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Air France-KLM SA (OTCPK:AFRAF) Q2 2019 Results Earnings Conference Call July 31, 2019 2:30 AM ET
Ben Smith – CEO
Frédéric Gagey – CFO
Conference Call Participants
Jarrod Castle – UBS
Stephen Furlong – Davy
Neil Glynn – Credit Suisse
Daniel Roeska – Bernstein
Savi Syth – Raymond James
James Hollins – Exane BNP
Andrew Lobbenberg – HSBC
Michael Kuhn – Societe Generale
Damian Brewer – Royal Bank of Canada
Malte Schulz – Commerzbank
Good day and welcome to the HY 2019 Air France-KLM Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Ben Smith, CEO, Air France-KLM; and Mr. Frédéric Gagey, CFO, Air France-KLM. Please go ahead.
Good morning, ladies and gentlemen. I am here today with Frédéric Gagey, and we are very pleased to welcome you to this presentation of Air France-KLM’s 2019 first half results. Firstly, thank you for joining the call and for your flexibility on the change in schedule. I’m going to share with you a number of strategic decisions contributing to the simplification and modernization of our fleet.
First, a few comments about our group’s activity in the second quarter of 2019. So within a challenging environment, owing to the current geopolitical tensions and economic uncertainties. Air France-KLM posted a robust second quarter with a 5.1% increase in passenger numbers and a 0.9% improvement in passenger unit revenue. The group increased its operating result, reflecting continued execution in unit cost reduction, which enabled us to more than offset rising fuel costs. In line with the net debt over EBITDA target of below 1.5 the group further strengthened its financial position. The group reduced its net debt by €466 million compared to the end of 2018.
After the strategic update, I will hand over to Frédéric Gagey, to take you through the detailed presentation of the second quarter results. Moving on to the Air France medium-haul fleet with its Airbus A320 family aircraft. We are currently operating Airbus A320s, Airbus A319s, Airbus A318s and the larger Airbus A321s. This medium-haul fleet is aging and a portion is due for replacement in the coming years. I’m pleased to announce that to begin renewal of the medium-haul fleet, Air France has placed a firm order for 60 Airbus A220-300 aircraft, with an additional 30 options and 30 purchase rights.
The Airbus A220 is the ideal aircraft for the Air France short- and medium-haul fleets for several reasons: one, it’s an environmentally friendly aircraft with 20% fewer CO2 emissions and a 50% reduction in noise. It’s also economically and operationally efficient with low aircraft and trip cost; two, it is the right-sized aircraft; three, it is a perfect fit for the product proposition we are currently developing. I’ll start with the first point, cost. Airbus A220s have a significantly lower capital cost in comparison to other next-generation aircraft of comparable size. Together with Frederic and our strategy, fleet and network departments, we have carried out an in-depth review of financial scenarios for the fleet. Compared to other aircraft types, the Airbus A220 scenario will result in significant CapEx savings.
In addition, the Airbus A200 has a lower trip cost compared to the current A320 family, mainly thanks to its fuel efficiency. Compared to the existing fleet, it will thus generate an EBITDA improvement. Finally, if necessary, the terms of the agreement with Airbus, give us the flexibility to postpone deliveries of firm orders. In addition, the 30 options plus 30 purchase rights for additional deliveries to replace the remainder of the old-generation aircraft in the medium-haul fleet provided even more flexibility going forward.
Another important factor on cost is the fact that the engines on the Airbus A220 the patent with the gear turbofans, provide the most fuel-efficient engine technology. The fuel burn per seat of an Airbus A220 aircraft is 20% lower than previous generation aircraft and the fuel burn per seat is even below the A319 NEO, combined with the lower capital cost, the fuel efficiency will deliver lower trip costs, lower than the existing Air France fleet and other comparable aircraft.
The Airbus A220 scores very well on environmental factors and is the quietest and cleanest jet aircraft of its size. These environmentally friendly aspects are due to the efficient design of the aircraft with advanced materials used in more than 50% of the primary structure, meaning both lower weight and required maintenance costs. It is a truly next-generation aircraft.
Concerning its size, with 150 seats, the Airbus A220-300 is optimal to replace our Air France’s current A318 and A319 fleet. The range of the aircraft allows it to operate all the current routes in the Air France medium-haul network. With its unique and top-of-its-class characteristics in terms of customer comfort, the Airbus A220 is a perfect fit for the product Air France offers its customers in terms of cabin layout. The most noticeable feature our customers will notice is the seats. They are the widest in any single-aisle aircraft currently on the market, given the 5-abreast seating configuration, while the large stowage bins allows one roller bag for every passenger.
We are all very pleased this aircraft will join the Air France fleet in the coming years, and we strongly believe that the Airbus A220 is going to be a key factor in making the Air France’s short- and medium-haul network profitable as well as enhancing our value proposition to our customers. During the 2018 annual results call, I mentioned the early phase out of 3 Airbus A380 aircraft whose leases were expiring and that we would be reviewing the remaining 7 A380 aircraft.
As you have heard, not only from us but also from many of the A380 operators globally, the profitable deployment of the Airbus A380 aircraft is limited due to the high cost of operations in addition to the challenges faced in terms of operational performance. Airbus has announced a suspension in aircraft production, and we see other operators reducing their A380 fleet as well.
As for the 7 remaining aircraft at Air France, a fleet of this number of aircraft is suboptimal as it will require a minimum of 1 spare for 6 operational aircraft. It would also be faced with a major cabin refurbishment program for these A380 aircraft to upgrade their product offer. Each costing upwards of €35 million. In addition to required maintenance costs, meaning an investment totaling €85 million per aircraft would be required. Therefore, an early phaseout of the Air France A380 fleet will result in substantial CapEx savings estimated at €400 million. Well, it does come as no surprise that we have decided on the early phaseout of the A380 aircraft.
Financially speaking, there will be some one-off costs, and we will also be accelerating the depreciation of the aircraft. The total amount is estimated at around €400 million and will be spread over the 2019 to 2022 period.
New generation aircraft will replace the A380, and several types are still under consideration. Negotiations with the manufacturers are in advanced stages, and we will keep the market informed in due course.
We can, however, disclose that we will require no more than 9 new wide-body aircraft to replace the A380 fleet. The early phaseout of the A380 aircraft will have a profitability uplift starting from 2022 and will generate positive equity over time. We announced at the end of June 2019, another important step to simplify and rationalize the fleet of the, group fleet. Air France and KLM will swap the remaining firm, Boeing 787 and Airbus A350 orders between them, in order to realize fleet efficiencies through harmonization of similar aircraft at both airlines.
The implementation of the swap between the airlines means that in 2021 to 2023 timeframe the 6 remaining Boeing 787 ordered for Air France will be transferred to KLM and the current 7 Airbus A350-900s are ordered for KLM will be transferred to our Air France. KLM presently operates 13 Boeing 787-9s and received its first Boeing 787-10 in July 2019. This fleet will further grow to a total of 21 Boeing 787s by the end of 2020 to which will be added the 6 Boeing 787s, initially intended for Air France for a total of 27 aircraft.
With regards to the medium-haul fleet of KLM, we have announced in June, our intention to purchase up to 35 Embraer E195-E2 jets with 15 firm orders and purchase rights for a further 20 aircraft of the same model for KLM Cityhopper. In order to enhance its existing network and to permit the efficient development of new routes, the Embraer 195-E2, will be a welcome addition to the KLM Fleet, giving greater capacity flexibility and help to manage down costs. In addition, the environmentally friendly E195-E2 also supports our sustainability goals with lower levels of noise and emission.
Now I will hand over to Frederic for the financial presentation.
Thank you, Ben, and good morning to everybody. I hope now you go to Slide number 12 concerning the financial results of the second quarter. As indicated by Ben at the beginning of the presentation, we can consider that the second quarter is solid in the sense that you see a strong development of the activity and operating result of €400 million, a margin of 5.7% and a relatively significant reduction in the net debt. So all in all, it is a result which are satisfactory.
Of course, when you look to the evolution compared to last year, which is a slight improvement of operating result, you have maturely to take into account the fact that last year’s second quarter, in Air France, mainly was impacted by the strike with a global effect, which has been estimated to €260 million at the EBIT level. But by themselves, this result for the second quarter achieved margin growth to 6%. I think it can be considered relatively satisfactory.
You also see that the ROCE of a 12-month trailing is at 9.3%, which is also a result which is acceptable. And as indicated by Ben, the ratio adjusted net debt on EBITDA is below 1.5%, exactly 1.4% for 12 months period, finishing June 2019.
I go, move to the Slide 13, when you have the evolution of the result activity network, including cargo. We have a good development of capacity in the passenger activity of 3.9%.; positive unit revenue, plus 0.9% for the passenger activity. And I will come back later on the development of the unit revenue per networks.
Cargo, there we have more negative signal. One is mainly the unit revenue is down minus 7.5%. It is a relatively important decrease but clearly related to all the problem today in the world exchanges which are due to the commercial law between U.S. and China and some economic, or macroeconomic negative evolution in some part of the world. So clearly, it was not the type of number we had seen in 2017.
We don’t know yet what will be the trend in the next quarter, but clearly, this minus 7.5% of unit revenue for the cargo is not a good signal.
Transavia is developing well. Again, we have increased capacity for the combined Transavia Holland in Transavia France by 9.2% in spite of this relatively aggressive growth. Unit revenue is also developing positively, plus 1.3%, and the margin is quite high, 10.4%, a bit decreasing compared to last year but still a very good margin, which is partly explained by the fact that we are entering the touristic period and also by the shift of Easter during the second quarter compared to last year.
Maintenance is increasing the margin at 4.9%, and the revenue is increasing significantly at plus 12%, so we are back to an improvement of the margin of an amount after, a bit more difficult here in 2018. We had already such an evolution during the first quarter of this year. So all in all, for the group, a margin of 5.7%, increasing compared to last year. But again, I will come on that a bit later on, partly explained, of course, by the strike effect in Air France for the year 2018.
So I go to the next slide, which is a split of the unit revenue compared to the last year. So we have given to use a unit revenue during the second quarter, during the 6 months, per network to indicate 2 things. First, during the presentation of the Q1, we have indicated that the unit revenue globally will be slightly positive, with a good long-haul and a negative short-haul due partly to the base effect of last year after the strike of the railways company in France. I am happy to see that we have been relatively precise and accurate, you see that the long-haul unit revenue for the quarter is, in fact, relative dynamic, plus 2.3%, with a positive number everywhere.
But in Latin America, where the difficulty is mainly in Brazil, Argentina, you see a drop of the unit revenue by 10%. And concerning the medium-haul point-to-point is negative, minus 9%. Medium-haul hubs is neutral at plus 0.2%. So let us just say that we have been, in fact, relatively precise when we have given the future or expected trend in terms of unit revenue. One remark, however, if you look at the results for the 6 months, so the Half 1 2019, you see that the development in the long haul, is a bit less dynamic than what you see during the second quarter, so just to say that the second quarter is an exceptional and that when you are looking at the 6 months is something, which is a bit more neutral or shy in terms of evolution of the unit revenue long-haul, which is, I’ll just say, slightly positive plus 0.8%, and again, negative in Latin America and positive in all the sub-network.
If I go to the next slide, which is the split of the capacity so clearly, evolution of the unit revenue has just been commented. You can also make quick calculation to show that mainly in long-haul, we are, generally speaking, was an increasing load factor but also an increasing yield, so it is not only the load-factor evolution, which is explaining the unit revenue trend, it is mostly the load factor and the yield paid by the passengers and also to keep in mind that the ancillary revenue are still quite dynamic, plus 20% compared to last year, supported by the branded fare and the new distribution capability system we have put in place already 2 years ago, and note also that the premium segment is relatively resilient.
During the second quarter of 2019, we have unit revenue, which is up 1.54 something. Unit cost. Unit cost is relatively good in terms of posted number, so we post that the change is just 1%. When you correct for the currency effect and the fuel price effect, we are at constant currency and fuel unit cost decreasing by 2.3%, which is a result of a good level of productivity. The productivity is improving by 3.1%. Also the fact, which is going into the negative direction, you have to take into account the effect of the 2 weather remarks, which have been find both in Air France and KLM last year and which are clearly influencing the evolution of the staff cost.
Also, keep in mind that in Air France, following an external consultation study, which has been managed during the second quarter, there will be a new plan on cost evolution, simplification, efficiency of processes, which will be launched back in September. Also, the fact that last year was impacted by the strike, played a role in terms of unit cost. We had last year, as you know, quite high customer compensation costs, which are, of course, and happily decreasing in the year of 2019.
I move to Slide 17. In the first quarter presentation, we show you the evolution of the performance improvement of Air France. You know that it is one of the priorities given by bank to the management of Air France Group. And let’s just say that the result for the second quarter are acceptable. You’ll see that in terms of on-time performance, Air France is ranked 16 in June; 12th in May; and 14th in April, which is not too bad. And if you look more precisely, amongst the European legacy carrier, Air France is at the top in terms of time performance, number 3 in May and in June.
On the right of the slide, you see the evolution of the Net Promoter Score. Also, in Air France and KLM, the trend in Air France is positive, coming from 12 last year; and 19, 2017; and now being at 24 in Q1; 25 in Q2. There is still a gap compared to KLM. But for Air France, trend of evolution versus Net Promoter Score is positive.
I go to Page 18, which is speaking by its self, evolution of the EBIT between Q2 2018, Q2 2019. Clearly, a positive contribution of the unit cost estimated to plus €135 million; a negative effect of the fuel price ex-currency, which is mainly explained, of course, by the hedging delta result, if you compare 2018 to 2019. I would come back on that a bit later on.
So in fact, the fuel prices are declining in 2019 compared to last year. It was a positive impact of €78 million, but also, this effect is more than compensated by the fact that the hedging is less positive in ’19 compared to ’18, even if, it is still positive. During the second quarter 2019, the currency impact is almost at full, slightly negative, minus €18 million. It’s positive on revenue, negative on fuel and on growth. And when we sum up the 3 elements, we have minus €18 million as a total.
Next slide give a split of the group profitability between Air France and KLM, what can we see is, if I take the top of the slide, when you look at the second quarter, Air France is improving but by plus €130 million compared to last year. But as you, of course, know, we have to take into consideration the strike effect, KLM, which is more like-for-like, because I believe that were no strike into KLM last year. You’ll see that the change is negative, minus €70 million, and a reduction of the operating margin by 2.8, even if, of course, the operating margin is still at a quite high level of 8.9%.
The result, when you look at the first half,
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