total capacity but over 50% of the Iberia capacity. And we had 7% growth on our intra-European. Most of that was in Spain. And as you know, Europe represents about 26% of our capacity. And we grew at Gatwick. This was principally through the acquisition of the Monarch slots but also through the densification of the aircraft. And just going back to what I said about ATC: Most of the capacity reductions that we had were with Vueling, where we cut their growth ambition because of the ATC environment. The transatlantic performed very well, new routes by Aer Lingus, British Airways, Iberia and LEVEL. The Aer Lingus performance continues to be very strong. Very pleased with both Philadelphia and Seattle has been a fantastic success.

And then in relation to the -- what we call the platform, we continued to improve our non-fuel unit cost, down 0.8%, down over 11% since we created IAG. We continued to take new aircraft, 25 aircraft delivered in 2018, more to be delivered in 2019 and beyond. And distribution, what we call NDC or New Distribution Capability/API now represents about 17% of total indirect sales. And the way to look at that is that although those sales are indirect, they're effectively at the same costs as our direct distribution. U.K. in -- with Avios, we merged the British Airways programs. And we continued to see good work from our digital teams looking to exploit new technology. And that's been clearly something that has not just improved our cost performance but also improved our operational and customer performance.

Now just focusing on the high-level financials, and Enrique is going to go through these in detail. Return on invested capital, 16.6%, above our targets. Lease-adjusted margin, 14.4%. Equity free cash flow, 2018 was a "higher than average CapEx" year, so therefore lower-than-average equity free cash flow but still very strong at EUR 1.8 billion. And adjusted earnings per share of EUR 1.177, 15.1% improvement. And you heard the Chairman comment on the proposed final dividend and the proposed special dividend to be approved by our shareholders at our AGM later on this year.

So I'm going to hand over to Enrique, who will take you through the detailed financial performance, and then I'll come back after he has taken you through that to address some other issues.

Thanks, Enrique.

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

Thank you, Willie. Good morning, everybody.

So I think we are going to be quite consistent through the morning in terms of emphasizing that year 2018 has been a very good year in terms of our financial performance and the rest of our operational performance as well.

By the -- if we focused on the year 2018 full year figures.

We recognize, first of all, an increase in terms of operating profit, one of our main targeted metrics, of EUR 280 million and then reaching EUR 3,230 million for this year. And then there has been a negative impact coming from net FX, basically having to do with transaction, which has been in the range of EUR 110 million. So in constant currency terms, the improvement year-on-year has been more on the line of EUR 400 million, which is really a big, big increase. By the Capital Markets Day beginning of November, we were signaling an increase in operating profits more in the range of EUR 200 million. We'll explain a little bit later about where have been the levers that have allow us to enhance the improvement just to reach the EUR 280 million, but at the end of the day, it has been a combination of better unit revenues, lower fuel costs and lower non-fuel unit costs as well.

So the foundations of these improvements have to do basically on this combination of passenger unit revenues growing by 2.4% in terms of constant currency and non-fuel unit costs which have been decreasing on a yearly basis by quasi 1%. But that's unadjusted, so if we get to real underlying apples-to-apples comparison, we'll be finding that the real saving in unit terms constant currency has been closer to 2.5% for the full year. We have had total unit revenues growing slightly higher than the passenger unit revenues, and that's because of our non-ASK-related businesses and in this case basically having to do with Iberia MRO third-party business and British Airways Holidays business. That has improved our unit revenues on a total base up to a level of 2.9%. And then total unit costs, of course, have to include the fuel costs, which as you well know, has been a significant headwind through the year in the range of 12% in constant currency terms.

So at the end of the day, we've been able to grow capacity in terms of 6.1% with an improvement in load factors. So really, we have been attending markets that were growing in terms of demand, so we've been able to improve load factors and unit revenues at the same time. We've been able to reduce our recurrent underlying non-fuel costs and to cope with an increase in fuel costs of 12%, improving our reported operating profit by EUR 280 million. So I think it has been a big success.

And a similar success has to do with the performance of the fourth quarter. And we've been improving last year operating profit, fourth quarter, by 150 -- EUR 105 million, sorry. So in constant currency terms, it has been in the range of EUR 114 million, which is slightly higher than the average of 4 quarters on a linear basis. And remember the EUR 400 million figure that we have noted for the full year. So fourth quarter has been relevant, has been important, has been slightly better than the average. And again, on a challenging capacity increase 6.7%, which we basically have been able to match with real underlying demand. So we have been achieving a passenger unit revenue, constant currency terms, improvement of 1.5%. We are going to be talking later more about the figure and how it's been allocated in our different strategic markets.

The second big reason behind our improvements in Q4, they have to do with non-fuel unit cost on an ASK-related basis. So as you can see here, we had a significant increase in non-ASK-related revenues, of course, dragging costs. If we carve them out, the underlying performance in non-fuel cost has been very, very positive. And this, of course, has to do with several things, we'll talk them later on, very much having to do with what we called efficient growth model. So we are growing fast with a very efficient growth model. And this has to do with not only the cost-cutting plans and efforts, the efficiency improvements of our legacy carriers but also of our new value carriers and the fast-growing tools as Aer Lingus and LEVEL. So this is again a very efficient combination of growth, revenue management, cost management and the challenge of fuel cost increase.

So on this bridge exercise that we bring to you every time, we can differentiate what has happened in Q4 between last year and this year.

FX in the quarter has not been very significant, slight headwind but not very significant. Growth, of course, has its positive impact, the 7%. Very importantly, passenger revenues, and this bar, of course, has to do with passenger unit revenue impact on total improvement.

Passenger unit revenue impact are very significant. And then fuel costs, of course, representing a significant burden. These comparisons is also one that we are proud about. So we are offsetting same day, same quarter 70% -- quasi 70% of the fuel cost drag through increased passenger management initiatives and unit revenues.

The other one is non-passenger revenue, which in this quarter has had a special impact. Of course, this bar represents additionalrevenues. And here, we should be decomposing this net EUR 21 million into a negative bar, of course, which has to do with you have more revenues but you are creating more attached costs. They have to do with the supplies that we need to create these additional third-party revenues, but then on the other side there is a big improvement in other non-fuel unit costs related to day-to-day operations.

And those are mostly recurrent, and we'll go through them later. And that's basically how we get to EUR 655 million.

Let's talk a little bit of revenues. Fourth quarter, significant growth basically focusing on our main strategic markets again, North America; Latin America; of course, Europe domestic; and consistently less growth allocated to Asia Pacific and Africa, Middle East and South Asia.

If we start with North America. Basically, 5% out of the 8.2% has to do with new routes. New routes represent a significant percentage of the capacity increase that we have seen in the fourth quarter. And new routes basically have to do with our expansion through our new tools, talking about Aer Lingus. We are talking about LEVEL, but also, in the case the British Airways, on their own initiatives of opening new destinations that we have been informing you about. So the rest is basically related to growth in routes in which we already operate.

And this has been done with not a dilutive impact in terms of unit revenues. It's a flat type of performance, but if we compare company by company and route by route, what we are seeing is positive performance in British Airways; positive performance in Iberia; and of course, dilutive effect in the case of LEVEL and Aer Lingus, where we are seeing growth levels in the range of 15%, 18%.

In terms of Latin American and Caribbean area, we're also growing very significantly. And of course, that level of growth, 15.8%, it's having to do -- or having a consequence in terms of unit revenues. This unit revenue negative performance is very much affected by 2 special markets. One is Argentina. The other one is Brazil. And what we are seeing lately is those markets are bottoming already, and that's the case of Argentina; or are slightly picking up again, which is the case of Brazil. So we believe we have gone through the worst, and we believe we are going to be having good news to show you later on in the year when we roll over the impact of the devaluation in the case of Argentina and when we start picking up the pickup of demand that we have seen in the case of Brazil.

Very good news on the domestic and European markets in spite of a capacity increase of quasi 7%. So maybe here our message is slightly different to others that you may have heard on the region. That's basically because the way we're playing our capacity growth on our main strategic market and how we cannot compare ourselves with what happens in the global Europe but what's happening on our main strategic markets and on our main hubs. So the fourth quarter has been positive both in terms of European performance, the balance between capacity growth and unit revenue growth. Very especially, domestic unit revenues are still growing fast. There's a reason here that we are benefiting from still, which has to do with the special discounts being given in Spain to residents in Balearic Islands and the Canary Islands. And these really have been exciting demand, filling better our aircraft in lower seasons and then improving unit revenues.

And we feel that's going to gradually be fading through rest of the year as we roll over these decisions and these incentives but still is going to be allowing us positive unit revenue performance for most of the year.

Asia Pacific, it's less relevant, the same with Africa, Middle East, because of a lower strategic significance, the lower capacity growth that we are deploying there. What we can say is, Asia Pacific, most of the markets are still behaving positively, with positive unit revenue performance. And if we need to mention a market that is lagging behind, that's Hong Kong. And Hong Kong is about overcapacity. So that's something that we'll probably be adjusting further on through the year, but we are still on the positive side in terms of unit revenues in both markets, with modest capacity growth.

And this is non-fuel unit cost performance Q4 again which I was mentioning. Well, fuel, as a reminder, constant currency terms has represented an increase of 9.2%. I was telling you before that fuel costs in Q4 is 1 of the 3 pillars where we have based the improvement in operating profit. It -- remember, when I was talking to you early November, that fuel prices in the market were just coming down from $84, which has been the recovery dollars per barrel of Brent. So really, our projections at that point in time were not very confident in terms of fuel savings. The reality is fuel prices dropped since then. And even with a high level of hedging, we've been able to benefit from our collar structures and then achieve better reductions in costs than the ones that we imagined at that point in time. In terms of unit revenues, we also have been able to achieve a better performance in the fourth quarter. And I will say especially Europe has been performing for us better than we thought.

And in non-fuel unit costs again, a significant improvement. Of course, we don't need to refer again to employee unit cost reductions,