Good morning, and welcome to the Corporación América Airports third quarter 2018 earnings call. A slide presentation accompanies today's webcast and is available in the Investors section of Corporación América Airports Investor Relations website at http://investors.corporacionamericaairports.com. As a reminder, all participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. As a reminder, today's call is being recorded. At this time, I would now like to turn the conference over to Gimena Albanesi of Investor Relations. Please go ahead.
Thank you. Good morning, everyone, and thank you for joining us today. Speaking during today's call will be Martín Eurnekian, our Chief Executive Officer, and Raúl Francos, our Chief Financial Officer. Also with us today is Jorge Arruda, Finance and M&A Manager. All will be available for the Q&A session. Before we proceed, I would like to make the following safe harbor statement. Today's call will contain forward-looking statements, and I refer you to the forward-looking statement section of our earnings release and recent filings with the SEC. I would also like to remind you that following the recent categorization of Argentina as a highly inflationary economy, in accordance with IFRS standards, commencing July 2018, we began applying IFRS Rule IAS 29.
This rule applies retroactively, starting January 1st of this year. For comparison purposes, in addition to presenting as-reported results, we are also disclosing the isolated impact of the adoption of hyperinflation accounting in Argentina and our results excluding IAS 29. The additional information in connection with the application of Rule IAS 29 can be found in our earnings report. Note that for comparison purposes and a better understanding of our underlying performance, in our presentation today, we will be discussing results excluding hyperinflation accounting in Argentina. With that being said, I will now turn the call over to our CEO, Martín Eurnekian.
Thank you, Gimena. Hello, everyone, and thank you for joining us today. It is a pleasure to welcome you to Corporación América Airport's third quarter 2018 earnings conference call. I will begin my presentation with a discussion of the highlights of the quarter, and then Raúl will take you through our financial results. Afterwards, I will provide an update on our key business segments and our view for the remainder of the year. We will then open the call to your questions. Starting with slide number three, we faced an increasingly challenging macro environment in some of our key markets this quarter, particularly in Argentina, where we are experiencing significantly weaker travel dynamics, and to a lesser extent, in Brazil. This resulted in a sequential deceleration in total passenger traffic growth of 1 percentage point to almost 6% year-on-year this quarter.
Against this backdrop, revenues posted a high single-digit year-on-year decline. In Argentina, we are seeing a drop in international travel along with a mix shift to domestic destinations. Revenues were also affected by the FX translation impact on local currency in Argentina, as well as in overall revenues in Brazil, resulting from the strong currency devaluations experienced in both countries. Looking at profitability, we turned in another quarter of margin expansion with EBITDA margin ex-IFRIC up more than 430 basis points to over 40%, driven by strong margin expansion in our core markets, Argentina, Brazil and Italy. In addition, as our cost structure is based in local currency, we benefit from the strong currency depreciation in Argentina. Excluding inflation accounting in Argentina, adjusted EBITDA margin ex-IFRIC expanded over 460 basis points year-on-year to almost 41%, and adjusted EBITDA increased by high single digits.
With the goal of expanding our airport platform for the long-term growth and to enhance the service we provide to our passengers, we made capital expenditures of $51 million in the quarter. Investments were largely centered in our airport infrastructure in Argentina and Italy. As you can see on slide number four, passenger traffic increased across the majority of our countries of operation. In Argentina, however, traffic growth continued to decelerate to almost 6%. We saw continued slower travel demand, along with an ongoing mix shift from international to domestic traffic as passengers look for more affordable travel alternatives. In Brazil, traffic was up mid-single digits, mainly driven by growth in domestic traffic at Brasilia Airport. Italy continued to report traffic growth of over 3%, mainly driven by higher international traffic supported by the addition of new routes and airlines, which more than offset softer domestic traffic.
In Uruguay, traffic contracted almost 5% year-on-year, impacted by continued lower passenger demand from key markets, Argentina and Brazil. Our other markets, however, posted solid traffic growth in the quarter. Passenger traffic in Ecuador was up 10% year-on-year, benefiting from easier comps as traffic in the year-ago quarter had been impacted by the cancellation of international flights as Hurricane Irma hit Florida. Peru also posted a robust performance, with traffic up 10.3% year-on-year, as new frequencies and promotions by low-cost airlines are driving higher demand, further supported by an improving macro backdrop. Finally, in Armenia, we saw a temporary spike in traffic of almost 14%, but expect traffic growth to normalize to recent levels. I will now hand off the call to Raúl Francos, who will review our operations and financial results. Please, Raúl, go ahead.
Thank you, Martín. Good day, everyone. As Gimena mentioned at the beginning of our presentation, for a better understanding of our performance, we will discuss our results excluding the impact of hyperinflation in Argentina. Now turning to slide five. Total revenues declined close to 8% year-on-year to nearly $390 million and almost 4% when also excluding construction revenues. We continued to experience a sharp currency depreciation in Argentina and Brazil this quarter, with a year-on-year devaluation of 85% in Argentina and 26% in Brazil. Aeronautical revenue fell mid-single digits as the good performance in Uruguay, Ecuador, and Armenia was more than offset by the lower revenue obtained in Argentina and Brazil. Lastly, despite the increase in traffic, Italy continued to face tough comps this quarter as marketing support expenses are deduced from revenue reflecting change in marketing agreements. While the year-ago quarter, they were included in SG&A.
Following a similar trend, commercial revenue declined 3% year-on-year, reflecting a weaker performance in Argentina and the FX translation impact in Brazil. By contrast, commercial revenues in Armenia rose by over 40%, driven by higher fuel demand and prices, while Italy is benefiting from our investment to enhance service offering to passengers, coupled with higher traffic growth. As you can see on slide six, our cost structure continued to benefit from the strong depreciation in Argentina and Brazil. This brought about a 12% year-on-year decline in total operating costs and expenses. Cost of services ex-IFRIC fell 5%, driven by declining salaries and lower concession fees in both Argentina and Brazil, partially offset by higher costs in Armenia. Concession fees declined in Argentina as a result of the devaluation impact of revenues. Lower concession fees in Brazil reflect a change in passenger curve used to calculate the amortization of the intangible assets.
SG&A also benefited from currency depreciation, declining 18% in the period, mainly as a result of lower salaries and sales taxes in Argentina. Italy also contributed to the reduction in SG&A, given as this quarter, marketing support expenses were deducted from aeronautical revenues. Coming to profitability on slide seven, we deliver a 9% year-on-year increase in adjusted EBITDA ex-IFRIC, reaching $137 million in the quarter. Brazil and Armenia were the main contributors to this increase, further supported by Uruguay and Italy. This was achieved despite softer adjusted EBITDA growth in Argentina, reflecting difficult market dynamics. Importantly, adjusted EBITDA margin ex-IFRIC expanded almost 470 basis points to almost 41% from 36% in the same quarter of last year. This was mainly driven by significant margin expansion across our three key markets, Argentina, Brazil, and Italy, that more than offset a margin contraction in our other operations.
Note, however, the margin expansion in Argentina is anticipated to moderate as inflation continues to catch up with the currency devaluation. Also, while we turned in strong operating results, our bottom line was negatively impacted by a higher financial loss that resulted from increased non-cash FX losses related to our U.S. dollar-denominated debt in Argentina. This was slightly offset by lower income tax expenses recorded in the quarter. As you can see on slide eight, our healthy balance sheet provides a solid platform to continue carrying out our strategic initiatives. Total debt at the close of the quarter was relatively stable at $1.2 billion. Our net debt to last 12 months adjusted EBITDA ratio increased slightly to 2.1 x from 2x in the prior quarter, mainly due to the impact of inflation accounting on adjusted EBITDA.
Excluding this effect, the ratio was 1.9 x, reflecting higher cash generation in the period. We keep a conservative maturity profile with less than 10% of our debt maturing within the year, and an adequate currency mix, with about 59% of our debt denominated in U.S. dollar, 25% in BRL, and 16% in EUR. Let me now turn the call back to Martín, who will go over performance at our key business segments and will comment on our outlook.
Thanks, Raúl. Let me now review the performance of our key business segments. Starting with Argentina on slide nine. We saw an 8% year-on-year decline in revenues ex-IFRIC, despite the 6% increase in passenger traffic, as business dynamics remain impacted by several factors. First, we are experiencing a stronger mix shift from international to lower priced domestic destinations. As a result, domestic traffic increased over 14%, while international traffic contracted almost 7%. Second, aeronautical revenues from domestic passengers and a portion of our commercial revenues that are in peso denominated remain affected by the FX translation impact from the sharp peso devaluation. Finally, in this context, we are seeing a mix shift in cargo volume with higher export activity and a lower number of higher margin imports.
Despite these changed market dynamics, adjusted segment EBITDA ex-IFRIC was relatively flat at $79 million in the quarter, reflecting higher cost dilution from our cost structure in Argentina, which continues to benefit from the peso devaluation. Adjusted segment EBITDA margin for Argentina expanded close to 400 basis points to almost 45% in the quarter. Note, however, that we expect margin to normalize going forward as inflation catches up with the peso devaluation. Maintaining our goal of further enhancing our airport infrastructure, we made capital expenditures of almost $47 million this quarter in Argentina. Investments were mainly targeted to the construction of the new departure terminal building at the Ezeiza Airport, which we expect will be finalized by mid-next year and will allow for a more efficient traffic flow while offering a better travel experience to our passengers.
This quarter, we also continued with the remodeling of the terminal buildings at Iguazu and Mar del Plata airports, and are making headway in the construction of the new terminal building and expansion of parking space at Comodoro Rivadavia Airport. We continue advancing with CapEx execution to absorb future passenger traffic growth. Until the overall CapEx program is approved, we are supporting the government's airplane revolution plan, investing above the minimum contractual requirements and in line with the CapEx plan we are developing closely with the government. Investments are mainly focused on Buenos Aires and specific airports in other regions in the country and are funded with cash flow from operations.
We are also pleased to report that El Palomar Airport, which is mainly focused on low-cost airlines, has been recently qualified for international routes and expect to start operating flights to neighboring countries Uruguay, Chile, and Paraguay by the end of the year. Please turn to slide 10. Passenger traffic growth in Brazil slowed to 5%, reflecting greater uncertainty in a pre-election environment. Revenues, in turn, were down 11% year-on-year, impacted by the FX translation effect from the depreciation of the Brazilian real. However, on local currency basis, revenue was up over 10%, reflecting the increase in passenger traffic and the positive contribution from recent commercial initiatives, particularly in advertising, VIP lounges, and space rentals. Adjusted segment EBITDA in Brazil was up by 75% year-on-year, reaching BRL 6.3 million in the quarter.
Higher operating leverage, mainly from a reduction in the concession fee, as Raúl just explained, together with lower SG&A, allowed us to deliver a strong expansion in adjusted segment EBITDA margin, which doubled to 21% from 11% the year-ago quarter. Keeping up with our CapEx program, this quarter, we invested close to $3 million for the construction of runway safety areas and engineering projects at Brasília Airport. In terms of the expansion of the terminal at Brasília Airport to accommodate an additional shopping area accessible from the outside, following the recent presidential elections, we are currently reassessing the scope of this project and expect to define how to best approach it over the next few months. Moving on to Italy on Slide 11. Passenger traffic continued to grow at a healthy pace, up 3.2% year-on-year. We also achieved a good top-line performance.
The redesigned VIP lounge, recently opened retail stores, and new space for duty-free shops continue to generate revenue growth. Comparable revenues, ex IFRIC, and excluding marketing support expenses, were up 6% in the quarter. We are also pleased to report higher profitability this quarter, supported by solid traffic growth, a pickup in commercial revenues, and higher operating leverage. Adjusted segment EBITDA was up 5%, and adjusted segment EBITDA margin at ex IFRIC expanded over 460 basis points to 37% in the quarter. Moving ahead with our CapEx program, we invested close to $5 million in the quarter for the expansion of the terminal at Pisa Airport and master plan development at Florence Airport. We expect to obtain the final project approval for the new runway at Florence Airport before the end of the year and start construction in the first quarter of 2019. Please turn to Slide 12.
While we do not provide specific guidance, given the challenging environment in Argentina and to a lesser extent in Brazil, we are providing some additional color this quarter. In Argentina, we expect to see a stronger mix shift to more affordable domestic destinations in the fourth quarter. Gradually, we should begin to see a slow pickup in inbound international traffic as traveling to Argentina becomes more affordable on the back of the weak peso. We expect this trend to continue in the remainder of 2018 and to deepen in 2019. Based on a slowly improving macro environment, we should expect to start to see a recovery in Argentina in the second half of next year, resulting in low single-digit decline in traffic growth for next year.
By contrast, with elections over in Brazil and the economy slowly recovering, we expect to see traffic growth to begin accelerating towards the end of the year, particularly in terms of international passenger traffic, with the addition of four new international routes. At the same time, we expect to continue seeing solid traffic trends in our other markets. We remain focused on further strengthening our global airport platform, developing new routes and frequencies while providing our passengers with a great travel experience. This is further underscored by our strong balance sheet. We are now ready to take questions. Operator, please open the call for questions.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press * one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * two. In order to allow all listeners to participate, please limit yourself to one question and one follow-up question. You may re-queue for additional questions. At this time, we will pause momentarily to assemble our roster. The first question comes from Ian Zaffino with Oppenheimer. Please go ahead with your question.
Hi. Good morning, guys. This is Mark on for Ian. Thanks for taking our questions. Very good quarter again, very solid. I'd just like to, I guess, touch upon the profitability you guys mentioned on the call and the press release. How it's expected to be impacted by inflation as it catches up and may lower some operating leverage down from sequentially this quarter. I'd just like to understand what are some of the expectations going forward, and are there any other levers you could pull to maintain that level of profitability? Thank you.
Well, thank you for the question. It's a really tough question you're asking. Forecasting inflation seems very difficult with the current environment in Argentina. We have seen high inflation numbers so far, but we are also seeing recession numbers in the economy that should curb the growth of inflation, but be very difficult to see. The dynamics we've seen in the last couple of years were that after the evaluation, in a period of time, inflation would catch up in other terms. It'd be very difficult to forecast for next year what will happen.
Okay. That's fair. Just a little bit on the top line. You guys are doing a great job in adding new flights and frequencies. I just want to see what the sort of expectations going to maybe the end of the year, fourth quarter 2018, what the sort of activity has been going forward and the expectations relative to performance this quarter. Thank you.
Well, our expectations are that the dynamics we are seeing throughout the year will continue. We are seeing a slowdown in international traffic.
Probably mainly due to the devaluation of the peso. We keep seeing domestic growth. We keep seeing airlines continuing with their plans to establish themselves in Argentina to fly domestic. Norwegian, for example, and a couple of other airlines that are working their way to starting to fly in Argentina. We're still optimistic in the domestic side of traffic. As we have seen this year, we do not expect those same dynamics to change in the fourth quarter.
Okay, great. Thank you, guys, and I'll jump into queue again.
The next question comes from Charles Cartledge with Flynn Robinson. Please go ahead with your question.
Thank you, and thank you very much for the presentation today. You point to increased cost pressure in Argentina, which I understand. If you were free to price as you wish, presumably you would compensate for these cost pressures with increased revenues, probably through increased passenger ticket revenues. I just want to clarify, to do that, if you wanted to do that, particularly on domestic fees or passenger fees, would you need ORSNA's approval? If so, what are you doing to get ORSNA's approval? Obviously you're operating under a fixed IRR regime. I believe that you're overdue a bit of a catch-up with regard to resetting that regime in the current year with all the dislocations that you're having to manage with the devalued currency.
If you could just walk me through the procedure, for example, raising passenger fees on domestic routes, that would be helpful. Thank you.
Well, it's the regulatory body that has to do the annual analysis and come up with an answer. We are waiting for that. Also, the fact that most of our revenues are in $ play a role in basically automatically increasing our tariffs in ARS and also play a role in the fact that our costs dilute in ARS. That's why we have also seen an increase in margins in this quarter, for example. That dynamic is not that clear, although we have to wait for the regulator to do its analysis and come up with an answer.
As a follow-up question, I'd just like to ask, I believe AA2000 has not had a regulatory reset for a couple of years now, but it's meant to happen every year. Is there any scheduled meeting with your regulator to make sure that you're on track on your IRRs, and if not, to reset passenger fees or landing fees appropriately? Thank you.
Well, we definitely work towards having them do their job, but since it's not within our power to force them, and also there can be temporary dis-adjustments of the IRR. We're definitely talking to them and hoping that they do their work and come up with a revision on the economic equilibrium of the concession. We hope that they basically finish up the job and publish a revision as soon as they are ready.
Thank you.
Once again, if you would like to ask a question, please press star then one. Our next question comes from Andrew Levin with Finisterre Capital. Please go ahead with your question.
Hi, how are you? Thank you again for the call. My first question is kind of related to the last one, which is just if there's been any discussion of a timeline on concession renewal, and then, because that'll probably be a quick one. Second question is on inbound versus outbound international traffic. If you could provide any color on how that's changed. I'd expect an increase in inbound, although the international is down significantly overall to Argentina in particular.
Okay. First of all, the second question regarding the outbound versus inbound traffic. As of the last quarter that we have reported, so third quarter 2018, we've had an outbound traffic of around 60% of our international passengers. And 40% inbound. This was down from the previous quarter of the breakdown was 66 Argentinians out, with 34 inbound traffic. We expect this trend to continue, and we expect that moving forward, we will have a reduced percentage of Argentinians in our overall international passengers.
Yeah. Regarding your first question, we are also waiting for the government to be ready to start the negotiations. There was this consultancy, which is still delayed. Also, we have seen a little bit of priority shift within the government in the last four to six months with all of what happened with the macro of the country. We hope that those discussions can start as soon as possible.
Thank you.
Our next question comes from Pierre Saffar with Star Alder River Capital. Please go ahead with your question.
Hi. Thank you very much for taking our question. I had a few. The first one would be, you have not really published any estimates of what is overdue in terms of catch-up based on your contractual IRR for the AA2000 concession in Argentina. I don't know if you could. Could you give us a little more color as to, when you do get the opportunity to catch up, based on the original contract, what do you expect you should receive? Because it appears the concession continues to deliver below what was originally signed. That's the first question. The second one would be on Brazil. You're currently building very significant commercial real estate in downtown in prime Brasilia. Could you give us a little more color as to how large you believe that opportunity could be?
Eventually, especially in light of the recent elections, eventually, this could be a very high EBITDA asset. How should we think about it, and when do you believe it could start to meaningfully make a difference in Brazil? The last question is just on the current stock price. How do you internally think about the current level? Is there any opportunity for you to maybe engage in buybacks or do you have an opinion about the current stock price? If you do not believe it reflects the prospects of the company, is there anything you believe you should be doing? Thank you very much.
Well, starting with your first question. It's similar to the one before. We need the government to do the yearly revision, to understand their view for the future of the concession and understand if we would be on track or not regarding the regulatory framework. We hope that happens soon, and as soon as it happens, we will be able to have an opinion whether we agree with the government's forecasts or not. You have to keep in mind that we need to meet the IRR by the end of the period. Again, there can be slight adjustments over or under during the period. Once we have that, we will be able to have a clear opinion, if we agree or not with their revision.
To your second question, regarding Brasilia, I will ask Jorge Arruda, who's on the line, to comment on the prospects for real estate development there.
Hello, this is Jorge Arruda. In addition to being the head of corporate finance in América, I'm also the head of Brazil and the CEO of our Brasilia Airport. The Brasilia Airport is almost a unique situation where we have a large airport that is actually located inside the city, so 10 to 15 minutes from the so-called ministry area. Also the fact that we have a large area within the concession agreement to develop. We plan to develop about 1 million square meters. We have this plan for a while. The crisis didn't help. We have since the beginning of the year been growing. Actually, late last year, we've been growing in terms of passenger and the economy is picking up. I'm sure you are aware there's a new government and there is, generally speaking, a very positive mood around. Therefore, we are quite optimistic.
We have a few agreements lined up. As we mentioned before, we don't provide guidance. Our plan is that third party develops the projects, and we basically lease the land, therefore, is pure income for us. We expect to have projects such as convention centers, entertainment centers, office space, and hotels, among a few others. We hope, and we are working towards being able to provide more specific details in our next quarterly meeting. Obviously, that will depend on how the macro environment shapes up in the country.
Thank you, Jorge. Regarding your third question, of course, we believe that the price does not reflect the increasing value of the company. We have clearly been affected by many factors, being Argentina's performance number one in terms of detail analysis. We are considering every possibility to defend the share price. Being number one, the sound and good management of the company for long-term growth, but also other alternatives as share buybacks and so on. We need to make sure that anything we do will positively affect the dynamics of our share. We see that while Argentina keeps creating concern among investors, we still need to wait and understand what will be the real mid or long-term trend of investments in Argentina.
At this time, there are no further questions. Please, sir, go ahead with concluding remarks.
I would like to thank everybody for joining us today. We appreciate very much your interest in the company, and we look forward to meeting you more and more over the coming months and providing financial and business updates next quarter. Our team remains available for any questions you may have. Thanks again, and have a good day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.