Investor Update

Jan 28, 2020

Slides

Hello, everyone, and welcome to Azul's Investors Update Call. My name is Beatrice, and I will be your operator for today. This event is being recorded and all participants will be in a listen only mode until we conduct a question and answer session following the company's opening remarks. I would like to turn the call over to Andrea Bocha, Investor Relations Manager. Please proceed. Thank you, Beatrice, and thanks to everyone for participating in such short notice. Joining me today are John Rogerson, CEO Alex Mofitani, CFO and Abhi Shah, our Chief Revenue Officer. Before I turn the call over to John, I'd like to caution you regarding our forward looking statements. Any matters discussed today that are not historical facts, particularly comments regarding the company's future plans, objectives and expected performance constitute forward looking statements. These statements are based on a range of assumptions that the company believes are reasonable that are subject to uncertainties and risks. With that, I'll turn the call over to John. John? Thanks, Andrea. Good morning, everyone, and Happy New Year. We've had a very busy start to 2020, and we're very excited to share some news with you today as we further move Azul forward to be more profitable and a better airline every day. So we're going to go through a few slides with you. We're going to go through the executive summary, take a look at the E2 economics, transaction overview, and then we're going to open it up for Q and A. I want to quickly just go through the executive summary. We had an ambitious plan to transform our fleet in a very quick period of time. And we have set out to do it over approximately a 4 year period. And we're here today to tell you that we're going to try and get essentially completed by the end of 2021. This is very exciting for us. It's very accretive and we're very excited what this means to our shareholders and to our crew members. There's over $4,800,000,000 of incremental EBITDA by 2027 and about $60,000,000 per E1 that we lose higher as we get new E2s in the fleet. I want to move quickly to Slide 5. We've showed this to you on several occasions, but we have roughly 900 flights a day in our domestic fleet and more than 50% of those are being flown by E-one aircraft. And so as you look at the opportunity for Azul moving forward, it's to transform all of the E-one flights into E-2s. And I want to walk through the economics of that quickly on Slide 6. Every Embraer next generation aircraft that we receive has 18 more seats. So we'll be producing more revenue, with a larger gauge. These aircraft are coming in at a lower rent than we were previously paying for our E-1s. The fuel consumption, as we've got 4 of these operating today, is around 19% better. And when you look at that on a per seat basis, it's about 26% better. The maintenance cost of this aircraft is 16% better and we're actually utilizing these aircraft about 2 hours more than our E-1s. This next generation aircraft is really a game changer for Azul as we move forward. And it's the most economic, environmentally friendly aircraft in its class. And so the seat mile cost of this aircraft is essentially where the A320neo is or the 737 MAX and does it with a significantly lower trip cost. As you move on to Slide 7, I just wanted to give you a little bit of the passenger experience. And Azul has always been about great passenger experience. But we're finding that the NPS, our net promoter score on the E2 is better than our E1s. And so this is going to help us continue to be one of the best airlines in the world. The carry on space for our customers is significantly better. They have wider windows. We have state of the art IFE system and Wi Fi systems on board the aircraft. It's a quieter cabin. So the customer experience overall, we maintain our 2 by 2 seating on these aircraft. We're taking the total fleet size up of the E-2s up to 75 aircraft. And so we're very excited what this will do for our customer experience and certainly for our profitability as we move forward over the next few years. I want to we did this transaction and been working on this over the last 3 or 4 months and finally came to a conclusion with both Watt and Breeze. And so I want to have Alex walk you through the transaction overview and how this is going to take place over the next month or so. With that, I'll pass it over to Alex. Thanks, John. Good morning, everyone. So as you know, we've been talking about this for a while. We told you that the performance of the E2 is so positive for Azul that it almost made sense for us to just ground the E1 and accelerate on E2, right? It wasn't exactly there. We needed a little bit of revenue to make that transaction work. So we went to the market and made sure we got the best deal we could find. And we found a good partner with LOT. We had already bought 7 of our E1s and for whom the aircraft is operating very well. LOT pays much less on a per fuel, on a per liter basis than we do. And so for them, the E1 makes total sense. And for us, the E2 makes total sense. So we were able to get to a market based agreement with them. And then we just replicated essentially that deal for Greek. So they are economically equivalent. They are essentially identical. And so these aircraft are going away. And once they go away, they never come back to us. So the sublet sea is going to take this aircraft and then they're going to have the responsibility to deliver this aircraft back to the resource. So this clearly resolves our goal of accelerating the exit of our E wins. When you look at Page 9, just to illustrate what that means, this the natural replacement line is how we would exit the E-one fleet naturally if we just waited until the end of the original operating leases, right? So essentially, we would have E1 flying with us until 2027. But obviously, we can't wait to get the E2 into our operation. And with this agreement with these two transactions, we'll be able to say it could be essentially done by 2021, as John said, right? We still have 7 aircraft, but I think this is a conservative assumption, most likely will be done by 2021. So it's a significant acceleration obviously from the natural exit of the E1s. It's also a significant acceleration from the previously planned that we had published originally. So this is good news all around. And then I think on Page 10, I think there's a summary really in terms of economics. If we follow the natural replacement line, what you would see is that our cash flow generation would follow the lower line in this chart. By accelerating, we're going to follow the upper line in the chart, and we're going to create all this incremental value that you see here. So essentially almost BRL 3,000,000,000 of incremental cash flow that would never be materialized unless we accelerated the exit of the E1. So obviously, by 2027, these lines meet each other because that's when we would have naturally been done with our U1 replacement. But that way, we can generate a significant amount of incremental value for Azul and its shareholders. As we've also been communicating to you on Page 11, let me talk a little bit about the accounting impact. With IFRS 16, all of these aircraft, whether they are operating leases or finance leases or owned aircraft, they get treated as owned aircraft. And obviously, we had a number in the books that assumed that the aircraft would stay in the fleet until 2027. Since these aircraft are going to leave prior to that, we need to take a noncash reduction to that book value, but this is purely accounting. Obviously, in terms of decision making, what matters is the 1,000,000,000 of reais that we're generating by accelerating the exit of the U. S. We also put in some comps here so that you can see the magnitude of the charge. We had other airlines riding up their E-1 fleet. They had younger older aircraft than us. Our fleet is younger, and that naturally means that our lineup is going to be a little bit higher. We also have more operating leases than the other carriers. The operating lease write off is also higher because you write it off to 0. And with an owned aircraft, you can write it off to the residual value. So naturally, our write off is slightly higher than our comps, but that's all explained by the age of the fleet and the fact that we have operating leases at Azul. Like I said, the locked deal is a market based transaction, and the Breeze deal essentially replicates the locked deal. Breeze is a related party, so we will need shareholders' approval for this transaction. But that's obviously, we will be very strongly that this is very positive for Azul. This is how we're going to create 1,000,000,000 of reals in incremental value. To make everybody feel very comfortable with this, we also got strong independent party verification of the deal. So we've got an independent consultant who's heavily specialized in Embraer Azaria Aviation. So basically, that's all of our analysis of whether this deal is market based, whether the 2 transactions are essentially equivalent and whether this is a good deal for Azul, which is what Azul has tested to. We also had do an audit of our agreed upon procedures as well. And so we're very confident with this transaction, and we're publishing on Page 13 our new 5 year operating fleet projection. This is our expectation. So here, you can see the exit of the E1. Like John and I said, we want to be done by 2021. I think this is a good working assumption. And this is our expectation, right? Given what we know now and what we expect for the future, this is what we expect to be flying over the next 5 or 6 years. But obviously, we have flexibility to adjust this as necessary, right? If market conditions are better or worse, if macroeconomic conditions change, we can flex up or down as required. But this is sort of the expected value of the fleet that we should be operating over the next few years. So with that, I'll turn it over back to John. Thanks, Alex, and thanks, everybody, for joining us. We've got Avi here as well. And so we'd like to open it up for any questions that you may have from the management team as it relates to this transaction. Our first question comes from Mike Linenberg, Deutsche Bank. Yes. Hey, good morning, everyone. So I just a couple of questions here. John, I just want to make sure I heard you right. You talked about the incremental benefit to EBITDAR to 2027 is $4,800,000,000 And I didn't hear if it was $16,000,000 per conversion? Or is it $60,000,000 It's $16,000,000 per year per fleet in cash flow. I see. So it's $16,000,000 dollars per year per aircraft. Okay. Yes, Mike, this is Alex. Just if I can chime in sort of how we did this analysis. Obviously, the cost that we have on the A1 is the sum cost, right? So we've looked at how much incremental benefit we would have by accelerating A2, how much incremental cost we would have by bringing in an extra E2 and then what's the benefit from the sublease transaction itself, right? So when you bake all that in, we're not assuming away the rent on the E1. We're stuck with that cost until the end of the original lease, right? So that's not a benefit. But the incremental revenue that we can get from AT and T, it's obviously we assume marginal load factor, marginal pairs for that capacity, right? We don't assume average load factor. We assume that only a small portion of both seats will get filled with a small pair. We get a much lower fuel burn, as John mentioned. We get a little bit of a maintenance benefit because of longer maintenance intervals, but that's not material. And we get the incremental cost of operating the E2 of owning the E2, right, which is the rent. Then we get the sublease from Lot and Breeze and some additional cash for maintenance. And we avoid the redelivery cost that we would have at the end of the original lease, but we incurred some costs now to deliver the aircraft as is to the operator. So when you bake all that in, it translates to a cash flow of about BRL 16,000,000 per year per aircraft, BRL 16,000,000, which translates to roughly BRL 2,900,000,000 of incremental cash flow. And once obviously, EBITDA, you don't consider rent and maintenance or roughly. So that's the $4,800,000,000 of EBITDA for the full term of the transaction. Okay. That's actually very helpful. And then the airplanes that are being subleased, do you have just the split of which airplanes are going to lot and which the number of airplanes that are going to Breeze? Yes, we do. So you see that on Slide 8. Yes, so what happened, so LOT has first pick, Mike, so they have 18 firm and they have 14 options that they can exercise. And then, Greece can take up to 28. Obviously, we only have about 53 of these, which is the opportunity that we have because some of these aircraft are so close to their natural redelivery that it doesn't really make sense for us to sublease them. But the 53 remaining lots can take up to $32,000,000 And then Greens will take the remainder. Okay. Great. And then just lastly, just to be clear, all the E1s, are they on operating leases? I just want to be clear on that. No. We have some we have about 12 that are on finance leases today. Okay. Because all of these will be yes, so actually, yes, 17 is here on PJ. 17 are on finance leases, but these will be leased to LOT and Breeze. And so the plan is to sell these aircrafts, and there's already a lot of interest for them because you're selling an aircraft with a lease already attached to it, which makes it an even more attractive aircraft, right? We have already been selling aircraft to Locke and other operators without the leads attached. Now we have a lot of interest from the source who would like to buy these aircraft with already 4 years of guaranteed revenue attached to them. Great. All right. You answered all my questions. Thank you. You're right. Yes. Our next question comes from Savi Syth, Raymond James. Hey, good morning. Just a couple of clarifying questions. First, just on the what would you say kind of the savings is on the EBITDA EBIT sense? And then also, does that include kind of the incremental cargo opportunity that comes the BT2? So let me answer the second question, and I'll pass it over to Alex for the first question. We've included nothing in here for our cargo operation. So this is just a pure E1 going out to E2. All we've done in this analysis include the incremental seats, the 18 seats that Abhi will have the opportunity to sell, but we have not included that. And then for EBIT, you can kind of see the impact on Slide 10. Yes. It's essentially the same number as cash flow. It's pretty similar to the cash flow number that we published. Okay. Got it. And then just on the timing of this, it was a pretty big drop off in 2020. Just is that pretty ratable through the year? Or how should we think about the timing? And I know you mentioned, Alex, are there some delivery costs in there? So is kind of the $16,000,000 is more kind of over time and it's a little bit less early on and then kind of builds up? So how should we think about kind of the timing of this? So Savi, Abhi will kind of talk through when the each E1 will go out and then Alex will kind of talk through the cost. Hey, Dabi. I've been here. Yes. So the in Qs actually, the E1s have actually some of them have already left and we have a bunch now starting to leave in February. So we're approaching the end of our summer peak season here. And so February, March, April, May, June is a very good time given the seasonality of demand late Q1 and Q2. So we have a bunch of airplanes signed to leave in February already. Makes sense also because for a lot, they want to have them in time for their summer. And so it makes sense to get the aircraft out now. So we'll have a bunch of airplanes leaving now starting in February. So we have a little bit of a valley in our capacity, which times up very well with the seasonality of Q2. And then it will continue through second half of the year. But the E2 deliveries, we have some coming now, but they really ramp up in the second half of the year. So you can expect airplanes more airplanes leaving now and then the E-2s will come to backfill them second half of the year. There's been a cutover at Embraer. So they're actually shut down for the 1st month of the year as they cut over between kind of old Embraer to new Embraer. So there's a little bit of a timing lag there. But and just to clarify something that Abi said, some have left the fleet in preparation to be sent to LAT and BREED. They're still on our books today, and they and we're not getting revenue for them, but they're still kind of in our books today. Yes. And in terms of the cost, I think, again, another value of this transaction is we're standing there potentially as is, but they need to be compliant with the regulation in each country, right? So with lots, there's a little bit more cost because they need to be IASA compliant and that we have to install some equipment in the aircraft. And that's essentially the bulk of the cost that we're seeing today, which is sort of in the order of magnitude of a couple of $1,000,000 per aircraft, which is also, again, baked into the projections. That's helpful. And if I might sneak in one more for Abi. Abhi, like what kind of markets is it just kind of strictly E1 markets? Or is there some markets that maybe you would want to put the E2s because they have a better range? Yes. So first of all, of course, our priority is to replace all of the E1 routes that we have. So we have roughly 500 departures a day. We've talked about that a lot. And our priority is to swap those over. The E1s primarily are in our network, a lot in Campinas in Telehorizonti and then like Unjiba, Hotel, Leisure, places like that. So corporate market, high frequency markets, the first route that the E2 has been trying is in company to Brasilia. And we gave the increased frequency on that route from 5 to 6 flights a day. There are some connected dot opportunities that are very interesting that the E2 economics enables and especially when it comes to increasing utilization, which we are doing with the E2, we're able to fly the G2 also slightly higher statements that we're not able to do with the E1. So we're able to connect dots that were further away that didn't make sense to the E1. We're able to add non stop destinations from complements, for example, that were longer, that were thinner, too small for the 320 and the economic didn't work for the E1. So it really, really opens up a lot of opportunities for us, not only in the 500 flights a day that we have that we want to switch over, but connect the dot opportunities. And you can expect along with the high utilization, a higher stage length as well for this aircraft. Our next question comes from Luca Barbosa, Morgan Stanley. Good morning, gentlemen. Thanks for taking my question. I have 2 actually. The first one, will Azul assume any credit risks from Lot and Breeze Group or the lease agreements will be transferred to the newly lessees? Yes. I think it's similar to other lease agreements. You essentially have the aircraft as the underlying collateral of the deal, right, which is very powerful, right? It's a very movable asset. Especially the jurisdictions that we're talking about today, it's very easy to repossess the effort in case of a credit risk. And then there's the buildup of the maintenance reserves that are in the deal as well. So we'll be building a cash balance throughout the length of the contract. And plus each transaction has security deposits, which is a few months' rent in advance. And so there's enough security for what we're doing. Okay. Makes sense. Thanks for the color. The second question is with the new fleet commitment, what would you expect in terms of ASK growth for 2020? Yes. So we haven't given our 2020 guidance yet, but what we've been saying all along and we continue to say this is that our ASK guidance has been very, very consistent 2018, 2019. And so you can expect something similar in terms of ASK guidance compared to what we've done in the last couple of years. So it will be a very similar ASK guidance. Perfect. Thanks for the color, Avi. Our next I have a question related to Breeze. Is anyone from Azul leadership going to Breeze with AVP or not? First of all, welcome back, Hernan. Thank you. No, nobody from Azul Management is leaving. David has an agreement with the Board of Directors at Azul that he can't, and they've got a great management team. They already have a CFO in place, commercial officer in place. And so he's built a good management team. And so we're working with them on this fleet transaction, but no senior member of the Azul team will be joining for his aviation group. Okay. Thank you. Why would we leave at this point in time? It's when the best years of us are in front of us. And so we're super excited to transform this fleet. And we've all done a start up, and so we're ready to continue running until we reach the value. Our next question comes from Stephen Trent, Citi. Good morning, Kevin. Thanks for the call. I had to join in a little bit late, so I apologize if I missed this, but just two quick ones for me. The first, just a quick question. From a mission capability standpoint, I'm also guessing that the E2 is still small enough to serve a bunch of those kind of medium sized airports that don't have particularly long runways? And just to make sure that my understanding is correct. Yes, Steve. We have no mission restrictions in our domestic network with digital. Great, great, great. Thanks, Abhi. And just one other quick one. I know from some time ago, you guys, if my memory serves me correctly, had a very, very small exposure to, I believe, Hong Kong Airlines from the, I guess, an HNA holdover. Maybe it was just 2 or 3 planes that, I guess, in a worst case scenario, 2 or 3 E-1s we have to take back. Any sense as to where that stands now and if those 2 or 3 aircraft are wrapped into this deal? They're not wrapped in this deal. And we actually have no guarantees on any E Jets that have gone to Hong Kong Airlines. I think what you're referring to, Steve, was on the wide bodies that they have. And I think it's an unfortunate situation that's happening in Asia right now. And so we look closely with this with the lessors and do a lot of business with the lessors. And so we're working through solutions jointly with them as things settle in China and with the HNAC group. We don't have any news to report at this time. Great stuff, John. A long time since I looked at that. So thanks for the first comment on Maria. Thanks, guys. I'll leave it there. Our next question comes from Matthew Kielywinski, Barclays. Hi, good morning. Thanks for taking the time. Just wanted to understand utilization a little bit more, the jump up. I think you mentioned a little bit more capabilities to do longer haul flying. But is there assumption you'd just be running the aircraft a little bit harder doing additional frequencies? And in the past, is that just kind of a function of the E-1s, were they just not capable? Or just any color on kind of the step up in utilization? Yes. Matt, so yes, so normally, utilization comes from stage length. It also comes from flying at night and on weekends as well. So the E-one really is a great airplane for your 1 hour, 1 hour 15 minute high frequency corporate routes, where you have 6, 7, 8, 9, 10, 11 times a day. But the problem with that is you have an hour flight, but then you have a 30 minute turn time in between those hour flights. So that's not very good in terms of utilization. And then you end up hitting the limits of the day, 5:30 am flights, 5 am flights or 11 pm flights that are not very good in terms of demand. So, what the E2 is able to do is, fly those corporate routes just as well, but also be able to fly longer haul routes that are 2 hour stuff, even 2.5 hours that perhaps is too thin for the 320. We're able to do wet eyes with the E2 that we're not able to profitably do with the E1. That increases utilization. We could even use the E2s on weekends for our vacations business, connecting dots that is too small for the 320. And so utilization really will come from stage length. It comes from extra red eye flying. And you're able to access parts of the day because of the unit the trip cost and the unit cost. You're able to access parts of the day profitably that you're not able to do with the E1. So it really opens up windows, scheduling windows that were not available with the E1. So that's really where the utilization comes from. And it's going to open up new market opportunities, new ROC opportunities that frankly will never serve in Brazil ever. And so we're going to be able to connect dots with this airplane that would never serve before. And I expect first nonstop stimulation, I expect the market to grow as a result. Okay, great. That's really helpful. And then forgive me if you touched on this before, but I think it was discussed briefly. But operationally bringing the new aircraft in, I've seen there's some minimal training. But any other operational impact of bringing a new aircraft in and switching out this year? No. So I think that's the benefit. So we've suffered through the last couple of years bringing all the A320s with the pilot training, but it's 2.5 days of training. I think we are the launch customer of the 195 E2. Embraer is a very strong partner of ours. They're in the same state as Sao Paulo. They're giving us tremendous support. And so we've been flying for about 3, 4 months now with E2 and it's been terrific. And so the dispatch reliability of the E2 has been above what we've seen on the A320neos. And so I think that's a testament to the great job that Embraer has done from an engineering standpoint. No, I think this aircraft works. And so this is something that we're working very closely with them on. And so anytime you take into aircraft, there are little problems, but engines are performing unbelievably well, and the operation has been fantastic so far. So we're pretty excited about that. Okay, great. Thank you. Our next question comes from Albert Valera, UBS. Hi, thanks for taking my questions. It's 2 from my side. First one, I see that the new fleet plan that some of the A320 news was delayed 1 year. I would like to know if it was a zero or those requests. And my second question is about the bids of the new request. Could you provide additional info about the new kind of the leads? What's the second page of operational leads and financial leads? So there's been no delay in the Airbus. It kind of delivers everything we've seen in our fleet plans. We've just taken a more realistic approach as to when we'll put them into service. And that's the only adjustment we've seen. So because the OEMs have delayed aircraft, so we've put a more realistic plan in place that we can execute to it. So that's the only difference. As for the lease rate, I think we've made it pretty clear that we were a startup airline in Brazil 11 years ago when the aircraft market was very tight. And so what we paid for our E1s is actually more expensive than we're going to pay for our E2s. And so that is a pretty phenomenal thing for an airline to do to pay less for a next generation aircraft that's got 18 more seats, 19% better fuel burn, lower maintenance costs. And so some of that was just paying for the sins of the past, just being a start up airline in Brazil in 2,008. And but we're this transaction kind of cleans us up once and for all and gets us moving forward in a new direction. But for sure, from a cash flow perspective, the E2s are significantly cheaper for us than the E1s are. And we have better conditions with financing, better conditions with the lessors in terms of cash reserves that we have on the E1s that we don't have on the E2s. And so overall, this transaction is very positive. Yes. In terms of financing, we like to have a good portion of our fleet that is finance fleet that is owned. And so over the couple of years that we had the crisis in Brazil, that served as a very good protection for us, right? Because the owned aircraft was easier for us to remove from the fleet and adjust our capacity. And so over time, over the next few years, we will favor finance leases so that we can build up this portion of our fleet that is debt financed and has more flexibility. Like we're showing right here, even the operating leases, we can find homes for, but it's not as easy, right? In an emergency, it's much faster for you to eliminate capacity with a fast enhanced aircraft. And so we will favor the majority of our aircraft going forward, especially on the back end of our 5 year plan, not as much in the couple of 1st couple of years, but more towards the back end, they will be refinancing leases. Thank you, Alex. Can I consider this likely was the previous aluets ratio of 70% operational yield and 30% net financial yield? Yes, we should get that's the point we want to get to by 2024, 2025. Perfect. Thank you very much. Thank you. Ladies and gentlemen, this concludes today's question and answer session. I would like to invite John to proceed with his closing statements. Please go ahead, sir. Great. Thanks, everybody, for the short notice and hopping on the call. We're very excited about what this brings to us from a transaction standpoint. We look forward to seeing you all at conferences over the next couple of months. And if anybody would like to follow-up individually, obviously, our team will be prepared to speak to each of you. Thanks everybody. Have a great day. That does conclude the Azul's audio conference for today. Thank you very much for your participation and have a good day.