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LATAM Airlines Group SA (ADR) (NYSE:LFL)

Q2 2014 Earnings Conference Call

August 13, 2014 10:30 AM ET

Executives

Gisela Escobar - Director, IR

Andres Osorio - CFO

Nicolas Goldstein - International Passenger Operations

Cláudia Sender - CEO, TAM

Alvaro Carril - Cargo Operations

Analysts

Bernardo Vélez - GBM

Savi Syth - Raymond James

Duane Pfennigwerth - Evercore

Mike Linenberg - Deutsche Bank

Eduardo Couto - Morgan Stanley

Thomas Kim - Goldman Sachs

Stephen Trent - Citi

Bob McAdoo - Imperial Capital

Operator

Good day, everyone, and welcome to the LATAM Airlines Group Earnings Release Conference Call. Just as a reminder, this conference is being recorded. LATAM Airlines Group's earnings release for the period was distributed on Tuesday, August 12. If you have not received it, you can find it on our website at www.latamairlinesgroup.net in the Investors Relations section.

At this time, I would like to point out that statements regarding the Company's business outlook and anticipated financial and operating results constitute forward-looking comments. These expectations are highly dependent on the economy, the airline industry and international markets. Therefore, they are subject to change.

Now it is my pleasure to turn the call over to Gisela Escobar, Corporate Consultant and IR Director. Please begin.

Gisela Escobar

Thank you. Hello, good morning every one and thanks for joining us on the call. We’re going to go over some slides and give you some highlights of the results that were published last night and then we will be happy to take your questions. I wanted to introduce the people here in the room with me. We have Andres Osorio, who is the CFO; we have Cláudia Sender, who is the CEO of TAM. We are also joined by Nicolas Goldstein, who is in-charge of International Passenger Operations and we are joined by Alvaro Carril, in-charge of Cargo Operation.

If we go Slide No. 1 on the slide presentation, just to go over some of highlights for the second quarter, as you saw in the numbers we had [indiscernible] second quarter positive operating income in the amount of $15 million despite various challenges that we faced during this quarter. As it is important to understand few different types of the effects that we had this quarter, there were a couple of things that were more nonrecurring in nature and that had a negative impact on our numbers this quarter, specifically as we've already mentioned, the World Cup that took place in Brazil from mid-June to mid-July and we’ll talk about that in a little bit more detail. And also a very weak seed export season in the cargo business that was a very seed export season in 2013 and that therefore had a very negative impact on the cargo result especially in the month of April.

When we look at the broader context, we are also facing some challenging scenario from a macro perspective. We have the economies in the regions that are although healthy, showing slower GDP growth rate than what we had originally anticipated and also depreciated local currencies, especially in Argentina, in Chile and in other countries in the region and an ongoing -- a very challenging competitive environment, especially effecting international operations.

What we’ve been doing in this context, which is in line with the strategy that we have already outlined is continue a very focused with disciplined approach to capacity. As we saw in the second quarter numbers, we had a reduction of 1.5% in ASK in the passenger business and 7.5% in the ASK in the cargo business and this resulted on the passenger side at least in an improvement in revenue per ASK of 1.8%.

We also have a very healthy domestic Brazilian market. We continue to see improvement in result in the Brazilian market and we continue to have the preference of the corporate passenger in the that market, despite the onetime impact that we had in the World Cup, which is really a nonrecurring effect, that market continued to perform well and we had very healthy [indiscernible]. And we continue to move forward with our fleet restructuring initiatives and with our fleet [indiscernible] and we've already explained, had very positive long-term benefit for the Company from a cost perspective and from a competitive standpoint as well.

If you turn to the second slide in the presentation, we have a summary of the numbers. You can see that total operating revenue $3 billion. That was down 1.7% versus last year with the main impact being a 12.7% reduction in cargo revenue. We had 1% approximately decline in operating cost and that led to $15 million in operating income and $396 million EBITDAR with an EBITDAR margin of 13% and operating margin of 0.5%. At the net income level, we had a net of loss $59 million, which significantly [indiscernible] and $30 million loss last year. Here we have a huge impact in the change from the exchange rate impact, which comes from the exposure to the Brazilian under some balance sheet.

As a result of that we had a loss for exchange rate differences in the second quarter of last year of $361 million, which this year was a gain of $104 million. This also going forward will continue to be mitigated. Over this time we have reduced our exposure on the balance sheet from $2.4 billion which is what we had in June 2013 to $1 billion which is what we had in this June 2014. So we significantly made progress in terms of reducing that exposure some and we’ll continue to reduce that until the end of the year.

And also the other element that’s important to mention at the non-operating level this quarter is the impact that we had from adjusting the exchange rate for the cash that we have presented for repatriation in Venezuela. We had recognized approximately $148 million but that implies -- that was a [indiscernible] exchange rate, which was VFE6.3 per dollar. We made an adjustment this quarter to that exchange rate which is VFE11 per dollar and that resulted in a non-operating loss of $56 million this quarter.

If you turn to the next slide to look at the main impacts on the operating side this quarter, the impact on our margin -- the big decline came from lower yield. If we look overall at the passenger business, we had yields down 2.3% and on the cargo business we had yields down almost 7%. And part of this was recovered by higher load factors in both businesses. Especially on the passenger side we had very high load factors that are 3.3 points higher than what they were last year and on the cargo side also 1 point improvement in load factors. Fuel was a negative. We have 5% increase in fuel prices compared to the second quarter last year and then we have some efficiencies in the other cost lines.

When we look at on the next slide the passenger business and we look at the revenue per ASK performance in each of the passenger operations, you can see that both on international and domestic Brazil routes, we continue to see improvement in revenue per ASK. On the international routes, this is mainly driven by passenger load factors that continue to be very high. We have a 3.9 point improvement in terms of passenger load factors on the international business and that’s offsetting impart the impact of lower yield.

In the domestic Brazil business and these are the numbers in U.S. dollars we have a 2.9% improvement in revenue per ASK. When we look at this number in real it’s a 12.9% improvement in terms of revenue per ASK, driven by both higher yield in real and also higher load factors. And it’s also important to note that these are higher load factors from levels in 2013 which were already very healthy. So we continue to improve on both the load factor and yield.

In the Spanish speaking countries which are the other five countries where we have domestic passenger operations, Chile, Peru, Ecuador, Argentina and Colombia, we have a 3.9% reduction in revenue per ASK, mainly as a result of lower yields. We have stronger load factors overall but we have a yields that have been declining in fact because of the strong devaluations that we’ve had in the different currencies, in the different markets but also as a result of generally a more challenging scenario and lower economic growth, especially in Chile for example.

If you turn to the next slide, which is slide number six and we talk a little bit more about the international passenger operations, here we have a context that continues to be challenging, mainly as a result of weaker demand in the European market and somewhat weaker demand in certain Latin American markets and a scenario that continues to be very competitive, especially in long haul routes flying to the region where we have many international carriers that have started or are adding capacity into South America. In addition to that we’ve had local currencies in the region depreciate, especially Argentina where we saw devaluation in the first quarter that negatively affected the demand of international passengers travelling out of Argentina.

And then also in this business unit is where we’ve seen the impact of Venezuela where we’ve made significant capacity adjustments as a result of the issues that we’ve had there with being able to repatriate our plan. Our focus in terms of the strategy of the international passenger operations has been to continue with the improvement in terms of our products. We are upgrading our products both by renewing fleet and making upgrades to our fleet, specifically the Boeing 777 which will be retrofitted with a new business class starting during the third quarter and through mid-2015. We are also incorporating additional 787s into the operations and we will have increasingly more routes that will be operated by this new aircraft, which is significantly more efficient. It's approximately 12% more efficient than the 767, and in addition to that has improved passenger experience. And we continue with our project in strengthening the hubs that we're building at Guarulhos airport which has been a -- which is benefitting greatly from the new terminal at Guarulhos, which was completed in time for the World Cup.

If we talk a little bit more on the next slide, some highlights related to the World Cup. I think first it’s important to mention that the operations of some during the World Cup, especially in the domestic Brazil were extremely successful and we had prepared in advance operationally a very challenging period of time for the Company mainly because we have -- the World Cup was focused in 12 cities in Brazil and we had a significant increase in demand to travel to those cities around the time that the games were occurring. So that meant adjustments in terms of our network, and additional demand to all those cities in a very concentrated period of time. We were able to have a flawless operation. We had 95% on time performance, very good customer satisfaction. And so from that perspective it was extremely positive.

We also -- as a result of all of the infrastructure investments that occurred in the period leading up to the World Cup, have been able to as I mentioned in the previous page, focus on strengthening the hub at Guarulhos airport and we are completing during the next few months the move of the LATAM Airlines Group international passenger operations to the new terminal. So this is a very lasting positive impact of everything that the World Cup will lead in Brazil.

Now the -- on the not so positive side, what we had and what -- you saw the guidance that we released a few weeks ago; we estimate that there was a negative impact in our results during this quarter that amount to approximately $150 million, mostly as a result of decreased revenue. And this comes mainly because the months of June and July are very high season months, especially in Brazil where there is a significant amount of demand for domestic travel as well as international travel. Its winter, it’s during the vacation period of July. A lot of Brazilians travel internationally and there is a lot of demand coming to us, which as a result of the World Cup we didn’t see because many -- mostly Brazilians were staying in Brazil to experience the World Cup.

So the largest impact here was decreased revenue and we’ve also obviously during this period because of all the plans that we had in place, we had somewhat a higher cost operation as well. But that’s the main impact and the total effect that we estimate, including both domestic and international operations is $150 million, approximately both in the months of June and July. So we're seeing a part of this impact this quarter and we will see a part of this impact in the third quarter but this is included in the current guidance that we now published a couple of weeks ago.

If we move forward here to talk about the Cargo business, during the quarter on the Cargo side we saw significant adjustments in terms of Cargo capacity, mainly as a result of lower belly capacity that’s coming from the lower ASKs in the international passenger business as well as reduced freighter operation. Our freighter operation, we continued to be very disciplined in terms of our capacity with freighters and we're evaluating opportunities to continue to adjust freighter capacity and really to focus on the belly operation.

Cargo traffic was down 6%. With that we had cargo load factors improve, but a very negative impact coming from lower yield. Here the seed export season is very relevant and we estimate that there is approximately $18 million of less revenues in the second quarter of 2014 specifically in April as compared to last year because of the 70% lower demand for seed exports by air cargo.

When we look at the cost side, overall we have total operating costs per ASK up 2.6% and if we look at that number ex-fuel is approximately 3.1%. We have a savings in terms of wages and benefits and in general other costs and we have slightly higher aircraft costs which includes maintenance, depreciation and aircraft rentals expense.

And if you look at the next slide, which is Slide No. 10, you can see our fleet plan for the next -- what we expect for the rest of this year and for 2016. We are expecting to end this year with approximately 327 jets and 2015 with a similar number of aircrafts, 326 aircrafts but with significant renewal of aircrafts going on in between. If you look at the delivery and the redelivery we have during -- this year we’re taking delivery or 20 aircraft and returning 32; next year we expect to take delivery of 27 aircraft and return 28.

And if you look at the arrow, Boeing along the bottom of the chart, you can see the increase in each year in the number of aircraft of the new technologies which have a significant benefit in terms of cost per ASK and also an improvement in terms of the total passenger experience. The numbers in terms of fleet CapEx [indiscernible] very significantly. It’s approximately $1.1 billion in fleet commitment this year and $1.9 billion in fleet commitments 2015. A part of this is financed with sale and leaseback. Approximately one third and the rest financed with ECA or [indiscernible] supported debt or other markets there.

When we look at the guidance for 2014 which is the next slide, this is the same guidance that we published a few weeks ago. We expect overall capacity to be relatively flat to slightly down, passenger capacity between flat and a decline of 2% where we have declines in the international passenger business and in the domestic Brazil operations. And in terms of the Spanish speaking countries we expect to grow this year between 3% and 5%, which has come down significantly from our original estimates which was close to 8%. So here we’ve made adjustments in terms of our capacity expansion, mainly as a result of the dynamics that we are seeing in the domestic Spanish speaking countries. On the Cargo side, we've also adjusted our cargo gross estimates to a decline in capacity of between 3% and 5%. And with that our operating margin estimates continues to be for this year in the range of 4% to 5%.

Finally a few words in terms of the balance sheet. We have a very solid balance sheet as a result of all the restructuring that we did at the end of last year and early this year. We have a solid cash position. We ended June with approximately $1.7 billion in cash and that represents 13% of our last 12 months revenue and we continue to see an improvement in our leverage ratios which is approximately five times EBITDA.

Those are all the prepared comments that we have regarding the second quarter. I think that covers most of the main highlights and we will be happy to take any questions that you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question is from the line of Bernardo Vélez from GBM. Your line is open please go ahead.

Bernardo Vélez - GBM

My first question is regarding Venezuela. Will you receive the remaining cash balance held in the country and just to be sure and correct me if I'm wrong, what you’re saying is that the government did respect the applicable VFE3.3 per U.S. dollar rate for the profits generated during 2013?

Andres Osorio

This is Andres Osorio. [Indiscernible] Venezuelan government on the depreciation of the sale of non-permitted funds cost for an exchange rate of CCAT 1. CCAT 1 as you know is currently at rate of roughly VFE11 with dollar whereas [indiscernible] 6.3. That’s the gladder [ph] for having taken the one-time one off of $56 million. Now in terms of payment, this deal with the government calls for an initial payment and then remaining payment of the next three years. That's the deal with the government.

Bernardo Vélez - GBM

Okay, thanks very much. And what will the impact be on your results and profitability coming from the capacity reductions in Venezuela and you could reaccelerate further capacity reductions in the year?

Gisela Escobar

The reductions that we’ve implemented are approximately 45% reduction in ASKs to the operation that we had last year at this time. And for now, we don’t have any changes planned to those itineraries. Obviously we’re always looking at the network but for now that’s the operation that we’re working with.

Bernardo Vélez - GBM

Okay. And what will be the impact on your results and profitability coming from this low end capacity in Venezuela, which if I understand correctly is one of most profitable countries you're in right?

Gisela Escobar

Well, last year there was -- it was never -- Venezuela as a total percentage of ASK was never such a large portion of international passenger operation for LATAM. We did have flights from many of the different cities where we operate, but the impact that we have is already all quantified in the new guidance that we’ve given and we expect what we’re doing with capacity is trying to put it in other markets to offset the negative impact that, that capacity reduction would result in.

Bernardo Vélez - GBM

Okay thanks and lastly could you comment on your exposure to the Argentinean market and how has it been performing, both in passenger and the cargo divisions in last few months?

Nicolas Goldstein

We were expecting a large decrease in the number of Argentina. We can see the reduction. However the reduction is not that big that we were expecting instead of probably 30% relative to 20% - 15% reduction in the demand and this number includes the reduction in number of passenger and it is going down both side.

Operator

Thank you. And next question is from the line of Savi Syth from Raymond James. Your line is open. Please go ahead.

Savi Syth - Raymond James

Just on the economic weakness that you’re seeing in the region, is it mainly Chile and Argentina that’s lane or kind of various other regions weak as well?

Gisela Escobar

Mainly what we’ve seen in general is that during this year various countries have brought down the GDP growth rate estimate. That includes Chile, it includes Peru, it includes Argentina, Brazil and so it’s been I would say occurring throughout the region. In some countries, we’ve had a more significant impact than in others but undoubtedly we’ve seen a slowdown in economic growth pretty much throughout South America during this first half.

Savi Syth - Raymond James

Okay got it and then on the weak seed export, is that due to timing? Is that due to kind of slowdown in the economy? Or was there a switch from air freight to maybe ocean freight?

Gisela Escobar

It was for the most -- it has to do with timing. So when the seed export season occurs earlier in the year, a large part of it goes by other types of transport, mainly sea. And when there was delay in term of the seed export season which has to do with the weather, basically when it occurs later in the year, most of it goes by air cargo and that’s what happened in 2013. This year since it occurred earlier, most of it went by sea and that resulted in a decline. We had approximately 11,000 tons of seed exported in 2013 and this year it was 5000 tons of seed and specifically in the case of [indiscernible] significant. Don’t wait to predict how that would necessarily evolve going forward, but this was especially weak season.

Savi Syth - Raymond James

If I may have a follow-up on previous question on Venezuela, are you accumulating any more bolivars in there or the bolivar accumulation neutral now?

Andres Osorio

So the amount that we have reported is [indiscernible] going forward.

Operator

Thank you. Next question is from the line of Duane Pfennigwerth from Evercore. Please go ahead.

Duane Pfennigwerth - Evercore

Regarding the World Cup impact I guess most of which should fall in the third quarter here, are you seeing any recovery in bookings yet and is it fair to say at least at this point internally that you expect margin expansion to resume in the fourth quarter?

Cláudia Sender

Hi, Duane this is Cláudia Sender here. Yes absolutely we have seen bookings coming back to a very healthy level, very similar to what we were seeing in previous -- before the World Cup. Also the price levels -- these levels have been going up to the same standards that they were before. So yes we do expect a much healthier operation for the rest of the third quarter.

Duane Pfennigwerth - Evercore

And then I guess just from a consolidated level, if we take in that impact in the third quarter and just look at your full year guidance, it seems like it assumes a margin expansion resuming in the fourth quarter, I wonder if you guys comment on that?

Cláudia Sender

Yes. I mean definitely the margin -- I mean we should see margin expansion improving in August but obviously the impact of the third quarter in the month of July which is seasonally very high is significant. So definitely a healthier margin will be in the fourth quarter.

Duane Pfennigwerth - Evercore

And then have you given any thought internally, have you at least analyzed maybe a stock repurchase program? I think investors would certainly appreciate that signal of confidence longer term that you can recover these margins? And thanks for taking the questions.

Nicolas Goldstein

No, we don’t think about it and we are not planning to do that.

Operator

Your next question is from the line of Mike Linenberg from Deutsche Bank. Please ask.

Mike Linenberg - Deutsche Bank

Just a couple of questions here. I know in the past you’ve indicated that you’d like to get back to an investment grade credit rating. And when I look at the press release, in the balance sheet section you talk about getting to this long-term leverage ratio of 3.5 to 4 times and then maintain the cash liquidity of approximately 15%. And we’ve seen that if you really wanted to get to an investment grade credit rating you’d probably have to have a leverage ratio a little bit lower than that, maybe more like in the 3 times area. So I am just, is it sort of a change in that long-term view, do you still aspire to get to an IG rating or is it just kind of longer than you anticipated?

Unidentified Company Representative

Hi Mike. Its [indiscernible] matter I mean definitely -- we have not changed our target in terms of the balance sheet indicator. The 3.5 times leverage is what we see as the investment grade levels. Of course it is coupled with healthy margins, healthy cash generation and the right liquidity levels. And those are the levels of leverage that LAN had in the past when it was in investment grade rating. So we don’t necessarily think that we need three times or less to be investment grade. We think that in between 3.5, we should be able to get there. And it continues to be our objective, but as you correctly say, I think that objective today is probably more ‘16 or further events than the next year event.

Mike Linenberg - Deutsche Bank

Just another question. I know the Azul has announced that they are going to start flying long haul from Brazil to the U.S. and it’s actually been some time since TAM has actually had to go head-to-head with a local carrier flying internationally long haul and I am just curious how you think about the potential competitive threat when you look at [indiscernible] and you look at just the amount of flights that they have in that market, and my sense is that maybe they won’t rely as much on the local market, [indiscernible] to the U.S. but it may be more with respect to flow traffic. And I just wonder if that’s something that you are looking at closely, how do you think about that as a competitor? Does it make sense for you to fly long haul out of [indiscernible] just your thoughts on that?

Nicolas Goldstein

Yes. We know they are entering by the end of this year. We were expecting that and we were preparing to complete but we are doing without a carriers. American Airlines already, actually a change in the offer, now they are going to fly from [indiscernible] as well. So going to add more some more capacity from Guarulhos. We are seeing some other frequencies Brasilia also with this we are going to complement and adds more cities from the domestic Brazil market going to U.S.

Mike Linenberg - Deutsche Bank

And if I could just squeeze in one more, you’re going to redeliver 39 airplanes over the next two years and you have to think that as you return airplanes, there’s got to be some cost associated with that, some cost headwind. And I'm curious about what that impact maybe annually to turn back those airplanes and of course there is some training events associated with them as pilots move away from say this last year 737 to the Airbus narrow bodies. Do you have any sort of estimate on what that is? Is it a margin point headwind? How do we think about that?

Alvaro Carril

Yes, Mike, this is Alvaro Carril. We’ve already delivered some [indiscernible] in the last 18 months. We’ve accounted for a one time impact on this issue on the first quarter you may remember that. We do account for the day-to-day normal re-delivery processes in our numbers. So it’s all been accounted for. And yes there is an expense but its size is ending on the type of airplane, the age of the airplane and the redelivery submissions. The impact is not significant over the numbers that we have. It’s the numbers that we have given you already on first quarter onetime expense.

Operator

Thank you. Next question is from the line of Eduardo Couto from Morgan Stanley. The line is open. Please go ahead.

Eduardo Couto - Morgan Stanley

Good morning Gisela and the rest of the team. Couple of questions from my side, first on the cost, did you have any fleet restructuring expense in the second quarter similar to the first quarter or there is no fleet renewal expenses this quarter?

Alvaro Carril

Only the fleet expenses that are associated to the essence that have been redelivered during the quarter in the normal course of business. So no important or relevant expenses that haven’t been accounted for particularly in the first quarter onetime expenses we will.

Eduardo Couto - Morgan Stanley

Are you expecting additional expenses for the upcoming quarters still?

Alvaro Carril

We have a few more redeliveries this year and the impact throughout the year is not significant.

Eduardo Couto - Morgan Stanley

Okay, thank you. Second question on the international routes out of Brazil. Are you anticipating like strong competition in terms of fares given that as you mentioned Americas is starting to fly out of Campinas in December, Azul also flying. So is there a risk to see a pricing war on the Brazilian international routes by the end of this year or no?

Nicolas Goldstein

This is Nicolas again. What we observed is a lot more capacity additions [indiscernible] and as we know in this industry these are things that happens on the industry trends to correct, we reduced this capacity and we expect others to reduce and these extensive capacity is impacting the yield. Same store our reduction [indiscernible] improvement in the route and we expect that others are going to follow us in this direction.

Eduardo Couto - Morgan Stanley

But actually the others are adding, right. So my point is through 2015 could be a plus year in terms of international routes out of Brazil?

Nicolas Goldstein

We do believe that we are going arrive some at new division in the short term as we stay like nine month, 12 month, I don’t know. But if you see the type of this industry we will arrive to a new division.

Eduardo Couto - Morgan Stanley

Okay, and just one other question on recently we saw the Brazilian government sending to Congress a lot of subsidize the regional flights in the country. Just want to hear your thoughts on is that is going to participate of this regional plan and when do you expect you have a final decision if we’re going regional or not?

Cláudia Sender

This is Cláudia again. Well, we're always looking into new opportunities for growth. The region is definitely an opportunity that’s been in our radar for quite some time now. And we look at the opportunity -- it has to be trend from both a strategic and financial standpoint regardless the subsidies. So as the subsidies from our perspective so this probably make sense and the growth in Brazil has been coming from the smaller cities faster than from the bigger from crowds [ph]. So yes it's something that we’re looking into very closely and we expect to have some decision by the end of this year.

Eduardo Couto - Morgan Stanley

And the timing between taking the decision and starting to fly is like six month, 12 months, how longer it take?

Cláudia Sender

I would say anything between six and 18 depending on the type of fleet and how we go about purchasing [indiscernible].

Eduardo Couto - Morgan Stanley

Okay. And the final question on the impact of the World Cup. Why the impact was so much bigger in July vis-à-vis June given, that the World Cup was more or less balanced between June and July. I was wondering why the July impact is four times bigger than the June impact.

Cláudia Sender

That has everything to do with the seasonality. July historically is one of our strongest months where you still have a lot of foot for traffic and you have very strong leisure traffic in our region as you know July is a very concentrated travel month. So in general both the yields and the traffic are stronger in July than in June, that’s why the impact is so much higher.

Operator

Thank you. Next question is from the line of Thomas Kim from Goldman Sachs. Your line is open please go ahead.

Thomas Kim - Goldman Sachs

I wanted to get back to the Venezuela currency question. At what point during the quarter did you shift to the SICAD 1 in recognizing your revenue?

Cláudia Sender

It happened at the close of the quarter. We -- basically the adjustment that we’ve made is we have the cash in Venezuela that amounts to -- that has been presented for repatriation to CADIVI and that amounts to VFE930 million approximately. So the adjustment that was made is that that cash in bolivars was presented on our balance sheet at 6.3 exchange rate. And we basically recognized an exchange difference when we change at the close of the month of June the CADIVI exchange rate to the SICAD exchange rate which is 11.

Thomas Kim - Goldman Sachs

Okay, so just to make sure I get the math right. So what was the ending cash? Is it the $147 million minus the $56 million so you’re at net $92 million in U.S. dollar terms at the end of the second quarter?

Cláudia Sender

That’s right.

Thomas Kim - Goldman Sachs

Okay, and then so obviously 1% last time you mentioned that Venezuela is about 1% revenue, obviously not necessarily a number but if you’ve got a book revenue now at SICAD I than that 1% is going to drop to basically 50 bps at that point. And is that also reflected in your guidance?

Cláudia Sender

It is reflected in our guidance but also it’s important that the revenue from our international operations is booked in U.S. dollars. So the adjustment that we made is in our cash balance, not in the revenue recognition which is always in the U.S. dollars.

Thomas Kim - Goldman Sachs

Okay, all right that’s helpful. Can you just walk me through the processes behind going to SICAD I versus some other companies that have actually already moved to SICAD II?

Andrés Osorio

This is Andrés Osorio. What happened in Venezuela is there is a problem with the money that was sensitive to CADIVI from 2013 and then you have the regular operation of 2014. 2014 has been booked all the airlines at SICAD I because that is official or to integrate to present it to the CADIVI or whatever do down. When going over the money of 2014, there has been some payment or allowanced to evacuate us the SICAD I. Many agreements have been signed among different airlines to the government, some of them has in order to evacuate money, our CapEx a haircut of whatever a 30%, 40%, and then they paid -- we bought the dollar at 6.3 which is the same market we brought also SICAD I which is our case. We have agreed with the government that we will have the right to repatriate $147 million [ph] at SICAD I.

If you in the past half the right to repatriate that 6.3 it’s kind of the same thing that having a haircut of 35%. But what we’re observing here is at what exchange rate you convert your bolivars that you have in Venezuela and that is why we decided it or the business today is running at SICAD I and mainly of the agreement with the government of Venezuela to evacuate the money of 2013 is at SICAD I we decided to convert our money that we have in Venezuela at the SICAD I and that put us on a one-time loss adjustment of $56 million.

Thomas Kim - Goldman Sachs

Okay, all right. And just I know you’re recognizing in dollars -- the revenue in dollars, but do you -- so future revenue recognition and from a real cash standpoint, so you’re originating traffic out of Venezuela. Would you be booking effectively at the SICAD II?

Andrés Osorio

No, SICAD II it’s another market like official black market because if the official currency today is 6.3, the SICAD I market to the airline and SICAD II is a market that the government allows you to sell or to trade dollars on a different price. But the third today in Venezuela are taking on SICAD I. So you self-pick it in bolivars thinking that SICAD I and then you can present it to the government authority your request to repatriate your money at SICAD I. Therefore in terms of margin we are much different that we are turning with the money that we are presenting to repatriate. And there are some delays but the government of Venezuela has paid 2014 to different airlines at the SICAD I during this year. But Venezuela is day to day living and we have good all our and our best forecast of what is going to happen in Venezuela in our guidance for the end of this year.

Thomas Kim - Goldman Sachs

Okay, I appreciate all that additional color. And then just with regard the Argentinean situation, can you give us some sort of benchmark to help us understand what the impact will be with the FX with regard to Argentina? I think it’s like 7% of your revenue. So it is mistrial how should we be thinking about the FX impact on your non-op expense and then more importantly even from a cash flow perspective?

Andrés Osorio

Before starting the answer of that will be another by [indiscernible] but the problem in FEMA [ph] there is no restriction today with the dollar. So the impact is basically on the selling and the dollar exchange rate but from the financial point of view so far we have on freight in equivalent of trading line or [indiscernible].

Nicolas Goldstein

Yes, as I mentioned before we were expecting a bigger downturn from Argentina due to the crisis they are having over there. However we still see passengers going and buying tickets with reduction close to 8% on the ticket value on the yield and amount of passengers reducing in total 20% [indiscernible]. But we were expecting as I mentioned before a bigger reduction and we are seeing this number growing and going back to regular number. Each week we are seeing big numbers getting there.

Operator

Thank you. Next question is from the line of [indiscernible]. Please go ahead.

Unidentified Analyst

Hi, good morning guys. I just had a couple of questions. First of all I would like to know if you could please share with us what’s the break on the breakdown of the revenues and costs per currency. And what measures are you putting in place to increase your billing revenue generation? My second question is it’s a follow up of the coming back to IG metrics. And basically I would like to know what measures are putting in place to reduce your leverage at the balance sheet level and if you are planning on doing any divestitures looking forward?

Andres Osorio

We didn’t quite get the first question. Could you please repeat the first question again?

Unidentified Analyst

So the basically the first question is I want to know what’s the current breakdown of the revenues and cost per currency?

Cláudia Sender

Yes, well. Regarding that in general we have approximately one third of our revenues denominated in Brazilian real and approximately 27% of costs in real. And that -- so we have an operating exposure to the devaluation in the Brazilian currency. For the rest of the currency, for the rest of local currencies we have more or less a natural hedge because we have approximately the same amount of revenues as cost denominated in the different currencies. So from an operating perspective, our most significant exposure is the Brazilian real.

Unidentified Analyst

And so in that sense -- sorry, and I just want to know in that sense what measures have you put in place to increase your billing into revenues generation?

Cláudia Sender

Sorry, can you repeat that, to increase what?

Unidentified Analyst

Your U.S. dollar leaned revenue generation.

Cláudia Sender

Well first the exposure that we have to Brazilian real is a real and you rightly said we have a very significant domestic operation in Brazil. And there are certain things that can increase the U.S. dollar revenues in generation in domestic Brazil. For example a larger percentage of domestic tickets sold internationally and things like that, that can reduce the exposure. But we also have a financial hedge that hedges that exposure. And we have 700 -- we took for the full year $760 million hedge of the real at an average of about 234 real per dollar for the year. So this is an exposure that we have to live with and in addition to that we have a financial hedge at least for this year.

Unidentified Analyst

Okay. And regarding the second question, regarding IG, coming back to IG metrics, I just want to know if you are planning on doing any divestitures anytime soon?

Andres Osorio

We’re not planning any divestiture. I think the leveraging company will be a company but the margin expansion. As you know last year we did a capital increase and we have significantly delivered the company as can be seen on slide number 12, the adjustment debt of EBITDAR as of June to 6 times and currently we’re running at five times. So this is going to be a consequence of the expansion on the margins, but no divestitures are planned.

Unidentified Analyst

Are you guys planning, do you have any expected timing when you are expecting to come back to IG metrics?

Andres Osorio

I think that question came up before. And we said that the continued numbers that we expect to have IG metrics roughly 3.5 times. This is I think more sort of long-term project but actually numbers that we see maybe by 2016.

Operator

Thank you. Your next question is from Stephen Trent from Citi. Your line is open. Please go ahead.

Stephen Trent - Citi

Most of my questions have been answered at this point. Just one follow-up if I may, your shift of the operations in Guarulhos Airport to the new terminal, if you could remind me, refresh my memory, one when it supposed to be done, and two given the reduction in connection times if there is any upside from block-hour utilization perspective?

Gisela Escobar

We believe that there -- we’re planning for change -- the move from Terminal 1 to Terminal 3 for the International operations will happen by the end of September. Of course that has some flexibility given that it will move entirely the whole airport. So the coordination is happening among a lot of airlines, but it didn’t happen by the end of this third quarter. And yes you’re absolutely right, the reduction in connecting time should not only give us more time to acquire a plane but also increase in the number of OLVs with the changed flight in the same airport. So we increase our sense of connecting that had number of passengers between regional long haul and domestic markets while still helping us to increase our on-time performance metrics.

Operator

Thank you. Next question is from the line of Bob McAdoo from Imperial Capital. Please go ahead.

Bob McAdoo - Imperial Capital

Thank you. Just a couple of questions about Argentina and Chile. If I understood what you said that the evaluation of the Argentinean currency does not cause as much of problem because in fact the percent of sales that you actually have or the tickets that are sold in and out of Argentina tend to denominated more in dollars as are the expenses in dollars and therefore it’s not out of balance and doesn’t cause a problem. Is that what you were saying?

Gisela Escobar

Yes, Bob, we sort of differentiated, there are two types of impact from the devaluation. From a financial perspective, we don’t have an imbalance in terms of revenues and cost in Argentina so we don’t have a financial impact from a depreciation of the Argentinean currency. What we do have and what has impacted us this year is the fact that a devaluation, specially a very sudden devaluation in Argentina like the one that occurred early this year has an impact on international travel because the international tickets are sold in U.S. dollars, international fairs in set U.S. dollars. So they become expensive for a passenger based in Argentina and therefore demand dropped and that’s the impact that we’ve seen.

Nicolas Goldstein

And probably, this is Nicolas again. Since I am from Argentina and I am too positive and this is well known, but really we do see a reduction in the demand. It is close to 20%. We don’t see like remarket there. There is reduction in the demand close to 20%.

Bob McAdoo - Imperial Capital

Okay. And then over in Chile, the currency there has been devalued to some extent. What is the -- from just a macro point of view in terms of what’s going on in Chile, why there is the weakness there, what is about Chile that is causing the overall weakness in the currency?

Gisela Escobar

We’ve seen first a slowdown in terms of the macro growth estimates throughout the year. The system has remained in I think more or less stable this year but there was a significant devaluation in January, February. And I think that has to do with the general macro and political situation in the country this year. It’s still a healthy economic environment. We're still looking at a growing economy this year. But compared to last year we were looking at 460 peso per dollar and today we’re looking 570. So it’s stabilized at those levels but as early this year it had an impact. Also significantly a large portion as you know of the Chilean economy index to mining industry and so a slowdown in that industry this year has had a significant impact in part of those downwards revisions to GDP growth.

Bob McAdoo - Imperial Capital

Good, very helpful. Thank you and then one just one quick one, and now make sure I understand what was said about Venezuela in terms, but you have restated this full amount and you have received a modest -- it sounded like a modest payment with a balance at these rates to be returned to you over four years. Is that correct and if so how much was the payment that you…

Andres Osorio

Hi this is Andres again. During the year we have received closely about $10 million from Venezuela but this agreement that we have made with the government, we haven’t received the initial payment yet. We think that this could happen within the next 15 to 30 days but I hope to give this good news on next conference call when we inform the quarter three. But again we -- if you take the cash that we have by December and the cash that we have today we have less cash in Venezuela. The adjustment is only to evaluate the bolivars that we have at the moment in Venezuela and we have today about 800 million bolivars in cash in banks in Venezuela. So we've been diminishing -- our operation has diminished and we used the cash that we have to pay our cost of the operation there. So the situation of Venezuela is uncertain and what we want to do is to transfer that on our balance sheet, that’s it. We hope that the government of Venezuela will give us the right to repatriate as we have said in our agreement and there is no -- we don’t see anything yet that to say something different. So we will wait and see and hopefully I will have very good news for you in the next quarter but our cash will be diminished month by month in Venezuela.

Bob McAdoo - Imperial Capital

But if you do get, it would be very helpful to all of us I think you’ve got a payment in the meantime, if you not wait until the next quarterly call to let us know, just to put out some kind of release because it would help us all feel more comfortable not only for you but for the airlines as to what might be a way to approach the problem. If there is a way that you could --

Andres Osorio

Don’t worry. We will make it loud.

Bob McAdoo - Imperial Capital

Make a nice loud clap or cheer or something. It would be helpful.

Operator

Thank you. Next question is from the line of Savi Syth from Raymond James. Please go ahead.

Savi Syth - Raymond James

Hi, just a follow up question on the international. With the Boeing 777 retrofit in moving to as the new terminal, could you share some kind of -- again what the potential magnitude of impact would be and like how much are you under-running because -- on the product side or is there anything that could help us as we model this out?

Cláudia Sender

We do believe that we will have a very positive impact especially on our business class load factor in yield given the products improvement which is very, very significant. Also the quality of the products that LATAM will have in the new terminal is unparalleled by any airline in this airport. We will have by far largest and best VIP rooms. We will have largest connection to serve both Brazil and the South American region. So we do not disclose the order of magnitude but we do expect a very significant increase in our routes, especially coming from executive class load factor but also from corporate overall economy class given the quality of the products that we will offer, the quality of the connection and the quality of the flows within Latin America and from Latin America to the other continent, given that LATAM is by far the airline that covers the largest flows within and to and from Latin America.

Savi Syth - Raymond James

And is the full impact -- should we expect that in the first quarter or would you see it right away in the fourth quarter?

Cláudia Sender

I think we will see part of it in the fourth quarter but the full impact given the sign that will take us to implement the entire retrofit of all of the 777, we will fuel it in 2015 full year.

Operator

Thank you. Next question is from the line of Bernardo Vélez from GBM. Please go ahead.

Bernardo Vélez - GBM

Hi, guys, just a quick follow up. You mentioned several savings for ASK coming from new and more efficient airplanes. But how will the leasing cost per ASK behave in these new planes compared to your current treat?

Gisela Escobar

When we talk about the savings and cost per ASK of the aircraft it includes -- it’s the total impact. So it includes the fleet cost as well as the savings in terms of fuel. So when we compare a 787 for example with the 767, the cost per ASK reduction of approximately 12% includes the efficiencies of the 787 as well as the fact that it’s a more expensive aircraft than a 767 on average. With the A350 which will eventually replace in the A330 fleet at some, when we look at that comparison, the reduction in terms of cost per ASK is more than 20% and that's comparing A350 orders with the exterior configuration of those aircraft with the existing A330s in our fleet and that reduction includes also the fleet cost. So they are all in numbers when we look at the cost per ASK reduction.

Bernardo Vélez - GBM

Okay, perfect. And there have been rumors daily about TAM buying or acquiring this regional airline I think and you have mentioned that you’re very closely looking at the regional market in Brazil. So could we expect some acquisition in the market or will you think of entering this regional market by yourself?

Cláudia Sender

The deal that we have in [indiscernible] is a clear entry line deal that we have with over 100 airlines across the world. So we are not looking into acquisition and its just partnership that makes sense for us. We’ll have a better coverage of the domestic market. So we’ll do it totally supplementary for our network they fly to destinations that we don’t. So it make sense for us to serve our customers better to have a partnership with an airline that flies to other destinations.

Operator

Thank you. That’s the end of the question and answers. I would now like to turn the call over to Gisela Escobar for closing remarks.

Gisela Escobar

Well, thank you very much for participating in the call today. And please feel free to reach out to us if you have any further questions. Thank you and good bye.

Operator

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 to you again soon. This concludes the presentation. You may now disconnect. Thank you and have a good day.

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Source: LATAM Airlines Group (LFL) Q2 2014 Results - Earnings Call Transcript
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