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 on a listen-only mode until we conduct a question and answer session following the company's opening remarks. Should any participant need assistance during this call, please press star zero to reach the operator. I would like to turn the call over to Andrea Böttcher, Investor Relations Manager. Please proceed.
Thank you, Beatrice. Thanks everyone for participating on such short notice. Joining me today are John Rodgerson, CEO, Alex Malfitani, 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, but are subject to uncertainties and risks. With that, I'll turn this call over to John. John?
Thanks, Andrea. Good morning, everyone. 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. We're going to go through a few slides with you. We're going to go through the executive summary, we're going to take a look at the E2 economics, transaction overview, and then we're going to open it up for Q&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 had set out to do it over approximately a four-year period, and we're here today to tell you that we're going to try and get it essentially completely 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 BRL 4.8 billion of incremental EBITDA by 2027 and about BRL 16 million per E1 that we retire as we get new E2s in the fleet. I want to move quickly to slide five. 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 E1 aircraft. If you look at the opportunity for Azul moving forward, it's to transform all of the E1 flights into E2s. I want to walk through the economics of that quickly on slide six. Every Embraer next generation aircraft that we receive has 18 more seats, so we'll be producing more revenue with the larger gauge.
These aircraft are coming in at a lower rent than we were previously paying for our E1s. The fuel consumption, as we've got four of these operating today, is around 19% better. 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 two hours more than our E1s. This next generation aircraft is really a game changer for Azul as we move forward. It's the most economic, environmentally friendly aircraft in its class. The seat mile cost of this aircraft is essentially where the A320neo is of the 737 MAX, and does it with a significantly lower trip cost.
If you move on to slide seven, I just wanted to give you a little bit of the passenger experience. Azul has always been about great passenger experience. We're finding that the NPS, our Net Promoter Score on the E2 is better than our E1s. 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. The customer experience overall, we maintain our two-by-two seating on these aircraft. We're taking the total fleet size up of the E2s up to 75 aircraft. 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.
We did this transaction and been working on this over the last three or four months and finally came to a conclusion with both LOT and Breeze. 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. As you know, we've been talking about this for a while. We've 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 an E2, right? It wasn't exactly there. We needed a little bit of revenue to make that transaction work. We went to the market and made sure we got the best deal we could find, and we found a good partner with LOT who had already bought seven of our E1s, and for whom the aircraft's 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.
We were able to get to a market-based agreement with them, and then we just replicated essentially that deal for Breeze. They are economically equivalent. They are essentially identical. These aircraft are going away, and once they go away, they never come back to Azul. The sublease fee is going to take this aircraft, and then they're going to have the responsibility to deliver this aircraft back to the lessor. This clearly resolves our goal of accelerating the exit of our E1s. When you look at page nine, just to illustrate what that means, the natural replacement line is how we would exit the E1 fleet naturally if we just waited until the end of the original operating leases. Essentially, we would have E1s flying with us until 2027. Obviously we can't wait to get the E2 into our operation.
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 seven aircraft, but I think this is a conservative assumption. Most likely we'll be done by 2021. It's a significant acceleration, obviously, from the natural exit of the E1s. It's also a significant acceleration from the previous fleet plan that we had published originally. This is good news all around. I think on page 10, 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.
Essentially almost BRL 3 billion of incremental cash flow that would never be materialized unless we accelerated the exit of the E1. Obviously, by 2027, these lines meet each other, because that's when we would have naturally been done with our E1 replacement. 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, when we 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. 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 non-cash reduction to that book value.
This is purely accounting. Obviously, in terms of decision-making, what matters is the billions of reais that we're generating by accelerating the exit of the E1s. We also put in some comps here so that you can see the magnitude of the charge. We had other airlines writing off their E1 fleet. They had older aircraft than us. Our fleet is younger, and that naturally means that our write-off 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 zero, and with an owned aircraft, you can write it off to the residual value. 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 LOT deal is a market-based transaction, the Breeze deal essentially replicates the LOT deal. Breeze is a related party, we will need shareholders' approval for this transaction. Obviously we believe very strongly that this is very positive for Azul. This is how we're going to create billions of reais in incremental value. To make everybody feel very comfortable with this, we also got strong independent party verification of the deal. We've got an independent consultant who's heavily specialized in Embraer, Azorra Aviation, to basically vet all of our analysis of whether this deal is market-based, whether the two transactions are essentially equivalent, and whether this is a good deal for Azul, which is what Azorra attested to. We also had EY do an audit of our agreed-upon procedures as well.
We're very confident with this transaction, and we're publishing on page 13 our new five-year operating fleet projection. This is our expectation. Here you can see the exit of the E1. Like John and Abhi 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 five or six years. 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. This is the expected value of the fleet that we should be operating over the next few years. With that, I'll turn it over back to John.
Thanks, Alex. Thanks everybody for joining us. We've got Abhi here as well. We'd like to open it up for any questions that you may have for the management team as it relates to this transaction.
Ladies and gentlemen, thank you. We will now begin the question and answer session. If you have a question, please press the star key followed by one. If at any time you would like to remove yourself from the questioning queue, press star two. For those following the call via webcast, you may post your questions on the platform, and they will be either answered during this call or by the Azul Investor Relations team after the conference is finished. Our first question comes from Mike Linenberg, Deutsche Bank.
Yeah. Hey, good morning, everyone. 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 BRL 4.8 billion, and I didn't hear if it was BRL 16 million per conversion, or is it BRL 60 million?
It's BRL 16 million per year per plane in cash flow.
I see. It's BRL 16 million per year per aircraft. Okay. That's great.
Yeah. This is Alex. Just if I can chime in terms of how we did this analysis. Obviously the cost that we have on the E1s is a sunk cost, right? We looked at how much incremental benefit we would have by accelerating E2. How much incremental cost we would have by bringing in an extra E2, and then what's the benefit from the sublease transaction itself. 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. That's not a benefit. The incremental revenue that [audio distortion] can get from AT&T, obviously we assume marginal load factor and marginal fares for that capacity. We don't assume average load factor. We assume that only a small portion of those seats will get filled with a small fare.
We get a much lower fuel burn, as John mentioned. We get a little bit of a maintenance benefit because of longer maintenance intervals, that's not material. We get the incremental cost of operating the E2, of owning the E2, which is the rent. We get the sublease from LOT and Breeze, and some additional cash for maintenance. We avoid the redelivery cost that we would have at the end of the original lease, we incur some costs now to deliver the aircraft as is to the operator. When you bake all that in, it translates to a cash flow of about BRL 16 million per year per aircraft, BRL 16 million , which translates to roughly BRL 2.9 billion of incremental cash flow. Obviously, EBITDA, you don't consider rent and maintenance, roughly.
That's the BRL 4.8 billion of EBITDA for the full term of the transaction.
Okay. No, that's actually very helpful. The airplanes that are being subleased, do you have just the split of which airplanes are going to LOT, and the number of airplanes that are going to Breeze?
Yeah, we do. You'll see that on slide eight. What happened, LOT has first pick, Mike. They have 18 firm, and they have 14 options that they can exercise. Breeze 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. The 53 remaining, LOT can take up to 32, Breeze will take the remaining.
Okay, great. Then lastly, just to be clear, all the E1s, they are on operating leases? I just want to be clear on that.
No, we have about 12 that are on finance leases today.
Oh, okay.
Actually, 17. It's here on page eight. 17 are on finance leases, but these will be leased to LOT and Breeze. The plan is to sell these aircraft, and there's already a lot of interest for them, because you're selling an aircraft with a lease already attached to it.
Yep.
Which makes it an even more attractive aircraft. We had already been selling aircraft to LOT and other operators without the lease attached. Now we have a lot of interest from lessors who would like to buy these aircraft with already four years of guaranteed revenue attached to them.
Great. All right. You answered all my questions. Thank you.
Thanks, Mike.
Yep.
Our next question comes from Savi Syth , Raymond James.
Hey, good morning. Just a couple of clarifying questions. First, just what would you say kind of the savings is on kind of that EBIT sense? Also, does that include kind of the incremental cargo opportunity that comes with the E2s?
Let me answer the second question, and then I'll pass it over to Alex for the first question. We've included nothing in here for our cargo operations. 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. We have not included that. Then for EBIT, you can kind of see impact on slide 10.
Yeah. It's essentially the same number as cash flow. It's pretty similar to the cash flow number that we both published.
Okay. Got it. Just on the timing of it, there's a pretty big drop-off in 2020. Is that pretty ratable through the year, or how should we think about the timing? I know you mentioned, Alex, are there some delivery costs in there? Is it some of the BRL 16 million is more kind of over time, and it's a little bit less early on, and then kind of builds up? How should we think about kind of the timing of this?
Abhi will kind of talk through when each E1 will go out, then Alex will kind of talk through.
Hey, Savi. Abhi here. Yeah. The E2s actually, the E1s, some of them have already left, and we have a bunch now starting to leave in February. We're approaching the end of our summer peak season here. February, March, April, May, June is a very good time given the seasonality of demand, late first quarter and second quarter. We have a bunch of airplanes starting to leave in February already. Makes sense also because for LOT, they want to have them in time for their summer, and so it makes sense to get the aircraft out now. We have a bunch of airplanes leaving now, starting in February. We'll have a little bit of a valley in our capacity, which lines up very well with the seasonality of second quarter. It'll continue through second half of the year.
The E2 deliveries, we have some coming now, but they really ramp up in the second half of the year. You can expect more airplanes leaving now, and then the E2s will come to backfill them second half of the year.
There's been a cut over at Embraer, so they're actually shut down for the first month of the year as they cut over between old Embraer to new Embraer and so there's a little bit of timing lag there. Just to clarify something that Abhi said, some have left the fleet in preparation to be sent to LOT and Breeze. They're still on our books today, and we're not getting revenue for them. They're still in our books today.
Yeah. In terms of the cost, I think, again, another value of this transaction is we're sending the aircraft essentially as is, but they need to be compliant with the regulation in each country, right? With LOT, there's a little bit more cost because they need to be EASA compliant, and then 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 million dollars for aircraft, which is also, again, baked into the projections.
No, that's helpful. If I might sneak in one more to Abhi. Abhi, what kind of markets, is this just kind of strictly E1 markets or are there some markets that maybe you would want to put the E2s because they have a better range?
Yeah. First of all, of course, our priority is to replace all of the E1 routes that we have. 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 Belo Horizonte, and then Curitiba, Porto Alegre, places like that. Our corporate market, high-frequency markets, the first route that the E2 has been flying is Campinas to Brasília. We did the increased frequency on that route from five to six 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 E2 also slightly higher stage lengths that we're not able to do with the E1.
We're able to connect dots that were further away that didn't make sense with the E1. We're able to add nonstop destinations from Campinas, for example, that were longer, that were thinner, too small for the 320, and the economics didn't work for the E1. It 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 connected dot opportunities. You can expect, along with the high utilization, a higher stage length as well for this aircraft.
Helpful. Thanks, guys.
Our next question comes from Lucas Barbosa, Morgan Stanley.
Good morning, gentlemen. Thanks for taking my question. I have two, actually. The first one, will Azul assume any credit risks from LOT and Breeze Group, or the lease agreements will be transferred to the new lessees?
I think it's similar to other lease agreements. You essentially have the aircraft as the underlying collateral of the deal, which is very powerful. It's a very movable asset. Especially the jurisdictions that we're talking about today, it's very easy to repossess the aircraft in case of a credit risk. Then there's the buildup of the maintenance reserves that are in the deal as well. We'll be building a cash balance throughout the length of the contract.
Plus each transaction has security deposits, which is a few months rent in advance. 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?
Yeah. We haven't given our brain to any 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. You can expect something similar in terms of ASK guidance compared to what we've done the last couple of years. It'll be a very similar ASK guidance.
Perfect. Thanks for the color, Abhi.
Our next question comes from Renata Faber, Itaú.
Hi, everyone. Thank you for the call. I have a question related to Breeze. Is anyone from Azul leadership going to Breeze with David or not?
First of all, welcome back, Renata.
Thank you.
No, nobody from Azul management is leaving. David has an agreement with the board of directors of Azul that he can't, they've got a great management team. They already have a CFO in place. They have a Chief Commercial Officer in place, he's built a good management team. We're working with them on this fleet transaction, no senior member of the Azul team will be joining Breeze Aviation Group.
Okay. Thank you.
Why would we leave at this point in time? When the best years of us are in front of us? We're super excited to transform this fleet and we've all done a startup, and so we're ready to continue running Azul.
Our next question comes from Stephen Trent, Citi.
Good morning, guys, and 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. On 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. Just to make sure that my understanding is correct.
Yeah. Steve, we have no mission restrictions in our domestic network with the E2.
Great. Thanks, Abhi. Just one other quick one. I know from some time ago, you guys, if my memory serves me correctly, had a very small exposure to, I believe, Hong Kong Airlines from the, I guess, an HNA holdover. Maybe it was just two or three planes that, I guess in a worst-case scenario, two or three E1s you have to take back. Any sense as to where that stands now and if those two or three 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. I think it's an unfortunate situation that's happening in Asia right now. We look closely with this, with the lessors, and we 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 HNA 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 refreshing my memory. Thanks, guys. I'll leave it there.
Our next question comes from Matthew Bouley, sorry, Barclays.
Hi. Good morning. Thanks for taking some time. Just wanted to understand the utilization a little bit more, the jump up. I think you mentioned a little bit more capability to do longer haul flying. Is there assumption you'll just be running the aircraft a little bit harder, doing additional frequencies? In the past, is that just kind of a function of the E1s? Were they just not capable, or just any color on kind of the step up in utilization?
Hey, Matt. Normally, utilization comes from stage length. It also comes from flying at night and on weekends as well. The E1 really is a great airplane for your one hour, one hour 15 minutes high-frequency corporate routes, where you have six, seven, eight, nine, 10, 11 times a day. The problem with that is you have an hour flight, but then you have a 30-minute turn time in between those hour flights. That's not very good in terms of utilization. You end up hitting the limits of the day, 5:30 A.M. flights, 5:00 A.M. flights, or 11:00 P.M. flights that are not very good in terms of demand.
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 two-hour stuff, even 2.5 hours, that perhaps is too thin for the 320. We're able to do red-eyes with the E2 that you cannot possibly 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. Utilization really will come from stage length. It comes from extra red-eye flying. You're able to access parts of the day because of 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. It really opens up scheduling windows that were not available with the E1.
That's really where the utilization comes from. It's going to open up new market opportunities, new route opportunities that frankly were never served in Brazil ever. We're going to be able to connect dots with this airplane that were never served before. I expect first nonstop stimulation. I expect the market to grow as a result.
Okay, great. That's really helpful. Then, forgive me if you touched on this before, but I think it was discussed briefly. Operationally, bringing the new aircraft in, I'd seen there's some minimal training, but any other operational impact of bringing the new aircraft in and switching out this year?
No. I think that's the benefit. We 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 E195-E2, and Embraer is a very strong partner of ours. They're in the same state of São Paulo. They're giving us tremendous support. We've been flying for about three, four months now, the E2, and it's been terrific. The dispatch reliability of the E2 has been above what we've seen on the A320neos. I think that's a testament to the great job that Embraer's done from an engineering standpoint. They want to make this aircraft work, and so this is something that we're working very closely with them on.
Anytime you take a new aircraft, there are little problems, but engines are performing unbelievably well, and the operation has been fantastic so far. We're pretty excited about that.
Okay, great. Thank you.
Our next question comes from Alberto Valerio, UBS.
Hi. Thanks for taking my questions. Two from my side. First one, I see that the new fleet plan that some of the A320neos was delayed one year. I would like to know if it was Azul or those requests?
My second question is about the deals of the new aircraft. Could you provide additional info about the new kind of the deals? What the percentage as operational leases and financial leases? Thank you.
There's been no delay in the Airbus deliveries. I think what you'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. Because the OEM had delayed aircraft, so we put a more realistic plan in place so that we can execute to it. That's the only difference. As for the lease rate, I think we've made it pretty clear that we were a start-up airline in Brazil 11 years ago when the aircraft market was very tight. What we paid for our E1s is actually more expensive than we're going to pay for our E2s.
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. Some of that was just paying for the sins of the past, just being a start-up airline in Brazil in 2008. This transaction kind of cleans us up once and for all and gets us moving forward in a new direction. For sure, from a capital perspective, the E2s are significantly cheaper for us than the E1s were. 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, overall, this transaction is very positive.
In terms of financing, we like to have a good portion of our fleet that is finance lease that is owned. 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. 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 debt-financed aircraft.
We will favor the majority of our aircraft going forward, especially on the back end of our five-year plan. Not as much in the first couple of years, but more towards the back end, they will be finance leases.
Thank you. Can I consider this like the previous Azul's ratio of 70% operational leases and 30% financial leases?
Yeah, that's the point we want to get to by 2024, 2025.
Perfect. Thank you very much.
Thank you.
Ladies and gentlemen, as a reminder, if you would like to pose a question, please press the star key followed by one. 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 would be prepared to speak to each of you. Thanks, everybody. Have a great day.
That does conclude the Azul audio conference for today. Thank you very much for your participation, and have a good day.