Hello, everyone, welcome to Azul's fourth quarter 2018 results conference call. My name is Paula, 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, followed by the company's presentation. Should any participants need assistance during the call, please press five zero to reach the operator. I would like to turn the presentation over to Andrea Böttcher, Investor Relations Manager. Please proceed.
Thank you, Paula, welcome all to Azul's fourth quarter earnings call. The results that we announced this morning, the audio of this call, and the slides that we reference are available on our IR website. Presenting today will be David Neeleman, Azul's Founder and Chairman, John Rodgerson, CEO. Alex Malfitani, our CFO, and Abhi Shah, our Chief Revenue Officer, are also here for the Q&A session. Before I turn the call over to David, 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 that are discussed in detail in our TDM and SEC filings.
During the course of the call, we'll discuss non-IFRS performance measures, which should not be considered in isolation and are described in detail in our earnings release. With that, I'll turn the call over to David. David?
Thanks, Andrea. Thanks, everybody, for joining us. December 2018 marked our 10th anniversary. If you look at slide three in the presentation, it is truly amazing when you look at those two route networks, what we've been able to accomplish in the last 10 years. When we founded Azul back in 2008, we had a clear mission, to offer our crew members the best jobs of their lives because we knew our customers would have the best flight experience of their lives if we took care of our people. After 10 years, we can clearly see the passion in our crew members. They love their jobs and our customers love flying us. We couldn't have better ambassadors for our brand. Because of this fantastic team, we were able to build an unbelievable network serving more than 100 cities with a fleet of 125 aircraft.
We have built a solid foundation going forward. Every next-generation aircraft we add will strengthen our network even more while reducing our costs. We are now starting to reap the benefits of our network that we have built. Another huge benefit of having great culture and brand, when difficulties come, like spikes in fuel prices and weakening currency, we have the ability to recapture revenue to offset a significant portion of these costs. That's exactly what happened in 2018. Even though fuel was up 30% and the dollar appreciated against the BRL 17%, we delivered a record adjusted net income of BRL 704 million in 2018. We also generated BRL 266 million in free cash flow and ended the year with a total liquidity position of BRL 4 billion, reflecting our commitment to sustainable growth and building long-term value in the company.
You can see some of our amazing crew members on slide four. Because of them, we continue to rank as the most on-time airline in Brazil in 2018, and we were also recognized as the most on-time LCC in the world. That's a fantastic achievement considering the size of our network and the diversity of our fleet. The performance of the A320neo in our network has surpassed all of our expectations. These aircraft are flying an average of 14 hours a day. Improving connectivity across our airline, just as we said it would. At the end of the year, we had 28 A320neo representing 30% of our ASKs, which have a 29% lower unit cost than our current E1s. Every single one of these next-generation aircraft are desperately needed and will continue to be so for many years to come.
During the second half of the year, we also start receiving the Embraer E2. I've talked a lot about that in past calls. I'm very excited about it. That aircraft has a CASK that is 26% lower than our current E1s and has an impressive trip cost advantage of 20% to even our great NEOs that we're flying today. With both of these next-generation aircraft, we are creating a competitive, sustainable advantage that will continue to drive margins higher. In summary, we entered our first decade confident that we will continue to offer the best job in the lives of our crew members, which translates to the best flying experience for our customers, which we believe will continue to drive positive returns for our shareholders. With that, I will pass the board over to John to give you more details on the fourth quarter results.
Thanks, David. As David looked back on what we built over the last 10 years, I want to say we're just getting started. The best is still ahead of us. I also want to thank our crew members for all their hard work during the past quarter. As you look at slide five, the core airline drove strong results in a tough macroeconomic environment. Even with a 37% spike in fuel and the 17% depreciation of the BRL, we reached an EBIT margin of 11.4% for the quarter and a 31% EBITDAR margin while recording net income of BRL 138 million. The reduction in net income YoY was driven by a one-time gain we had in the fourth quarter of 2017 related to the TAP bond that expired, totaling BRL 154 million. We grew capacity by 14% in the fourth quarter while also expanding our top line by 14%.
Our RASK, adjusted for stage length, increased 2.7%. It's even more impressive that our stage length adjusted RASK for the whole year increased 7.6% with a 16% increase in capacity. CASK ex-fuel decreased 8.1% as we continue to add more fuel-efficient aircraft to our fleet. We ended the year with 28 A320neo, representing 30% of our fourth quarter capacity, and expect to end 2019 with an industry-leading 50% of our capacity coming from next-generation aircraft. As you can see on slide seven, fuel and currency had a negative impact of approximately BRL 270 million in our fourth quarter operating results, which represents 12 margin points. Thanks to our margin expansion strategy, our ability to recapture revenue and reduce costs, we recorded an operating margin of 11.4%, recovering 10 of the 12 margin points during a very challenging macro environment.
Moving on to slide seven, our loyalty program, TudoAzul, maintained a strong growth pace during the quarter, reaching 11 million members. Gross billings ex-Azul went up 29% YoY. We now have gross billing share of 18%, up from 16% just one year ago, and still well below our fair share of this market. We will continue to focus and grow this business. On the right side of the slide, you can see that our cargo business continues to perform extremely well. Revenue increased 57% YoY, benefiting from the expansion of our network and fleet. We have a diversified customer base, including the main retailers, manufacturers, and online companies in Brazil who value our reliable and far-reaching logistics solution.
Looking at the balance sheet on slide eight, I'm proud to report that we ended the quarter with a strong liquidity position representing 44% of our last 12 months revenue, while also reducing our total debt to BRL 3.4 billion. On slide nine, we give you a look at the impact of IFRS 16 on our 2018 results. The new lease standard becomes effective January 2019 and consists of recognizing all aircraft on balance sheet, similar to how finance leases were treated before. In addition, under this new rule, some maintenance expenses for leased aircraft will also be capitalized. As a result, our EBIT margin in 2018 would've been 15.1%, six percentage points higher than the 8.8 margin point reported under IAS 17. Under IFRS 16, our EBIT margin is the best in the region. Our leverage would've been three, a reduction of 1.2.
Going to slide 10 and looking at our 2019 guidance, we expect to grow our total ASKs between 18% and 20% in 2019, with most of this growth coming in the domestic market. As we've been telling you, our domestic capacity growth will be low risk and focused on strengthening our network, driven by replacing smaller aircraft with larger aircraft on routes we already serve. As a result of the acceleration of our fleet transformation plan that we announced earlier this year, we will end the year with approximately 50% of our ASKs coming from next-generation aircraft. On the cost side, we expect CASK to go down 1%-3% in 2019. As you know, we have a multi-year margin expansion strategy, and we expect to grow our EBIT margin every year over the next few years.
Consistent with this strategy, our EBIT guidance for 2019 will be 18%-20% compared to a margin of 15.1% in 2018. This estimate does not take into consideration any impact related to aircraft sales transactions or the potential acquisition of selected assets from Avianca Brasil. Moving on to the last slide, we've been monitoring Avianca Brasil's judicial recovery process very closely and have identified an opportunity to further strengthen our network and accelerate our fleet transformation plans. Earlier this week, we announced that we signed a non-binding agreement with Avianca Brasil to acquire certain assets for BRL 105 million. These assets consist of Avianca Brasil's operating certificate, 70 slot pairs, and approximately 30 Airbus A320s. It's important to highlight that these assets will be transferred to a new entity, a new co, which will be free and clear of all debt and liability as provided by the Brazilian bankruptcy law.
The operating lease contracts of the aircraft that will fly at the new company will be all renegotiated to market rates. The offer is subject to a number of conditions, including the due diligence process, regulatory and credit approvals, final approval from the bankruptcy judge. We believe this process could take approximately three months. In summary, we're confident about the future of the Brazilian aviation market and our ability to continue expanding margins, all while creating the best experience for our crew members and customers. With that, Dave and Alex, myself, and Abhi are here to answer questions.
Ladies and gentlemen. Sorry. Ladies and gentlemen, thank you. We'll now begin the question-and-answer session. If you have a question, please press the star key followed by the one key on your touchtone phone now. 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 Savi Syth, Raymond James.
Hey. Good afternoon. This is Matt on for Savi, actually. My first one, John, in regard to Avianca Brasil, if it is successful, could you talk a little bit about how long you think the transition period would last?
What the non-recurring integration cost might be, in terms of how much inventory is already sold, how much of that would you really need to honor when you close down? That would be great.
Yeah, Matt. I think the process should run pretty quickly. There's a creditors meeting later this month, the bankruptcy judge is aware of the situation. I think we really can't get behind the scenes of what's happening today. We believe there's a tremendous amount of upside in how this network could plug into our network. As we look forward, we think we could do it relatively quickly. They're coming with an operating certificate with pilots that are already flying, flight attendants that are already certified on the aircraft. At this time, we really are not giving any estimate, but we don't believe it's a significant acquisition or a big integration, because when it comes into a new co, a lot of the typical headaches that you get with a normal acquisition, you don't have to experience. Again, we're excited about it.
I think either way, there's going to be less capacity in the market because of this. As we're looking at acquiring an airline that's got roughly 30 aircraft in their fleet, and they had up to 55 aircraft just last year. I think overall, I think this is very positive for their customers, for the crew members, certainly for Azul, and I think overall for the industry as well, because there's going to be some capacity rationalization that happens as a result of this.
Perfect. Thanks for your color there. Also, speaking of in terms of capacity in the U.S.-Brazil market, it seems like schedules are showing a fair amount of cuts going into Q2, and that's before any of all the MAX noise. Do you think cuts, excluding what's going on with the MAX, is sufficient given the current supply-demand?
Hey, Matt. It's Abhi here. Yeah, you're right. We are seeing the capacity cuts mostly May onwards. Pretty much everybody is participating, including Azul. I think as has been the sentiment on other calls from our colleagues in the region, we'll have some pretty tough comps first two quarters. Q3 and Q4, we expect to see an improvement in the international market driven by stability in the currency as well as these capacity cuts. The booking curves are longer, so we're going to see when we get there. I'm definitely very encouraged by the capacity cuts. I'm seeing right now U.S.-Brazil nonstop capacity down about 20% May YoY from all the players involved. That's very encouraging. Everybody's participating, which is good as well, including Azul. I'm encouraged by what I'm seeing. I'm encouraged by stability in international bookings going forward.
We're expecting positive RASM inflection second half of the year.
That's great. Thank you very much.
The next question comes from Mike Linenberg, Deutsche Bank.
Hey, good morning, everybody. Abhi, I just want to go back to the comment that you made about RASM inflection second half of 2019. Were you specifically referencing international markets, or are you referencing Azul as a whole? Could you actually give us some additional color on what you're currently seeing since we've seen kind of the lion's share of the March quarter? Give us a sense of maybe what you're seeing and how things are looking into Easter week into the second quarter.
Hey, Mike. Yes, I was specifically talking
Yes.
About international only. Just looking at the international
Okay.
Booking curve, demand, the capacity cuts. Also, you got to remember, the comps are pretty tough. First quarter last year, dollar was BRL 325. Fourth quarter 2017
Okay
dollar was BRL 3.25, and now it is BRL 3.80. We have some tough comps. The industry has tough comps, really. Those will start to turn the second half of the year together with the capacity cuts. For international, I am expecting positive RASM inflection Q4 and Q4. For Azul overall, I think the RASM for the year, if you look at our margin guidance of 15.1% last year, 2018, going to 18%-20%, 3 points of that is coming from CASK and up to 2 points of that is going to come from RASK. That is what you can expect for the whole year.
Okay.
In terms of breakdown by quarter, I think the largest YoY RASK quarters would be Q2 and Q3, primarily because of the trucker strike in May last year as well as the World Cup. I think that is going to be the most positive. I think the other quarters are going to be pretty steady as well. I think you will see first quarter similar in terms of RASM increase, then strong Q2, a higher Q2, higher Q3, and a Q4 also in the 0-2% range. Again, higher comps. Remember, we are growing capacity 18%-20%. With larger aircraft. To be able to continue to increase RASMs like we did last year, to do it again this year with 18%-20% really shows the strength of the market and the strength of our network.
Okay. Abhi, that actually just leads me to my second question, which is the 18%-20%, that presumably is just Azul metal as the plan stands today, the growth plan stands today. Now all of a sudden, if we assume some assumption of Avianca Brasil assets, there is a two-prong part to that. One, how does that change the potential growth trajectory, and I realize I am probably putting the cart in front of the horse here. Then the second piece is that, how are things trending on Avianca Brasil? I realize that you may not have the best information, but the concern would be that you assume a lot of assets and you assume some additional routes that have seen a significant falloff in bookings.
In order to get the passenger levels back to where they were before Avianca Brasil filed for bankruptcy, you would have to engage in some stimulative fare activity. I realize that is kind of a multi-part question, however you can answer that.
Yeah.
Thanks, guys.
I'll give it a crack, and I'll let John and David jump in if they want. In terms of the capacity growth, it already includes some of the A320neos that Avianca voluntarily exited as part of their transformation plan. Some of these aircraft are already contemplated in this 18%-20%. There's a couple, low single digits worth of aircraft that's already in there. And part of what we announced in the fleet-
Okay.
Acceleration a couple of months ago. Again, I don't know what their bookings are. I don't have the ability to know what their bookings are. It's sort of hard to answer that. I do think, just looking from a commercial perspective, that the Azul announcement will allow the market to have confidence in Avianca, and confidence that they will continue to serve many of the routes. I think that should help in bolstering Avianca's bookings. Again, I don't have access to the numbers. I cannot have access to the numbers, so I can't really answer that in detail. I do think the market overall, thanks to our announcement and this partnership, is sensing support and confidence in Avianca, and that will and should help their bookings.
Plus, I think, as we mentioned earlier, they had a lot more routes than what we are anticipating putting into the NewCo. Obviously, we had a pretty good indication of which routes they were doing better on and which ones we were doing worse on. Overall, as we said earlier, there's going to be a cut in the capacity in the market no matter how you shake it. There'll be less seats flying, even with our growth than we found last year. That should help make the transition.
Okay. Very good. Thanks, David. Thanks, Abhi.
The next question comes from Andressa Varotto, UBS.
Hi. Thanks for the opportunity. I have two questions. First, on jet fuel, we saw Azul's jet fuel price expanded 7% QoQ, while oil Brent price decreased around 10%. Is this related to the delay in the pass through of oil price to Azul, and should we expect a reversion in the next quarter? Thanks.
Yeah. I'll let Alex kind of walk through the detail, you have to remember that Brent and WTI fall a lot quicker than we see the benefit because there's a lag in Brazil. It's about a 45-day lag. You want to walk through how it works, Alex?
Yeah. As John mentioned, there's a 45-day lag, and that works obviously on the way down and on the way up as well. Whatever you see on the screen, in general, on average, it takes 45 days for it to start reflecting the fuel price that we actually pay into our planes. WTI and Brent, first, they have a bigger crack spread to jet fuel. We also tend to look more at heating oil because it has a stronger correlation with Jet A, which is what we actually buy. On December 31st, these prices were about 20% lower actually than where they are today. There was a lot of change in prices within Q4. It was a volatile year overall in 2018, but Q4 was also volatile. December 31st was 20% lower than where we are today.
You can do the math and see how that will reflect into our power prices. We're hedged to the tune of about 30% of our next 12 months. Our average price is, we're a little bit in the money, even though we were out of the money in December. Today we're slightly in the money. Our average price is a little bit better than where you see the market today. I think with that info, you can probably figure out where our prices are going to be.
Great. Thanks very much. Secondly, we saw a reduction in maintenance expenses in the quarter compared to the historical level. Is this something that should continue going forward? If yes, is it included in EBIT margin guidance, and how much would it represent? Thanks.
Yeah. First, on Q4 specifically, a couple of factors. As we've been talking about, we've been investing in spare parts inventory. We've been investing in insourcing some of our maintenance activities. This all makes sense because we're now bigger. We have critical mass where it does make sense for us to do that. Also, we have a lower cost of capital. Also, in the old accounting policy, IAS 17, we would expense some maintenance on leased aircraft as occurred. When we had the maintenance event, that's when we would recognize the maintenance expense. That creates some lumpiness between quarters. There are quarters with more maintenance expense, there are quarters with less maintenance expense. Q4 obviously was a quarter with less maintenance expense, particularly on engines. Going forward-
IFRS 16 really changes a lot of this because some of the maintenance expense on leased aircraft that we were recognizing as OpEx will become CapEx. Our maintenance expense overall next year will be lower than this year. Even if you take into account the fact that we're growing, it would be normal for it to be higher, and it'll be nominally lower than what it was in 2018, mainly because of IFRS 16. That's embedded in our CASK guidance of -1% to -3%.
Very helpful. Thanks very much. Our next question comes from Dan McKenzie, Buckingham Research.
Well, hey. Morning, guys. Thanks for the time here. I guess first question, I wonder if you can help us understand how the debt picture changes for Azul under the scenario where it's successful in acquiring Avianca's assets. How much debt does Avianca Brasil have today? How much of that would follow under a deal closing?
Yeah. Dan, as we explained, we're actually acquiring what's called a UPI in Brazil or a new company. All that would go in there is just the operating leases that will need to be renegotiated. There's actually no debt associated with the acquisition.
Okay, good. That's what I was hoping you could clarify. Thank you. I guess as you think about deal economics, how does it change CapEx plans for this year or next year? As you think about Avianca's working capital needs, does it require more cash on top of what you're proposing at this point?
Dan, I actually think it gives us a lot of flexibility. What we see with the Avianca Brasil acquisition, assuming it takes place, and we look forward to doing that, is those 30 aircraft, the majority of those aircraft are going to come in on shorter-term leases, which will actually be replaced with our neos that will be coming over the next couple of years. It's a way to kind of accelerate a couple of years our growth, we can kind of measure our growth going forward. Hey, do we extend these leases or actually just return the leased aircraft and bring in our neos?
I think it's a way to reduce the risk going forward as we already get pilots and flight attendants and maintenance technicians already ready to go that are already trained on the specific aircraft that we're growing over the next couple of years. That's the way we look at it. Think of it's kind of pulled forward our growth a couple of years. What happens with the neos that come in, most likely the CEOs come out as a result.
Understood. If I could just squeeze maybe one or two more in here, quick ones. I guess first off, if you could just help us understand, kind of the two big risks that acquiring another airline is simply is IT and labor. I'm just wondering if you can just sort of comment around IT compatibility, lack of IT compatibility, how you're thinking about that labor. Just secondly, foreign exchange has been a stubborn headwind here. For those investors that don't know Brazil well, how are you handicapping the potential for economic and fiscal reform later this year? 99% probability the big stuff gets passed, maybe 50%. Big picture, how are the initiatives that are critical to Brazil's economic growth being perceived by politicians?
Dan, I'll talk about sort of the IT stuff real quick. We obviously have some good experience with this with the TRIP merger. TRIP at the time had the Sabre reservation system, and we of course have Navitaire, but we were able to transition that pretty quick. I think we had the code share and the flight in one system within six months. Certainly we've done it before. Avianca has the Amadeus reservation system, which Azul also has as part of our code share and alliances platform. We feel confident regarding the IT. It requires some work, but nothing we haven't done before or don't know how to do.
Dan, from a cultural impact of taking on crew members from another airline, Azul is 12,000 strong today. Avianca is significantly smaller than we are. We by far and away have the best product and experience in Brazil. I would tell you that Avianca Brasil is a close second. I think they have fantastic crew members, and I think they've run a great operation. I think that Azul coming in is probably very welcome. There's been a lot of uncertainty at that airline over the last six months at least and maybe longer. I think that that's something that we're willing to manage. David talked a lot on the call today about it's got to be the best job of your life.
I think that's what we have for the majority of our crew members, and we intend to extend that to the new members of the family that would come in over the next couple of months.
I mean, with the TRIP acquisition, you walk through our company today, that's what, it's been five years. It's indistinguishable. You don't know who's Azul and who's TRIP because we've been able to assimilate them into our culture, and it's been amazing to watch. We don't think that's going to be any different with the crew members that from Avianca that join our company.
Dan, back to your other question on reforms. Something's going to get passed. Is it going to be 100% of what everybody wants? Probably not, something's going to get passed. It's all anybody's talking about at the government level. I think that the government's hyper-focused on it. I think that we're looking forward to the reforms that take place, I think you're seeing the military and everybody's kind of on board and saying that this needs to happen. I think the states are behind it. I think most of the political parties are behind it. Again, I don't want to handicap it because we have to run our business. Any time you have a business plan that depends on the government, it's not a good business plan.
What I would tell you is we're going to continue to expand margins in light of what happens from a macro perspective. I couldn't be more optimistic about the changes that are happening in Brazil. We've gone through a couple of rough years in Brazil, at least the government's focused on the right things right now, that gets us excited.
That's fantastic. Thanks so much, you guys.
The next question comes from Savi Syth, Raymond James.
Hey, it's Matt again. Thanks for having me back on here. Just a quick one. You guys gave really good color on the RASM trends throughout 2019. I was wondering if you do that with some of the overall cost trends so I can think about that through the year.
Yeah, sure. Sure, Matt. As you saw, we gave guidance on continuing our CASK reduction in 2019, which should go down between one to three percentage points. Obviously, that's mainly from our fleet transformation, right? As you know, and we've mentioned many times, the CASK in the new aircraft goes down between 26%-29% compared to our current aircraft, right? It's important to note a couple of specific things about 2019. First, with IFRS 16, rent and some maintenance, which are dollar-denominated, they are capitalized and depreciated, right? That should reduce the volatility to FX. As you model, you'll see less sensitivity, obviously, in the short term, and that gets added to the balance sheet and depreciated over time. Also, this year, we have the payroll tax that had gone away.
It's coming back, and it's coming back since January 1st, that adds additional cost to our salaries line. You'll see that starting Q1, that line is going to be bigger. That's included in our -1% to -3% CASK guidance, right? We're going to look for other opportunities to, beyond the fleet transformation, to continue running a more efficient airline and reducing costs and finding any kind of opportunity that we have to take costs out of the company.
Great. Thanks, Alex.
Sure.
Our next question comes from Lucas Laghi, Citi.
Good morning, guys. Thanks for taking my question. My question is regarding the next steps of the joint venture with Correios after CADE's approval. When we could see an impact of this JV in Azul's numbers? Thank you.
Yeah. We received CADE approval. There's another step with government approval. I think what's kind of slowed this down a bit is we've had three different presidents at the Correios in the last 12 months. Anytime government changes, there's new leadership in that area. For now, we're focused on Azul Cargo, growing that business as quickly as we can. Still very optimistic about the opportunity. Unfortunately, we can't give you much more update at this time because we're now kind of working with the new leadership team on what the new joint venture would look like jointly with them. They need to take some time to get up to speed as well. That's the latest where we're at.
All right. Thank you, guys.
Ladies and gentlemen, as a reminder, if you would like to pose a question, please press the star key followed by the one key on your touch-tone phone.
Well, great. I guess that's it for the questions. Again, I'd like to thank everybody for joining us, and look forward to talking to each one of you. If you have any questions, our team's available. We're always open, but we really are excited about our business, and we're excited about the direction going forward, and we'll see you next quarter. We expect that hopefully things will continue to improve, and we'll do our part. Thank you very much, everybody.
Ladies and gentlemen, that does conclude the Azul's audio conference for today. Thank you very much for your participation, and have a good day.