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Executives

Alejandro de la Fuente Goic - Chief Financial Officer

Gisela Escobar

Jorge Vilches

Cláudia Sender - Vice President of Sales & Marketing and Director

Andrés del Valle

Analysts

James D. Parker - Raymond James & Associates, Inc., Research Division

Ricardo Alves - Morgan Stanley, Research Division

Stephen Trent - Citigroup Inc, Research Division

Ivan Rudnick

Bianca Faiwichow

LATAM Airlines Group S.A. (LFL) Q4 2012 Earnings Call March 20, 2013 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 LATAM Airlines Group Earnings Conference Call. My name is Shakwana, and I will be your coordinator for today. [Operator Instructions] 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

Thank you for joining us today. This is Alejandro de la Fuente, and with me on the call are Cláudia Sender from our Domestic Brazil operation; Jorge Vilches, from our International Passenger division; Eduardo Riquelme from our Cargo business; Andrés del Valle from our Corporate Finance Department; and Gisele 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 result 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. Revenues this quarter are impacted by the negative effect of the 14% depreciation on the Brazilian real on passenger and cargo revenues denominated in reals.

The challenging operating environment in the International Passenger businesses continued weak market demand in the Cargo business and the change in LAN's reservation and inventory systems to a new system provided by shaver, which took place in September 2012. Although it is difficult to measure the exact impact, we estimate decreased revenue of approximately $25 million to $44 million [ph] during the quarter. Net income reached $8.5 million in fourth quarter 2012, excluding special items. Special items include: a $21.9 million of merge costs and the onetime charge of $52.7 million related to the sale of LAN's A318s and the delivery cost of LAN Colombia's -8. Excluding these items, operating income reached $119 million in fourth quarter 2012, a 61% decrease, compared to pro forma operating income of $307 million in fourth quarter 2011. This resulted in a 3.4% operating margin, compared to an 8.8% pro forma margin in fourth quarter 2011.

Turning to Slide 4, you can see a more detailed evaluation in our operating margins for the fourth quarter 2012. The main impact during this quarter was the decline in passenger and cargo yields. This impact excludes the negative effect of the depreciation of the Brazilian real. 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 the 3.3% increase in consumption and with the 4.8% increase in the average fuel price per gallon. Excluding fuel and special items, unit cost per ASK declined 4.1% as compared to fourth quarter 2011.

Taking a closer look at passenger operations on Slide 5, you can see in detail the evolution of the business during the quarter. Total passenger traffic for LATAM Airline Group grew 10.7%, while capacity increased 6.7%. Consequently, 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 a consolidated basis.

We see different dynamics in different parts of our passenger network. On Slide 6, you can see in detail our capacity expansion by market. 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 2012, we faced a challenging environment in our international passenger operations. We have seen significant pressure from international competitors adding capacity to South America. This has led to downward pressure on fares, 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 merge, 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 Lima hub, as well as strong increases on routes between Brazil and the U.S. Renewed capacity is on routes that are strategic and profitable for the longer term. However, in especially considering the current market environment, competitive pressure resulted in a 2-point decline in load factors, as well as lower yields in this business unit.

Considering the current situation, we have decreased our capacity growth estimates 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 postmerger, although we remain confident that we 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 codeshare agreement between TAM and American Airlines has been delayed as a result of additional regulatory approvals required in Brazil from [indiscernible], for example, in Brazil.

On Slide 7, we will take a closer look at the Brazilian domestic passenger operations. We have made significant progress in the turnaround of this business unit. We continue 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-digits improvements in revenue per ASK as measured in real. Results in US 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 the basis for continued healthy load factors and 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 a challenging environment, reflecting a slowdown in global trade momentum, which is reflected in the 1.5% decline in cargo world traffic during 2012 and a 1.2% decline in Latin America's 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's 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 the admin leases. Total capacity increased 3%, mainly due to additional belly capacity in long-haul passenger operations.

The yield decline of 1.6% was mainly the result of the depreciation of the Brazilian real on the domestic Brazil cargo revenues. During the fourth quarter, LATAM obtained the second main route in Brazil. With this, we already have 2 Boeing 767 freighters operating main routes within Brazil.

Please turn to Slide 9 for an update on the expected synergies from the merge. We remain confident in our synergy targets of between $600 million and $700 million to be fully achieved by the full year after the merge, June 2016.

During the second half of 2012, LATAM recognized an estimated $72 million in merge 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 occur as a result of the integration process over the coming quarters.

LATAM Airline Group estimates onetime costs associated with the merge and the 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 merge.

For 2012, the total amount of 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 these direct costs, 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 estimate synergies. Regarding the international passenger operations, the company has already established connectivity, cross-selling and code shares on all of its domestic routes and in almost all of its international routes, like the Santiago - Orlando, Santiago - Madrid and Santiago - London. Both TAM and LAN have aligned their 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 code share between the 2 carriers.

Another important milestone in our integration process was achieved during March with the announcement of the election of oneworld as the global alliance for LATAM Airline Group. The second quarter of 2014, TAM will join oneworld, the leading airlines for flights within Latin America and from the region to bolt 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 their 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 and freighter aircraft are being commercialized under the TAM Cargo plan, which is well-positioned in the Brazilian market.

During this period, increased cargo traffic has been impacted by macro economic conditions. The implementation of connections in the Guarulhos and Guayaquil airports has been key to consolidate cargo traffic from the region to the U.S. and Europe.

The strong exports, mainly of perishable goods in the northbound routes, have been able to mitigate the impact of the weakness in the southbound 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 are 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 have 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 gallons saved as of December 2012, and we target that in 2015, the savings will reach to approximately 6 million gallons.

Please turn to Slide 12 to see our estimated 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 a relatively moderate increase in this business in order to adjust capacity to market conditions. TAM's 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 added 2012 -- we ended, sorry, 2012 with the fleet of 327 aircrafts, the largest in Latin America. LATAM is in the process of adjusting its fleet plan in order to match its capacity expansion plans for the expected competitive and macroeconomic environment on international and domestic Brazil passenger markets.

LATAM's current fleet plan shows a decrease of $1.2 billion in the expected capital expenditure for 2013 to 2015. We continue to operate alternatives to rationalize fleet orders.

During the fourth quarter 2012, LATAM successfully issued Ex-Im Bank guarantee bonds for an amount of $640 million to partially replace existing Ex-Im Bank guaranteed debt and to prefund certain fourth quarter 2012 aircraft deliveries. The rate of these issuances was fixed at 1.56% in US dollars. This financing were for the company's 2012 aircraft deliveries, which involved a total amount of approximately $2.7 billion for a total of 40 aircraft. Additionally during November 2012, LATAM issued an Ex-Im Bank guarantee bond for an amount of $212 million to refinance 3 Boeing aircrafts, which were delivered in the second half of 2011. This bond was issued with a floating rate. The spread was set at 33 basis points over LIBOR 3 months. With this, the weighted average cost of debt as of December is 4% -- around 4%.

On Slide 14, you can see our consolidated fuel hedge position for the upcoming quarters. Our financial hedging strategy is in addition to our fuel surcharge policy applied 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 can see on this slide, we have hedged 56% of the estimated fuel consumption for the first quarter 2013 and an 11% of the estimated fuel consumption for the next 3 quarters 2013.

In closing, I can say that the past quarters have been challenging as we worked through the integration between LAN and TAM in a difficult competitive environment, where we are dealing with a variety of standard pressures in our different markets. Nevertheless, we have made significant progress in term 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 merge of these 2 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'll be pleased to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Jim Parker representing Raymond James.

James D. Parker - Raymond James & Associates, Inc., Research Division

I have a couple of 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

Jim, that's the actual amount. It's not the run rate. And the $250 million to $300 million estimate for 2013 is also the actual amount.

James D. Parker - Raymond James & Associates, Inc., Research Division

Okay. And my second question has to do with LAN Columbia. What was the loss in the fourth quarter? And which quarter do you think you are going to get into the black with this operation this year?

Alejandro de la Fuente Goic

No, LAN Columbia, in the fourth quarter, was breakeven, and we expect it to be a profitable year for 2013. We are not providing any more details on the Columbia. It's part of the network plan. So -- but the operation is well conditioned and improving every month.

Operator

Your next question comes from the line of Ricardo Alves representing Morgan Stanley.

Ricardo Alves - Morgan Stanley, Research Division

I have one question regarding the declining yields we saw. You mentioned that one of the reasons was softening 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 -- will be healthier, but I wanted to hear your thoughts on this, maybe main routes that are being affected by this increasing competition you mentioned. And then my second question, sort of a quick one. And 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?

Jorge Vilches

Yes. This is Jorge Vilches from the international business unit. Good morning, everyone. Regarding your first question on declining yields, yes. We saw mainly this downward trend in yields focused mainly on TAM operation because of the 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-day weekly frequencies to Brazil, and we added 20% in additional capacities. So this forced all the carriers to be very aggressive also in their commercial conditions to the channels and lowering fares. And that's why all the industry suffered a decline in yields. But we're very confident is that our additional capacity was focused on those routes that we know in the future are going to be fairly profitable, which are São Paulo - Miami and São Paulo - New York. We focus our increase in 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, Research Division

Okay. That was very clear. I just -- if you have any color on the second.

Alejandro de la Fuente Goic

Yes. On the second, well, in the third quarter, we have -- we had $20 million in total cost and the second quarter, $22 million. That's a totalized $42 million. And we expect, in total, around $150 million.

Operator

Your next question comes from the line of Stephen Trent representing Citi.

Stephen Trent - Citigroup Inc, Research Division

Just 1 or 2 questions for me. I'm thinking -- excuse 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

As you know, we're convinced of the importance of having an investment-grade and that a solid balance sheet is an important competitive advantage in this industry. We are rating the best way to improve our balance sheet indicators, clearly the operating and improving the cash flow generation of the company and improving margins. There's no decision right now regarding a capital increase, but we're also reevaluating our fleet plan and CapEx required for the coming year. But we can't say at the moment.

Stephen Trent - Citigroup Inc, Research Division

Okay, great. And just one other question and I'll let someone else 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 buying, purchasing tickets directly versus people purchasing tickets via Multiplus points, and what kind of impact that could have on your yields?

Cláudia Sender

This is Cláudia Sender from the domestic Brazil business units. I apologize that -- we dropped the line and I don't think we heard your whole question. If you don't mind repeating it so I could answer it correctly?

Stephen Trent - Citigroup Inc, Research Division

No, not a problem. Not a problem. I was just curious in the domestic market, 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?

Cláudia Sender

All right. So regarding our revenue strategy, we do believe -- 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 or loads. So we're looking at a very relevant raft [ph] increase in the fourth quarter and maintaining this trend in the first quarter of 2013 and projecting a two -- a double-digit raft [ph] increase for 2013. Regarding capacity costs, it's very relevant to remember that our key competitor has shut down in operation. That's why there was a very significant capacity cut in the fourth quarter. However, we already see some capacity maintenance and 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 year in Brazil. And regarding the balance between Multiplus and the passenger money purchase value for this way, Multiplus is a very relevant client for us, not only because it brings the frequent flyer passengers but also all the alliance clients that Multiplus -- the coalition clients that Multiplus has to 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. And we have announced, 1st of March this year, a change in the program, which we believe will have a very positive impact in our profitability, but also will be very beneficial for our frequent flyer customers.

Operator

Your next question comes from the line of Ivan Rudnick representing CHG.

Ivan Rudnick

My question is related about your cash position. Considering the -- your fleet plan and your estimated CapEx for -- around $4 billion in the next 2 years, I would like to know if you feel comfortable with your cash position right now? And if you're considering alternatives of increasing the cash, such as capital increase?

Andrés del Valle

Andrés del Valle here. [indiscernible] on the [indiscernible] de la Fuente, we responded [indiscernible] on boosting our liquidity, yes. We are, as of the end of last year, we ended up over the total cash balance of something like $1.1 billion. On top of that, we have committed claims [ph] of $200 million, and we are currently working on a fleet to close [ph] deal, which is underway -- and we expect to go to market sometime in May in the region of $400 million to $500 million, which will, I mean, increase our liquidity. Talking about the CapEx, we have reduced a bit of the CapEx for this year. Rather than being $2.3 billion, it'll be in the region of $2 billion. We are also financing a higher percent of the total CapEx. And for next year, we expect to be -- and even for this year, improve margin, which will be more in line with the CapEx plan.

Operator

[Operator Instructions] Your next question comes from the line of Bianca representing GBM.

Bianca Faiwichow

You mentioned in the report that the RASK in Brazil increased in reals 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're doing the segmentation between leisure and business passengers, but I just would like to know what happened in the consolidated yields in the Brazilian domestic reals?

Cláudia Sender

Yes, as we mentioned before, our RASK has increased double digits in the fourth quarter last year, and this trend remained for the first quarter this year. However, we do not disclose the exact figure for yields and RASK.

Bianca Faiwichow

Okay. And just another question. You said that you expect a double-digit increase in RASK for 2013. So can we expect this coming from increasing load factors? Or we can have something coming from yields? And this double-digit is in US dollars or in reals?

Cláudia Sender

Well, if you remember correctly, the first quarter last year, we were still operating below BRL 2 per dollar exchange rate and for -- 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 of 2012, we -- 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 yields 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 just comes from yield recovery.

Bianca Faiwichow

Okay, perfect. And my last question is actually regarding the investment grade one more time. And how does Multiplus capital increase helps you in recovering the investment grade, I mean, with the prepurchase of airline tickets?

Alejandro de la Fuente Goic

So on a consolidated basis, we're improving now our -- [indiscernible] our position but, no. We're far away from recovering the investment grade. As I mentioned, we're working right now in improving our balance sheet through generation -- cash flow generation and improving margins. That's the best way for recovering this investment grade to prove to the investment rating company -- agencies that we are on the track to AA investment grade.

Operator

Your next question comes from the line of [indiscernible] representing BCI.

Unknown Analyst

I just think before the 2 Brazilian government regulation process, we are seeing difficulties in achieving synergies. Has it been more difficult than expected?

Gisela Escobar

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 milestones. So specifically, in the case, for example, of the frequent -- of the codeshare agreement between TAM and American Airlines, we require approval in Brazil from [indiscernible], which means that there is going to be still a delay of a few months before this code share can be implemented. But on 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 estimate.

Jorge Vilches

Yes. [indiscernible] If you allow me, regarding what Gisela just mentioning before we got dropped out of the conference, I was going to add on this regard of American and the codeshare. 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 old line U.S. And with this strategy, with this new codeshare, we're going to be able to penetrate one, which is the biggest market connecting U.S. and Brazil that we were not participating in yet. So this is a very important tool that we're going to make use of once we have the codeshare agreement signed.

Operator

Your next question comes from the line of Renerco [indiscernible].

Unknown Analyst

My question is in 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

Yes. As you have seen in the last years, we've been increasing our presence and strengthening our Lima hub. And what we're 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 bidirectional hub that we didn't have today. Today, we only connect in one direction. Now we're going to be able to connect in both directions, going south and going north. And this is going also to allow us to have a better connection with a significant market, as in Brazil, and from the southern markets that are important in our fleeting strategy, which are Argentina, Cordoba, 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

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 goodbye.

Operator

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

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