Air France-KLM's (AFRAF) CFO Pierre-François Riolacci on Q2 2016 Results - Earnings Call Transcript

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Air France-KLM SA (OTCPK:AFRAF) Q2 2016 Earnings Conference Call July 27, 2016 3:30 AM ET


Jean-Marc Janaillac - Chairman & CEO

Pierre-Francois Riolacci - CFO


Jarrod Castle - UBS

Neil Glynn - Credit Suisse

Ruxandra Haradau-Doser - Kepler Cheuvreux

Andrew Lobbenberg - HSBC

Oliver Sleath - Barclays Capital

Jack Diskin - Goodbody Stockbrokers

Damian Brewer - Royal Bank of Canada

James Hollins - Exane BNP Paribas

Anand Date - Deutsche Bank

Andrew Light - Citigroup

Jean-Marc Janaillac

Good morning to you all. Thank you for coming to this conference organized to unveil the 2016 half-yearly results of the Air France-KLM Group. And I would like to thank everyone who has joined us by telephone or webcast. I'm very pleased to be here with you for this first presentation. Over the coming weeks and months, I look forward to holding more in-depth discussions with each of you.

Pierre-Francois Riolacci will present the Group's performance for the first half of the year and more precisely its financial position. Before handing over to him, I would like to share with you my initial impressions after my first three weeks as CEO of the Air France-KLM Group, as well as the attitude that is driving my approach.

Since my arrival, my priority has been to go out and meet the employees and customers of Air France-KLM, as well as our partners, in order to better understand the Group's economic and social situation. The observation I can make is that we have considerable strengths, but our weaknesses are extremely penalizing. We have considerable strengths. We have two powerful hubs, Schiphol and CDG, and Paris and Amsterdam are two extraordinarily attractive cities and two major pools of economic development in Europe. We have a very balanced network to different continents of the world. Our network remains a world first, uniquely positioned to capture growth in emerging countries such as in Africa.

We have strong partners, especially Delta as part of a powerful joint venture. In the week after I arrived I traveled to Atlanta to meet with the CEO of Delta, Ed Bastian and his team. And he expressed warmly the importance of this partnership for Delta.

The Group has also significant market share on each of its two domestic markets, France and Netherlands. Our brands are strong, synonymous with trust. The move up-market of our products and services is recognized by our customers and by the market. I want to salute the momentum provided by my predecessor Alexandre de Juniac, who mobilized all the energies of the companies around putting the customer first.

Finally, I've been struck by the deep attachment to the two airlines that all the teams have been showing wherever I've been at the hubs in the cabins, in the cockpits, in our workshops and among our sales-forces. But some of our weaknesses are extremely penalizing. Despite recent improvements, our profitability is still too weak and our competitiveness is insufficient, which is hampering the development of the Group in a very competitive environment. The Group lacks reactivity as it has a complicated organization. Its strategy lacks clarity for its employees, who do not seem to have a medium-term vision which justifies the efforts required from them. Finally, I felt a sharp loss of trust, which I shall talk about in a moment.

Social dialogue is very demanding within the Group, and we have a certain number of deadlines and need to make a success of our negotiation. The news reminds us of this every day, especially today with the start of a seven day strike by Air France cabin crew. I am very saddened by this strike that I find most regrettable. Such a disproportion between the very serious economic and commercial consequences of this strike and the disagreements which have caused it prove that we are not experiencing a rational situation. This is a movement that deeply reflects what I have felt since I arrived, namely a loss of trust between management and certain staff categories, between the various different categories of staff and, more generally, a loss of trust in the Company's future.

I will devote all my energy in the coming weeks and months to restoring that trust, without which nothing is possible. This is the meaning of the strategic approach I started when I arrived and which will be concretely translated as from the beginning of November. I want to base this approach on listening, dialogue and the desire to involve all staff in this project. The current strike is contrary to the new spirit that I wish to breathe into the companies and can only complicate the process. There is work to do; no one can dispute it. But even if the social context is important, we cannot reduce the reality of Air France KLM to this one dimension.

What is the subject today? International competition in the airline industry is getting harder. In the short term, Air France-KLM must stand firm against the headwinds which are affecting the entire airline industry. They are geopolitical instability, terrorism which is affecting the attractiveness of Europe and especially of France, overcapacity in a number of international routes, pressure on fares, instability of the price of fuel. Like our competitors, we need to maintain and even to increase our efforts to adapt to this challenging and unstable environment. We must be in line with the dynamics of international air transport. We must have a renewed ambition based on a credible and sustainable joint project. We must provide ourselves with the means, both in terms of proper financial resources and operating performance, as well as the involvement of all our teams.

The project will take in account the expectations of staff, but also, of course, those of our other stakeholders, our shareholders, creditors and partners, placing the utmost importance on the collective interest of the Group. And it will be primarily focused on our customers. It will continue the ongoing initiative, aimed notably at upgrading the product, developing partnership and improving the growth in our areas of excellence, like maintenance, but also turning around loss making activities like cargo and point-to-point. It will be supported by renewed efforts to generate synergies between growth and productivity, which is the only way to build a sustainable future and by the equitable sharing of value. Lastly, it will include responses to major and evolving challenges, like the development of low cost markets and the renewal of the fleet. After this introduction, I will now hand over to Pierre-Francois, who will talk about the Group's economic performance in the first half of 2016.

Pierre-Francois Riolacci

Merci, Jean-Marc. Good morning all of you. Special greetings for those who are on vacation who are plugging in on the phone, with getting up early. We'll start right away with the key highlights of the second quarter. I would like to mention that of course we still have a strong tailwind with the lower fuel price for more than €400 million for the quarter, so it's still a big number. But for sure, no surprise that we have seen much stronger headwinds building up throughout this quarter. Of course we have still some issues in some places which are hurt by recession, like Brazil. But on top of that, we have this major geopolitical uncertainties, Brexit at the very end of the period. As you could expect, there is no impact of the Brexit on the second quarter. But more importantly the terrorist attacks that happened in Europe and especially in France, who of course are now hurting France as a destination. I will elaborate a bit further on that matter.

No surprise therefore that PAX revenues are down compared to the trend that we have during the first quarter. And it has actually deteriorated throughout the quarter, because April was much more in line with the first quarter, where June was definitely down year on year quite significantly. And this has to do mainly and first with the ramp up of the summer capacity. You remember that we mentioned, releasing the Q1, that we were worried by the shoulder periods, that is Q2, where the capacity, summer capacity are building up and where the demand is still not at the peak. And we have seen, indeed, such a bad impact, together with, of course this impact on demand coming from the political turmoil in Europe. On long haul, softer demand, excess capacity growth. That's basically true everywhere, with one exception, which is Africa, where we have seen more capacity discipline. Even our previous resilient areas, like North America and the Indian Ocean and Caribs, are now more under pressure. So during the second quarter, the unit revenue of the PAX business is down 5.6%. Adjusted from currencies it's down 4.1%. Another takeaway of the quarter is that now the currency impact on the revenues is not going the right way; it's going the wrong way because indeed about the moves of euro against U.S. dollar.

No sign of improvement, neither on the cargo market. And it's fair to say that unit revenue is still under heavy pressure and the improvement of the results are only on the base of the restructuring which has been completed. So, decrease of revenues of 3.7%, but some key achievements during this quarter. We are quite pleased with our unit cost performance, which are down minus 1.5%, excluding fuel, ForEx and pensions, which is slightly ahead of our own schedule, in the context of very strong capacity discipline. So you know it's an achievement to reduce unit cost when capacity is flattish. Successful restructuring of point to point, cargo, full freighters, ramp-up of Transavia, all these operations have been delivered in the context of a better profitability. So indeed, you see in the key data that the revenues are down. I will not elaborate further. But you see also that all our KPIs, all operating KPIs are definitely up, from EBITDA to operating result, and going through EBITDA for a significant amount during this second quarter, while of course, much lower than what we had seen during the first quarter.

All in all, if you look at the first half, the profitability is strongly up with EBITDA growing €463 million, current numbers. I would like to mention that in all these numbers, you have a strike impact in June from Air France, which is a bit less than €40 million. We have decided not to adjust, not to retreat anything from strike. So all the numbers that you see are including the €40 million of the June strike. The good points that I would like to mention also on the first half is that the operating free cash flow is up, €373 million, despite much higher level of investments. So that's really clear signal that our cash flow statement is very sound. You see also a further decrease of the net debt to €4 billion, bearing in mind, as you know, that we have basically very little disposal during this first half of the year and that our disposal program is expected to be completed during the second half of the year. So I think, again, we are not late on our schedule.

The return on capital employed is peaking at 11.7% on the last 12 month basis. That's a record high for our Company for many years. And the adjusted net debt to EBITDA ratio, which is a critical credit ratio, is down to 2.9 again in line with our expectations. I will not elaborate too much on the contribution per segment because I will, of course, come back to each of the business. You see that PAX revenue is down, so this is clearly the outcome of capacity being slightly down and unit revenue decreasing significantly year-over-year. You see on cargo the impact of the restructuring of full freighter, but also the impact of the unit revenue decrease. All in all, if you look, the unit revenue for everything, the REASK, we are down 5%, minus 4% for PAX and minus 15% for cargo. Strong growth of the MRO business, I will come back on it, and growth also of Transavia. On the operating income you see the reported €138 million improvement. And I think a good sign is that all our divisions, on a like-for-like basis, that is excluding ForEx, are positive or growing significantly over the quarter. That's also the sign that everyone in the Company is trying to move up.

Now if you move into the businesses, the PAX business first. Capacity, as I mentioned, is slightly down, 0.2%, but with a very split variation between Air France and KLM. Air France actually is down minus 1.4%, where KLM is up 1.6%, long haul down 0.5%, medium haul plus 1%. And we are finished with the adjustment of the point-to-point capacity, as expected. The unit revenue is down nominal 5.6%; adjusted for currency, 4.1%. This has been achieved through very strong efforts of revenue management with the ramp up of our Karma solution for managing fares, a strong sales effort with really impressive outperformance by the sales, network decision also. But it's fair to say that we had to face this massive capacity growth that hurt us quite a lot from May and in June as well. And you can see from the graph which is on the left bottom part, we have reminded you the load factor per month. And you see that where, in April, we were better than last year, plus 1.2%, you see that in June we are struggling to maintain the load factor. So this is a clear expression that we have, throughout the quarter, a change in the pressure. And same on unit revenues, we had very good performance in April, very close to zero minus, where in May/June we are far beyond minus 5%. So definitely we see a change in the performance.

To explain what's going on, this is a slide that we usually don't show in H1, but which reminds you that we have a large network. We have a balanced network, which is today a very strong advantage because we are much more agile to shift capacity from one place to the other. And I can tell you that we have been very active, moving parts of the network to other places. And also we have always a very strong commercial position in each of the market in which we operate. That explain partly also the relative resilience of our unit revenue compared to some of our competitors.

I would like also to remind you that the capacity for summer 2016 in the market, the industry capacity is up by 7%. It's plus 8% for North America, which is slightly better than before because some U.S. carriers have started to cut capacity at the end of summer. Latin America is plus 4%, so it is again the pressure here is a bit easing because some competitors cut capacity in Brazil, some other on Caracas. So we see a bit of an easing in the growing pressure, but it's still very much unbalanced. Middle East plus 14%, Carib and Indian Ocean plus 9%, Asia is plus 4% and Africa is plus 1%. So definitely, depending upon the market, we have a very different view.

On that graph that you know very well, I think the key point is the unit revenue nominal, which is down, as you can see in Q2, by 5.6%, this is brand new. And where you have been used to see a decrease in the unit revenue excluding currency, this is the first time in two years that we see decreasing unit revenue in nominal. And it's clear that the fact that we do not get any more the currency impact is, of course challenging. So if we look at the global network, I think that I mentioned already quite a few points. I would like to highlight that the pressure on the west is still very strong. South America you see that despite a very stable capacity minus 0.2%, we still face a decrease in unit revenue, excluding currency of minus 10%, that's a lot, minus 14% including currency. You see also that North America, which was a resilient point on the last quarter, the pressure is growing with a nominal RASK which is down 5.7%. Of course for an important market, that's a major point. On Africa, we can grow capacity 2.3%, while maintaining a unit revenue down only 1.7%. So that's definitely a resilient part of the network.

Asia, despite a significant cut in capacity, minus 6.2%, especially we have cut capacity on Japan given the poor result of these routes, despite this cut in capacity, we are facing again a decrease of unit revenue. And here we see a clear downturn in the Chinese market. From March/April we have seen the Chinese market softening. And the groups, Chinese groups are down 50% year on year on the quarter. So we see definitely a very strong adjustment on China. Carib, Indian Ocean, we have grown capacity, but we are not the only one. And we see again some pressure in that part of the network which was quite resilient.

On the medium haul we grow capacity by 1%, with a decrease of unit revenue of minus 4%. Point to point is resilient, and you see that point to point business, even if we have stopped with decreasing massively capacity, is quite resilient in unit revenues. On medium haul hub we have really a split performance between Paris and Amsterdam. And Amsterdam is doing reasonably well, where Paris is hurt, as I mentioned, by the political events.

On cargo, I mentioned already, there is no sign of improvement. Capacity in the full freighter is down 16%. Including bellies we are down minus 3.2%. But despite this decrease in capacity of minus 3.2%, we struggle to maintain the load factor. So it's clear that there is a huge pressure in the market. We are very pleased to have started restructuring the full freighter early enough. And thanks to this restructuring, we managed to improve our results. I think that you see in the graph on the left part of the slide, which shows the operating income of the full freighter, we are close to breakeven in H1 2016, which I think is quite a good achievement.

We face a massive deterioration of the unit revenue in the market, which is down minus 14.9%; minus 12.9% on a currency adjusted basis. But we are able, thanks to the restructuring, to post a very strong performance on the cost per ATK, which is down minus 14%. And even without fuel, we are down by about 5% on the cost per ATK. With decreasing capacity, it's a very strong performance. On maintenance I must say that it's quite a different story. The third party revenues are sharply up 12.9% adjusted for Forex. You see that the operating margins is also slightly up. And the backlog is at a record high, above $9 billion, with new contracts on the A350s which have been secured both on engines and components. I think that definitely a very strong performance.

The business is still difficult. And we see pressure on the shop visit of the small engines. We see also difficult points in the supply chain. So we need to be careful. And you should not expect that we should maintain that sort of margin throughout the next quarters. But still, of course, we deliver quite an impressive result on the E&M business.

Transavia story is a growth story. We grew capacity by 12%. It's even plus 20% in term of passengers. We have been hit by the political turmoil that has been, of course, the start of our operation in Munich at the end of March. At the same time we had Brussel attacks, and Brussels was one of the first routes of Munich. We had issues in Turkey, which have been impacting especially our Dutch operations. But still, as you can see, we have been doing reasonably well in terms of unit revenue, because, at the end of the day, despite the growth in capacity, the unit revenue is down 5.7%, stage lengths adjusted. You should not underestimate what's going on in the in our Dutch operations because this year Transavia Netherlands is basically completing the shift of its business from charter to scheduled. That is a real low cost profile.

And I think that's quite impressive to achieve still, despite a 60% decrease in charter capacity, to achieve still growth in ASK with reasonable unit revenue performance. And same for France, where we grew 30% ASK, with limited decrease of unit revenue. All in all it's a reasonable performance for Transavia. Of course there is one point that we need to look very carefully; that's the development of our Munich operations. They are lagging behind the initial business plan because we started a bit later than expected. Also we had this routes adjustment. Today it's fair to say that we have not demonstrated that we are successfully operating Munich, but that's for us a very important experience that we will be following up carefully over the next few quarters.

On the operating cost now, and that's an important part of our story, I will not discuss in detail that slide, page 12, not also on the phone, but just to mention that the increase in the aircraft cost, plus 6% that you see, is linked to mainly a reversal of provision that we had in 2015 in Air France which is not there anymore. So it's really a one off. And we have maybe more structurally an increase in the lease cost in KLM because we have old aircraft which are phasing out and we are phasing in, as the 787. So we have a slight increase of the lease cost. On the purchasing of maintenance service and parts, this increase is due only to the growth of our external revenues. And that when we said $100 million in maintenance, we buy 70%, so it's $70 million of spare parts and services outside. So that's the main driver.

On fuel, I mentioned already that we had the further reduction of the fuel bill by €500 million; that's a big amount. For the first time you see that the change in the fuel hedging is positive. That means that we are not yet in a situation where the hedging payout will be positive, but it's less negative that it was one year ago. And that's this change in fuel hedging that will be in the quarters, in the upcoming quarters, supporting the further decrease of the fuel bill. Indeed we expect some further decrease of the fuel bill in the next few quarters, as you can see on that graph. There is no change compared to the previous guidance that we gave you. We have more than 80% of our consumption for the second half of the year which is today hedged, part of it being hedged through a call option structure, so there's no downside and only the protection.

For the rest we stick; we haven't changed our hedging policy with the exception of this call option that we have discussed already. And the average price of the hedging is about between $55 to $60 per barrel. You see also that in 2017 we still expect some decrease in the fuel bill for about €200 million for 2017. One of the achievements of the quarter is in decreasing the employee cost. Again we have a significant decrease of the headcount for about 2,000 average FTEs. The real achievement is to convert this decrease in headcount into reduction of staff cost, which has been the case this year minus 2.9%. And it would be even slightly higher if we were excluding the profit sharing, because as our profits are growing the cost of the profit sharing is increasing as well. So we are going in the right direction controlling this employee cost.

Just a few words about the social agenda. I suspect there might be a few questions that we will try to answer with Jean Marc. However, I would like to mention that many things are going on within Air France and KLM today on the social side. You know that we are on the 2016 voluntary leave plan is ongoing. We are talking about 1,400 people leaving the Company from September 2016 to March 2017, and 200 cabin crew at the end of the year. So this is being implemented successfully. We have, as you know, a CLA negotiation. On cabin we have the strike which starts today up to August 2. We have done as you can imagine, our best to get through. If you have questions, we will of course answer.

On the cockpits, I think we have an agreement to suspend the Transform but also to suspend any industrial action up to November 2016, which is the time we will release our updated project. So I think we can work peacefully for these few months. On KLM, we benefit in 2016, of the CLAs which have been negotiated last year. We are making good progress in the HPO implementation, High Performance Organization. Many requests for advice from the work council have been completed successfully, so again we are moving forward. Of course we have some tough negotiation on ground, on cabin, on cockpit; no surprise about that. But again, we are making good progress even if sometimes attention is high especially on ground, where we have one union out of five who refused to sign the CLA and who is calling for action. But that's I think, the sign that we are also trying to move across the boundaries.

All in all we post quite a good result in terms of unit cost reduction, excluding currency, fuel price, pension down minus 1.5%, which give us some confidence to achieve the minus 1%, which is our commitment for the full year. If you look at the overall performance and the improvement in our operating income, I think that the first takeaway is that our capacity to keep the savings of the fuel bill is much lower during the second quarter than in the first quarter; it's down 55% to 15%. So that's, of course, a big drop. Still it has a positive impact of 60 million. And you see that, on top of that, our unit cost reduction is bringing €80 million. So 60% of the improvement of our performance during the second quarter is totally self help and is based on unit cost reduction. I would like once again to highlight that our capacity to retain part of the fuel savings is not just because we are sitting on our hands; it's all the efforts which are done by network, revenue management, sales people and I think they should be commended for that.

Based on that strong operating performance, we have decreased once again the net debt. If you look at the operating cash flow, it's up on the first six months by above €100 million to €373 million. The big increase is coming from the cash flow, the operating cash flow, mainly driven by the strong improvement of EBITDA. We have a big cash-out on the voluntary leaves in June. The total amount for the year is expected to be minus 200, so most of it is done. And it has to do with voluntary leaves plan in Air France. The change in working capital is as usual very positive at this time of the year. It is fair to say that we see a level of pre-paid tickets which is a bit lower in Air France than it was at the end of June 2015 which is a sign of the difficult revenue development that we have seen, it is consistent, it's not massive, but it is there. Strong growth of investment, which are up by about €300 million in line with our previous guidance, so at the end of the day, the debt is at EUR4 billion.

We will maintain our discipline and focus in investment, but growing, however, our investment efforts during the year. We have today a good level of visibility on our disposal program. You know that the Servair transaction has been agreed. There was one condition precedent, which was the success of the HNA Chinese group public offer on Gategroup. It has been declared successful on July 21, so this CP is completed. And we see no reason to believe that we should not be able to close the Servair transaction somewhere in October or November. That's our target, common target with the buyer. So based on that, and based on the good cash flows that we had at the end of June, we believe that our capital expenditure should be, for the full year, between 1.8 billion to 2 billion.

So this is on the high end of the range that we had indicated earlier. And this includes some buyback of leases. You remember that we had already indicated that if our cash flow was there and if we were able to complete our disposal program, then we would be willing to buy back some leases to improve our future unit cost without any negative impact on the adjusted net debt. And that's -- we have a few transactions that we have in mind that we could complete by the end of the year. And as you can see, the guidance for the disposal has been slightly increased to 0.3 billion to 0.6 billion. As you can imagine, the main variable of adjustment is the Amadeus shares which are fully hedged.

A word on pensions, because there has been a few events during the quarter, the big one being, of course, the much lower long term interest rates in the Eurozone. As you can see, the net pension deficit at the Group level has surged from minus EUR200 million to minus EUR2 billion.

This has been the case despite the very strong performance of the assets, which are improving by EUR800 million. But once again, this is mainly due to the increase of the DBO, defined benefit obligation, massively, on the back of this lower long term interest rates, which are down 80 basis points in one quarter, with a very strong acceleration at the very end of the month of June due to the Brexit. No surprise for you. Of course, it is a non cash impact. It is not good for our equity. It is not good for the future charge in the P&L next year, because if things stay where they are, it would probably mean that our pension charge in the P&L would increase somewhere between EUR50 million and EUR100 million next year. So that's not good news. However, again, it's non cash.

We have a specific issue with the KLM pilots' scheme, which is the outcome of many things coming together. In a nutshell and to make a long story short, in this plan, KLM pilots benefit from a guarantee on indexation. And there has been a new financing agreement adopted early 2015 in Netherlands that provides that any fund to maintain a guarantee in indexation should show a cover ratio of a minimum of 123%, which is a big number. And the cover ratio today of our pilots' fund is 113% due to the low interest rates. So this is really, all these, the coincidence of the new financing agreement on one side and the very low interest rates on the other side, that creates that unbalance of the cover ratio. Such unbalance, if not addressed, should lead us to cash out a significant amount by the end of the year. We don't know precisely, because it depends, of course, of the rates and the assets, but it could be a significant cash out.

We are not ready to do that cash out. So we have started negotiation with pilot unions to remove this indexation guarantee. It's fair to say that we have not made huge progress in that negotiation so far. And we are still, of course, discussing. But there is a scenario where, in the coming days, weeks, we could terminate, we could decide to terminate the financing agreement of the pilots' scheme. And therefore we would avoid, in any case, the cash out, which is, for us, a key point. That would create a new situation. That would create the requirement of a new negotiation. We are reasonably optimistic that we could conclude that negotiation. But even if we could not, then we would not have to cash out. And, however, we would have an impact on equity and P&L because then the net pension assets of the pilot funds would have to be removed of the balance sheet. Everything is explained in the notes, for those who have a special appetite for these pension schemes. All in all, financial ratios are improving quite a lot. Debt is decreasing. EBITDA, EBITDAR is improving significantly. So I think that's going definitely into the right direction.

I would like to mention that both airlines, this is the graph you are used to see for Air France and KLM, are contributing to the improvement of the performance. And that's, of course very important. However, you can see that the improvement of the margins of KLM are quite higher than Air France. And this has to do mainly to the gap in unit revenue. Today you have, in the second quarter, on the PAX revenue, we have a gap of variation which is about 3%. So the deterioration of unit revenue in Air France is 3% down compared to the unit revenue performance of KL, and that explains a significant chunk of this performance. It's fair to say also that the unit cost in KLM is improving a bit higher than in Air France, bearing in mind that the capacity is or capacity variation is also very different. We have not, of course for this first half, given the change in the management, we have not delivered to you a strong business strategy update. However, I would like just to mention that all the Perform charters, all the Perform projects are going on. Whether it's improvement of the product, everything about efficiency, customer related project, everything is moving on. And I think, of course it's very important until we have our new project that we keep the momentum and everything which has been delivering this result during the first half.

On the outlook, no major change. I would like first to highlight the second bullet, which is our vision of what could happen with the fuel savings. You remember that before we were mentioning that we expected fuel savings to be significantly offset. Today we expect for the next quarters that fuel saving will be more than offset by the pressure of unit revenues and ForEx. That's, of course a more cautious vision. That factors in the deterioration of the unit revenue and especially the pressure on France as a destination. We are confident to deliver our unit cost reduction of 1%. We will maintain strong capacity discipline and we maintain our target to generate €600 million to €1 billion of cash flow after disposals, with the adjustment that I mentioned on the CapEx target and the disposal target, leading to a significant net debt reduction.

That's it for the financial part of the presentation. And with Jean-Marc we are pleased to welcome your questions.

Question-and-Answer Session


We'll take our first question today from Jarrod Castle from UBS. Please go ahead, your line is now open.

Jarrod Castle

Thank you very much and good morning. Three if I may. Can you give an indication of what the magnitude of the yield decrease is at the moment, with some kind of geographic color versus the Q2 exit rate? Secondly, just in terms of your CapEx plans, if there is some kind of a material downturn could we see deferrals of plans in terms of fleet or other areas of CapEx as we go into 2017? Then just any views in terms of obviously you're trying to manage your own business, but any views in terms of resolution on the air traffic control strikes in France, what can be done about that? Thanks.

Pierre-Francois Riolacci

Okay. Just a few words on the yield and the CapEx plan. On the magnitude of the yield decline for summer, it's a bit early to be very positive. What we can tell you is that forward booking load factor is down for July, August compared to last year slightly down. In July we have recovered the gap. So we caught up during July, but we still have a gap in August. Of course we still have a few weeks to manage. But as you can imagine, catching up means further pressure on the yield. We have heard comments from our competitors that they see some areas being down by minus 8 up to minus 10. I think that could be up to that sort of magnitude in July, August. I think we need to be very careful on the summer. But it's a bit too early to be positive.

On the CapEx plan, yes of course we are exposed to a downturn. Again, we have a strong advance in terms of cash flow at the end of June. We are pretty secured on our disposal program. And of course, there will be up to the very end of the year there will be some arbitrage on the CapEx that we decide to do or not to do. When it comes to CapEx, you try to make decisions which go a bit further than the quarter, but you look also at the year after. And just deferring expenses to the first or second quarter of '17 is not necessarily the best decision. Again, we will manage our CapEx plan to make sure that we achieve our targets of free cash generation. We have different levers we can push on. Yes, of course you can always defer a few prepayments on aircraft. But again, that's not the best way to manage a company, but if it was really necessary to deliver a commitment, I think that will use all the levers.

On the ATC strike, well I think it's a very difficult question. I'll turn maybe to Frederic, if you want to say something. But unfortunately ATC strike has been going on in France for years and years. And I'm afraid they will go on for a while again. So of course we are penalized by this ATC strike but so far there is little that we can do.


Thank you. We will take our next question today from Neil Glynn from Credit Suisse. Please go ahead, your line is now open.

Neil Glynn

Good morning, everybody. If I could ask three quick ones please. The first one, Jean Marc, when can we expect your vision for the Company? Clearly you've obviously just really entered and I guess it'll take some time to properly assess the pre-existing strategy, but any thoughts as to how long you're giving yourself to make any strategic changes if you deem any necessary? Then a second question on capacity plans. You obviously haven't changed capacity plans for this year, but if the outlook is deteriorating as you touch on, and as seems clear, why isn't there any change at this point? How do you consider the outlook for winter and even 2017, given what you're digesting on a daily basis in terms of capacity? And then the third question, just interested in terms of how you would compare and contrast Transavia and Air France short haul booking sensitivity to the continued events in France, as well as elsewhere, versus long haul sensitivity. Is short haul a little less sensitive or how do you make any distinction? Thank you.

Jean-Marc Janaillac

For the first question it would be very arrogant for myself to arrive and after three weeks to have a clear vision of strategy. So as I told, I gave -- I think we need three or four months in order to prepare a plan. And I will not talk about change of strategy. I would more talk about giving a clear vision of the future and the way to reach these goals. And the method is as important as the strategy, and I really want to share it and to work with all the people of the Group to build this strategy. So I gave the goal is to present at the beginning of November this strategy. But as Pierre-Francois stressed, meanwhile Transform is going on and we pursue all the actions that are right now implemented within Perform.

Pierre-Francois Riolacci

I will first answer your third question, because it helps to answer the second one. The deterioration of unit revenues, as I mentioned, is general in the network. And you see the end balance between supply and demand a bit everywhere, except Africa. I also pointed out that there is clear pressure on France as a destination. That's where we are the most sensitive. To be very clear, when you look at the local flows, that is the flows which are going to CDG but which are not connecting, that's where we are hurt. On these local flows you have the part which is coming from France which is actually slightly up. So on that part, we have no issues, there is no issue with the French market, the French market is doing okay. It is growing. Not growing like hell but it is growing, and we have no problem on that local flows. Where we are hurt is local flows to France.

And that we have let's say a double-digit decrease expected for the summer and that we have seen already for the Q2. We have a double-digit decrease from external markets to France. Mainly on Asia, Asia is really sharply down compared to last year. That's coming from Japan, that's coming from China, that's coming from everywhere. We have Brazil, which is also very strongly down, and to a lesser extent we have the U.S. So we have these outside markets to France which are under pressure. So the sensitivity, as you can imagine is much more on the long-haul and to a certain extent it is also the medium haul. The short-haul is not under pressure. We see no sign on the short-haul. And again, we see no sign on Transavia, because Transavia is a home market. It's an outbound market so we are not under pressure. So the sensitivity, the main sensitivity is really on the long-haul.

Then it comes to your question about capacity. First I think it's a good question for our competitors, because so far we have been very disciplined in terms of capacity, minus 0.2% on the quarter. I think that if everyone was behaving like that we wouldn't see the same landscape in terms of unit revenues, I will stop there. Now this being said, I think that we have been very active in managing our capacity, I mentioned that KLM capacity is up 1.6% with a unit revenue development which is quite satisfactory and there is no reason for us today to adjust capacity there. And Air France capacity there. And Air France capacity is down minus 1.4%, but that's where we have today the most difficult part. So I think we are doing the job and we are definitely prepared to take any necessary action in terms of capacity, to make sure that we maintain and we protect our routes' profitability. I think we have delivered so far. There is no reason to believe that we will not do it in the future.


Thank you. We will take our next question today from Ruxandra Haradau Doser from Kepler Cheuvreux. Please go ahead, your line is now open.

Ruxandra Haradau-Doser

Good morning. Three questions, please. First, from the monthly traffic figures supplied of Aeroports de Paris, and Schiphol airport and they said that particularly KLM but also Air France had been very successful with transfer traffics this year. Transfer traffic at Amsterdam Airport up 4.7% year to date, in Paris before June, several months transfer traffic was up between 4% to 8%. Some hubs of airlines that belong to your main competitors have reported significant negative transfer traffic figures year to date. In Q1 your unit revenues decreased significantly less than its peers, and in Q2 RASK trend is probably in line or better than its peers. Load sectors are better but it does not seem as you are buying in transfer traffic. So could you please give us details on what you consider the drivers for the good transfer traffic performance in H1?

Second, Transavia started with very low fares in Munich. Your website suggests significant fare increases since then. How are currently your average fares in Munich relative to the average fares in Transavia's remaining network? And finally, you have already some targets for 2017 to reach breakeven in some of your divisions, subdivisions. Could you please remind us how much do these targets depend on agreements with labor unions in 2016? According to your current strategy, in case you will not reach an agreement, would at least some of these targets still be achievable? Thank you very much.

Pierre-Francois Riolacci

Okay. Thank you for your questions. To be, I am not sure I have got all the questions all right. I will try to bring you up to date. On Transavia average fare on Munich, I'm sorry, I'm unable to answer about the average fare of Munich versus the average fare of Transavia. For sure it's lower because we are in the ramping up. So at the beginning of the commercialization we are always lower, but that's something we can try to come back to you. I turn to my investor relations department and we will try to follow up that question and tell you. On the performance, on unit revenues, indeed we outperformed in Q1 quite a few competitors. We shall see for Q2. It's fair to say that compared to many others we are overexposed to the French destinations. No surprise given our foothold. However, I think that despite this overexposure, we are not, we should not be doing too bad in the second quarter compared to our competitors. Let's see what we see in their upcoming releases.

I would like to highlight that our capacity behavior is very different from many of our competitors. And, of course, that's the main reason why we are able to post a reasonable unit revenue development. We share -- we have ongoing discussion with the unions on the labor costs, which is still close to 60% of our cost outside fuel. So for sure it's an important component. As I mentioned, we have many things which are ongoing today. These things, these projects will deliver future savings in the quarters to come, including the second half of the year, but also in 2017. So, for sure we still have to complete negotiations, especially with the crews, to secure the long term gains that we have in Perform. But for the next few quarters we are very confident that we can deliver further unit cost reduction. We have momentum at the end of June and we have clear further contributions which are kicking in, in the next quarter, so we should be able to deliver further unit cost reduction.


Thank you. We will take our next question today from Andrew Lobbenberg from HSBC. Please go ahead.

Andrew Lobbenberg

Hi there. I'd quite like to come back on that last remark about how you've got multiple areas where you're pushing to drive unit cost improvements and where you're continuing to negotiate on productivity and cost improvements at KLM and indeed on the ground staff. To what extent do those efforts get handicapped by the behavior and the policy of negotiations with Air France cockpit and cabin, where you're no longer at the moment pushing for immediate cost reductions? So, how does that limit your ability to drive cost elsewhere in the business in terms of the politics between the different work groups? My second question would look to Italy and just ask what you see the outlook is for Alitalia in terms of any potential future cooperation, both within Europe, and equally what their thoughts are on the North Atlantic? Then a third question, quite curious to come back to the pilot pension at KLM and to understand, I guess, what the worst case scenario would be in terms of an equity hit if the negotiations go unfavorably? What's the worst downside to the balance sheet hit from that process?

Pierre-Francois Riolacci

I start maybe thank you, Andrew, for the questions. I start with your technical question about the equity impact. I think that in the worst case scenario, that is that we have to terminate the agreement and we are unable to reach an agreement on the existing pension fund. Of course, there will be a new fund. But if we cannot reach an agreement of the existing pension funds then it will mean it could be an equity cost of €500 million to €600 million. That is mentioned in the notes to the financial statements.

Jean-Marc Janaillac

For the question on Alitalia, it's one of the topics we are working on right now. And I will meet on Friday the CEO of Alitalia to discuss their, our agreement and their role on the North Atlantic JV. On the first question, of course it's important to have the same kind of direction and rhythm on the question of competitivity between the people of KLM and the people of Air France, and it will be really -- my main task to give the same direction and to give this direction so that all the employees work and behave in the same direction. It's the most important I think, in order to achieve our goals of a reduction of our unit cost.


Thank you. We will take our next question today from Oliver Sleath from Barclays. Please go ahead.

Oliver Sleath

Right. Yes. Good morning everybody. Thank you for taking my questions. Three, please. Firstly, just to pick up on Neil's question on your growth rate and potential growth outlooks for 2017. I think there had been a view earlier in the year that Air France could look to return to growth in 2017, subject to making a satisfactory agreement with the pilots. But now that that negotiation process is being re-launched in early November and we also have clearly a deteriorating demand environment in France, is it fair that we should be assuming that any meaningful growth from Air France wouldn't be coming until at least summer 2017 season now at the earliest? And second question about Brexit, given the currency shift I just wondered have you seen any more aggressive pricing behavior from the UK based airlines who are able to price more aggressively in foreign currencies? So I'm thinking anything you've been observing for example from easyJet on the short haul side or British Airways in terms of its pricing on some of the transfer traffic flows, given the FX shifts? And finally, could you provide any sense for how the pension deficit splits at the moment between Air France and KLM? Thank you?

Pierre-Francois Riolacci

Sorry, I didn't get your last -- pension deficit split between France and KLM. Okay. Well, on that one you remember that KLM was in a position of very strong net pension assets over the past. This obviously is very different now. I think that out of the €2 billion of deficits that we are at the Group level, I would say that Air France is accounting for 70%, something like that, and three-quarters for Air France and a quarter for KL. On the Brexit -- the other way round? Okay, the other way round. On the Brexit no, we have not seen yet significant change to the pricing behavior. It's too early to say that we see any significant impact of the Brexit. We hear what you hear in the market about some other operators shifting capacity from the UK to Europe, but today it's too early to say that we see a change in the pricing behavior.

Jean-Marc Janaillac

On the first question as I told, the plan we will present on November will need to be based on synergies between growth and productivity. So it's going to be the base of the discussion to elaborate this plan and we'll give you an answer on your question. But I think growth and productivity must be linked.


Thank you. We will take our next question today from Jack Diskin from Goodbody. Please go ahead.

Jack Diskin

Hi. Good morning. It's three questions from me. Firstly, I just want to ask on the visibility over forward bookings, I appreciate that this seems to be diminishing year on year, but could you provide any color in terms of what percentage of your diminished capacity out to the end of September for Q3 is already booked and how this compared to last year? Secondly then, I just was looking for a bit more color around how the premium side of the business has performed from a yield perspective through Q2 and how this is developing for July and August and whether we should assume that this is broadly in line with what you're seeing on the economy side and at a Group level? Then finally, just on the labor side of the business and you mentioned at the last update in May, Q1 update that the level of headcount reduction in Q2 would be lower than what we've seen in Q1 that seems to be the case. So is it safe to assume that by year end we should expect something in the region of 2,000 FTEs?

Pierre-Francois Riolacci

Okay. On the front cabin, rear cabin, we see a bit more resilience of the premium seats so far. That's a constant trend that we have seen over the last few quarters. So given that one of the big hits is coming from tourism from Asia, where there is a lot of economy, I think this is a trend that should be maintained over the next few quarters.

I think that on Q3 it's difficult for us to tell you more than I have already mentioned. Again, we see -- we lack pressure in the pipe that is the capacity to steer up the revenues given the load factor, which are lagging behind, so that's for sure a handicap. But it's difficult to quantify in unit revenue development for the full Q3. Yes, the headcount will continue, of course, to be down in the upcoming quarters. And I think that we should maintain the sort of gap, given that again at the end of the year we'll have the first leaves of the new voluntary plan, which are kicking in in Air France, and we have also some leaves in KL. So yes, we will carry on increasing the FTEs in the same sort of magnitude.


Thank you. We will take our next question today from Damian Brewer from the Royal Bank of Canada. Please go ahead.

Damian Brewer

It seems to be the fashion, I've got three questions. First of all, could I start with Transavia? Just if we took account of the growth you've made in France, the transfer of business scheduled rather than charter operation in the Netherlands and the Munich operation, in Q2 how much of that business was effectively new versus Q2 last year, whether it's by passengers or ASK or whatever data you've got? I just want to understand the unit revenue development in the context of the business' maturity.

Secondly on Paris, looking to Q3, could you give us some flavor of how you're trading in terms of forward bookings on long-haul routes where you're starting to encounter competition from Norwegian and whether that's any worse or the same as the rest of the business? Then very finally coming back to, I guess effectively the two previous questions about the premium trends. How much is the new product in the business cabin now rolled out across in particular the Air France fleet at the end of Q2 and where would you be by the end of this year? And given its relative success, are there any plans to speed that process up? Thank you.

Pierre-Francois Riolacci

Thank you. On the new product we're at 37%. We plan to be more than 50% of the new product to be rolled out for the Group at the end of 2016. We have decided also to upgrade our A330 in Air France. So that has been decided. I think that we are building up. Of course, as you mentioned, the feedback that we get on the new product is very strong, with a clear improvement of the net promoter score, so for us it's a big challenge to maintain the pressure. We were discussing earlier the CapEx. I think it's very important that we maintain a strong amount of CapEx to upgrade the product, because it gives, indeed, some good results in terms of customer satisfaction and therefore probably shows up somewhere in the yield resilience that we have.

On what we see from July, August, September, it's a bit difficult to mention what is the impact especially of Norwegian. But, again, when we look at the forward booking in the system it's not the place where we are the most hurt; it's clearly Asia which is by far driving the decrease. I mentioned also Brazil as being down very significantly. And if we look at the US, indeed we are a bit under pressure, but it's hard to say whether it's coming from Norwegian or the growth of other US carriers. So it's not anywhere in the same sort of magnitude. That's something we'd be able to comment probably at the end of the third quarter. I mentioned on Transavia that we have very significant growth in France, 30%. We still have new routes that we have added. But it's fair to say that this year we have also added frequencies. You know it's better to add frequencies at new routes. We see the unit revenue in the new routes ramping up. It takes time. It takes 24 months to really get to the nominal unit revenue. It depends. Sometimes we are disappointed and we have to change our mind, so that's part of it.

I think that on Transavia Netherlands, I know the charter is down by 60%. So it means that the schedule has been improving, growing dramatically over the period, but I cannot tell you from the top of my head the number of ASKs which are coming from the schedule versus the decrease in charter. But it's probably very significant, with new routes which have been opened also. So we are in this process of ramp up. Maybe that's something we'll follow up probably for the full year is to give you an idea of how we ramp up the fares on these new routes.

Damian Brewer

Okay. Thank you. Can I just check the 47% of the new business product, was that for Air France or was that for the Group?

Pierre-Francois Riolacci

That's Group, 37% . 37% was last year and it's 51% at the end of this year.


Thank you. We will take our next question today from James Hollins from Exane. Please go ahead.

James Hollins

Hi. Yes. Two questions from me, please. The first one is just on long-haul capacity. It looks like it was up 0.6% in the half but was down 0.5% in Q2. Just looking at the fleet, it looks like some 777s and 787s have come in recently. I was wondering if we would see H2 long-haul passenger capacity down year on year. If you could give a rough figure, that would be very useful. The second one is for Jean-Marc. I know you're not willing to give too much outlook on strategy, etc. I was wondering if you could give some initial feedback on particularly KLM, where you've seen particular strengths or weaknesses and, most importantly, how you found the attitude of the senior management of KLM to, I guess the wider Air France KLM Group? Thank you.

Pierre-Francois Riolacci

On your question of long haul capacity, no we do not expect to decrease capacity in H2. I think that our capacity should be even slightly higher in H2 than compared to H1. So no, we do not see a decreasing capacity in H2.

Jean-Marc Janaillac

I didn't catch totally your question, but Air France KLM is a Group with two companies in two different countries with, of course two different cultures. It's one of the strengths of the Group. And the goal is building on these two companies, I repeat with their own culture in each product, and to have a more powerful Group. So the idea is not to integrate, to have the same kind of reality, but really to cooperate in a better way and to give to the Group a better meaning and better strength that it has, so now it's all what I can tell you at this stage.


Thank you. We will take our next question today from Anand Date from Deutsche Bank. Please go ahead.

Anand Date

Hello. Morning, everyone. I've actually got a couple of questions. We've seen the U.S. carriers, like Delta like your partner, Delta, announce significant cuts to their transatlantic winter, but it didn't feel like we've really seen anything from the Europeans yet. Is this just because of FX or is there actually some other reason why the Europeans are still, in general, putting a lot of capacity there? Arguably is it because there's nowhere else to put long haul capacity? That's number one. Number two was just on the would there have been a material difference to the minus 0.2% capacity if we excluded ATC strikes? Number and then could you comment a bit on whether you've had any engagement with HNA on any other parts of the business, whether there's more that you could do with them? And then I was just curious as to why, what's the logic behind buying in more of your planes now. Isn't the risk that lease costs or plane prices actually decrease near term, so it might be better to wait? Thank you.

Pierre-Francois Riolacci

Thank you. On buying leases, it's very much a question of opportunity. You need to be in the situation where the lease expires and then you have the opportunity to discuss. Sometimes you can make a good deal, sometimes you can't. When you can, it's better off. The reason is, as we have a new standard in IFRS which is coming applicable in 2019, maybe even earlier. And with that standard all the operating business will be retreated on the balance sheet. There is no secret that the cost of financing through an operating lease is much higher than buying the aircraft or even going for a finance lease. So for sure it is creating a lot of value, with actually very limited impact to the balance sheet to buy back these leases. So again, it's a question of opportunity; it's not a vision of the long term market. It's really a vision of opportunity.

HNA, we had a deal as you know, on Servair. It's fair to say that on the spree of acquisitions everywhere in Europe. For sure they would be happy to discuss about many things. I think it's a group we take very seriously. They are good players, but you know also that we have other Chinese partners which are of paramount importance for us. And we need to make sure that we maximize the value we can create, which doesn't mean that we could not consider here and there some deals, but nothing strategic or major as we could imagine.

On the ATC strike on capacity, yes, for sure, there is a small impact. But it's difficult to argue that will have a massive impact, so I would not mention it as a major point. And vis-a-vis the capacity on North Atlantic, you may remember that this year it was mainly the U.S. carriers which were growing. And contrary to the year before, the European carriers were a bit more prudent. So I think they have more headroom to adjust their capacity because they had been growing of course, much more intensively. Is the ForEx coming in their decision? It could be, but you know the ForEx is so volatile and so difficult to foresee, I'm not sure you can shape up six months in advanced capacity just based on ForEx. Of course you can steer on a daily basis and weekly basis but it's very different to shift capacity on this very unstable ForEx that we have. I see it as much more to do with the flexibility that the U.S. carriers had in growing their capacity this year versus the European players. No questions in the room? Any questions in the room? Yes.

Andrew Light

It's Andrew Light from Citi. On the pilot negotiations at Air France, I think it was the original intention to reduce long haul capacity by I think, 7%, 8% next summer if an agreement was not reached with the pilots on productivity. Is that still the intention?

Pierre-Francois Riolacci

I think that we are reasonable people, we are here to do business. That's our first focus. So we make a capacity decision based on economics. It's clear that you've seen the yields and the performance that we have achieved during the first half of the year. And it's fair to say that the capacity of Air France has been actually upgraded in 2016 compared to the previous estimate that we had, because we decided that at the beginning of the year, given the market we had, it was better to increase capacity. We'll make reasonable decision on capacity based on the economics. Now for the rest, there is a big discussion which is upcoming, and I think that would be a bit bold to make any statement about '17 capacity until we have decided about these new projects that we are working on in the months to come. But again, it will be rational.

Jean-Marc Janaillac

Okay. Thank you very much. Thank you.

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