Mar 14, 2019
Operator
Hello everyone and 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 following the company's presentation. [Operator Instructions] I would like to turn the presentation over to Andrea Bottcher, Investor Relations Manager.
Please proceed.
Andrea Bottcher
Thank you Paula and welcome all to the fourth quarter earnings call. The results we announced this morning, the audio of this call, and the slides that we'll reference are available on our IR website.
Presenting today will be David Neeleman, Azul's Founder and Chairman; and 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 CVM and SEC filings. Also during the course of the call, we'll discuss non-IFRS performance measures which should not be considered in isolation and are discussed in detail in our earnings release.
With that, I'll turn the call over to David. David?
David Neeleman
Thanks Andrea. Thanks everybody for joining us.
December 2018 marked our 10th anniversary. If you move in Slide 3 in the presentation, it is truly amazing when you look at those two right networks where 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. And that's exactly what append in 2018.
Even though fuel was up 30% and the dollar appreciated against real 17%, we delivered a record adjusted net income of BRL704 million in 2018. We also generated BRL266 million in free cash flow and ended the year with total liquidity position of BRL4 billion, reflecting our commitment to sustainable growth and building a long-term value in the company.
You can see some of our amazing crew members on Slide 4. 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 A320neos in our network have surpassed all of our expectations.
These aircraft are flying an average of 14 hours a day including connectivity across our airline just as we said it would. At the end of the year, we had 20 A320neos representing 30% our ASKs which have a 29% lower unit cost in our current E1s.
Every single one of these next generation aircrafts 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.
Now, I've talked about that in past calls and I'm very excited about it. Now, 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 using great neos that we're flying today.
With both these next generation aircraft, we are creating a competitive sustainable advantage that will continue to drive margins higher. In summary, we ended our first decade confident that we will continue to offer the best job in the lives of 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 word over to John to give you more details on the fourth quarter results.
John Rodgerson
Thanks David. As David looked back on what we built over the last 10 years, I want to say we're just getting started and 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 5, the core airline drove strong results in a tough macroeconomic environment.
Even with 37% spike in fuel and a 17% depreciation of the real, we reached an EBIT margin of 11.4% for the quarter and a 31% EBITDAR margin, while recording net income of BRL138 million. The reduction in net income year-over-year was driven by one-time gain we had in the fourth quarter 2017 related to the TAP bond that expired, totaling BRL154 million.
We grew capacity by 14% in the fourth quarter, while also expanding our topline 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 20 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 6, fuel and currency had a negative impact of approximately BRL270 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 macroenvironment. Moving on to slide 7.
Our loyalty program TudoAzul maintained a strong growth pace during the quarter, reaching 11 million members. Gross billings ex-Azul went up 29% year-over-year.
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% year-over-year, 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 8, 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 BRL3.4 billion.
On slide 9, we give you a look at the impact of IFRS 16 on our 2018 results. The new standard becomes effective January 2019 and consists of recognizing all aircraft on balance sheet, similar to how finance leases were created 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 have been 15.1%, 6 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 have been 3, a reduction of 1.2.
Going to slide 10 and looking at our 2019 guidance, we expect to grow our total ASK 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 focus 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% to 3% in 2019. As you know, we have a multiyear margin expansion strategy and we expect to grow our EBIT margin every year over the next three years.
Consistent with this strategy, our EBIT guidance for 2019 will be 18% to 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 plan.
Earlier this week, we announced that we signed a non-binding agreement with Avianca Brasil to acquire certain asset for $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 NewCo, which will be free and clear of all debt and liability as provided by the Brazilian bankruptcy law. Also, the operating lease contracts of the new aircraft -- of the new 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, David, Alex, and myself and Abhi will be happy to answer your questions.
Operator
Ladies and gentlemen, thank you. We will now being the question-and-answer session.
[Operator Instructions] Our first question comes from Savi Syth, Raymond James.
Matt Roberts
Hey, good afternoon. This is Matt on for Savi actually.
My first one, John, in regard to Avianca Brasil, it is successful. Can you talk a little bit about on how long you think the transitioning period will last?
What the non-recurring integration costs might be? And in terms of how much inventory is already sold?
How much of that do you really need to honor if you goes out of the way?
John Rodgerson
Yeah, Matt. So I think the process should run pretty quickly as there's a creditors meeting later this month and the bankruptcy judge is aware of the situation.
I think we can't really take behind the scenes of what's happening today, but we believe there's a tremendous amount of upside in how this network could plug into our network. And so as we look forward, we think we can 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. And so at this time, we really are not giving an estimate, but we don't believe it's a significant acquisition or a big integration, because when it comes into a NewCo a lot of that the typical headaches that you get with a normal acquisition you don't have to experience.
And so 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 add up to 55 aircraft just last year.
So I think overall, it's 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 happened as a result of this.
Matt Roberts
Perfect. Got it.
Thanks for your color there. And then also Dave in terms of capacity in the U.S.
to Brazil market it seems like schedule they are showing a fair amount of cuts going into 2Q and that's before any of all the Max noise. So do you think cuts excluding what's going on Max is sufficient given the current supply demand?
Abhi Shah
Hey, Matt, it's Abhi here. Yeah.
You're right. We are seeing capacity cuts mostly May onwards.
Pretty much everybody is participating including Azul. So I think as has been the sentiment of other colleagues – from our colleagues in the region.
We’ll have some pretty tough comps first two quarters. But 3Q and 4Q we expect to see an improvement in international market driven by stability in the currency as well as these capacity cuts.
So the booking terms are longer. So we're going to see when we get there, but I'm definitely very encouraged by the capacity cuts.
I'm seeing right now U.S. Brazil non-stop capacity down about 20% May year-over-year from all the players involved that's very encouraging.
And everybody is participating which is a good as well including Brazil. So I'm encouraged by what I'm seeing.
I'm encouraged by stability the international bookings going forward. So we're expecting positive RASM inflection in second half of the year.
Matt Roberts
That's great. Thank you very much,
Operator
The next question comes from Mike Linenberg, Deutsche Bank.
Mike Linenberg
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 you referencing Azul as a whole?
And could you actually give us some additional color on what you're currently seeing since we're seeing kind of a lion share of the March quarter given a sense maybe what you're seeing and how things are looking into Easter week into the second quarter?
Abhi Shah
Yeah. Hey, Mike.
Yes, I was specifically talking about international only. Just looking at the international curve, demand, capacity cut and also you got to remember the comps are pretty tough.
First quarter last year's dollar was 3.25, fourth quarter 2017 the dollar was 3.25 and now it's 3.80. So we had some tough comps.
The industry had tough comps really. And those will start to turn the second half of the year together with the capacity cut.
For international, I'm expecting positive RASM inflection 3Q and 4Q. For Azul overall, I think the RASM for the year, if you look at our margin guidance of 15.1 last year 2018 going 2018 to 2020 three points of that is coming from CASK and up to two points of that is going to come from RASK, so that's what you can expect for the whole year.
In terms of breakdown by quarter, I think the largest year-over-year RASK quarters will be 2Q and 3Q, primarily because of the truckers strike in May last year as well as the World Cup. And so I think that's going to be the most positive.
But I think the other quarters are going to be pretty steady as well. So I think you'll see first quarter similar in terms of RASM increase and then strong 2Q – higher 2Q, higher 3Q and a 4Q also in the 0 to 2 range, again higher comps.
And remember, we're growing capacity 18% to 20%. So to have – to be able to with larger aircraft, so to be able to continue to increase RASMs like we did last year, to do it again this year would be 18% to 20% really shows strength of the market and the strength of our network.
Mike Linenberg
Okay. And then Abhi that led to my second question which is the 18% to 20% that's presumably for Azul that all – as the plan stands today the growth plans stands today.
But now what coverage do you assume some assumptions of Avianca Brasil assets sort of a two-pronged part to that, one, how does that change the potential growth trajectory? And I realize, I’m probably [indiscernible] here.
But then the second piece to that is that how are things trending on Avianca Brasil? I mean, I realize that you may not have that information such as concern was that you assume a lot of assets, and you assume some additional routes that have seen a significant fall off in bookings.
And so in order to get the passenger level back to where they were before Avianca Brasil filed bankruptcy, you would have to engage in some similar to fair activity. So I realized that's kind of a multipronged question.
However, you can answer that. That’s it.
Abhi Shah
Yeah. I'll give it a crack and I'll let John and David jump in if they want.
But in terms of capacity growth, it already includes some of the A320neos that Avianca voluntarily exited as part of their transformation plan. So, some of these aircraft are already contemplated in the 18% to 20%.
So there’s a couple -- a low single digits growth of aircraft that's already in there. And part of what we announced in -- generation, a couple of months ago.
In terms of that booking, again I don't know what they're bookings are. I don't have the ability to know what their bookings are, so 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, and I think that should help in bolstering Avianca's bookings. But 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. But 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.
David Neeleman
Well, first, I think as commented earlier, they have a lot more routes than what we are anticipating putting into the NewCo. So, obviously, we had a pretty good indication thereof, which routes they were doing better on, and which ones we're doing worse on.
And so overall as we said earlier, there's going to be a cut in the capacity in the market, no matter how you shake it. So there'll be less fleets flying even with our growth than what’s on last year.
So that should help make the transition.
Q –Mike Linenberg
Okay. Very good.
Thanks, David. Thanks, Abhi.
Operator
The next question comes from Andressa Varotto, UBS.
Andressa Varotto
Hi, thanks for the opportunity. I have two questions.
First on jet fuel, we saw jet fuel price expanded 7% quarter-over-quarter while oil Brent price decrease at around 10%. Is this related to the [indiscernible] oil price to Azul?
And should we expect revert in the next quarter? Thanks.
John Rodgerson
Alex, kind of, walk through the detail, but 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 – why don’t you walk through this, how it works out.
Alex Malfitani
Yeah. So, as John mentioned there's a 45-day lag and that works, obviously, on the way down and on the way up as well.
So whatever you see on the screen or 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 are -- they have a bigger crack spread to jet fuel, so we also tend to look more at heating oil, because it has a stronger correlation with jet, which is what we actually buy.
On December 31st, these prices were about 20% lower actually than where they are today, but there was a lot of change in prices within Q4. I was evolved earlier overall in 2018, but Q4 was also volatile.
So December 31st was 20% lower than where we are today, so you can do the math and see how that will reflect into our prices. We're hedged to the tune of about 30% of our next 12 months and our average price we're a little bit in the volume.
Even though we were out of money in December, today we're slightly in the money, so our average price is a little bit better than where you see the market today. So I think with info you can probably figure out where our prices are going to be.
Andressa Varotto
Okay, thanks. And secondly, the reduction in maintenance expenses in the quarter compared to the historical level.
And is this something that should continue going forward? And if yes, is it included in fixed margin guidance?
And how much would it represent? Thanks.
Alex Malfitani
Yeah, so 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 in-sourcing some of our maintenance activities this all makes sense, because we're now bigger, we have critical mass, where it doesn't make sense for us to do and also we have a lower cost of capital.
Also in the old accounting policy, IAS 17, we would expand some maintenance on leased aircraft as occurred, right? So when we have the maintenance event that's when we would recognize the maintenance expense.
And that creates some lumpiness between quarters, right? There are quarters with more maintenance expense.
There are quarters with less maintenance expense. Q4 obviously was a quarter with -- lacks maintenance expense particularly on edges, right?
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, right? So our maintenance expense overall next year will be lower than this year.
And even if you take into account the fact that we're growing, it would be normal for it to be higher and would be nominally lower than what it was in 2018, mainly because of IFRS 16. And that's embedded in our CASK guidance of minus one to minus three.
Alberto Valerio
Very helpful. Thanks very much.
Operator
Our next question comes from Dan McKenzie, Buckingham Research.
Dan McKenzie
Good morning, guys. Thanks for the time here.
I guess first question, I'm wondering if you can help us understand how the debt picture changes for Azul. Obviously, there's a scenario where it's successful acquiring Avianca's assets.
So how much debt does Avianca Brasil have today? And how much of that would follow under a deal closing?
David Gary
Yes. So Dan, as we've explained, we're actually acquiring what's called the UPI in Brazil our new company.
And so all that would go in there is just operating leases that would need to be renegotiated, and so there's actually no debt associated with the acquisition.
Dan McKenzie
I'll take this. Thanks for clarifying.
Thank you. And I guess, if you think about deal economics, how does it change CapEx probably for this year or next year?
And if you think about Avianca's working capital needs, does it require more cash on top of what you're proposing at this point?
David Gary
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.
So we'd kind of accelerate a couple of years our growth, but then we can kind of measure growth going forward, hey do we extend these leases or actually returned the leased aircraft and bring in our neos. And so I think it's a way to reduce the risk going forward as we already did pilots and flight attendants and maintenance technicians already ready to go, they're already trained on the specific aircraft that were growing over the next couple of years.
And so that's the way we look at it. And so think of it it's kind of pull forward our growth a couple of years.
But then what happens with the neo that come in? Most likely, the neos come out as a result.
Daniel McKenzie
Understood. And then if I could just squeeze maybe one or two more in here quick ones.
I guess, first off, if you can just help us understand kind of a two big risks that acquiring another airline is simply is IT and labor. And 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.
And then just secondly, foreign exchange has been a stubborn headwind here. So for those investors that don't know Brazil well, how are you handicapped being potential for economic being fiscal reform later this year?
99% probability the big stuff gets passed, is it maybe 50%? Big picture, how are the initiative that are critical to Brazil economic growth being perceived by politicians?
A – Alex Malfitani
Hey Dan, I'll talk about sort of the IT stuff real quick. So we obviously have some good experience with this with the Trip merger.
Trip at the time had a stable reservation system and we of course have not there, but we were able to transition that pretty quick. I think we had the codeshare and the flight in the system within six months.
So certainly not -- we've done it before. Avianca has the Amadeus reservation system which Azul also has as part of our codeshare and alliances platforms.
So we feel confident regarding the IT. Require some work, but nothing we haven't done before or don't know how to do.
A – John Rodgerson
Yes. They are -- from a cultural impact of taking on crew members from another airline, Azul is 12000 strong today and Avianca is significantly smaller than we are.
We by far away have the best product and experience in Brazil. But I would tell you that Avianca Brasil is a close second.
I think they are fantastic crew members and they are fantastic -- they have 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. And so I think that that's something that we're going to manage.
And David talked a lot on the call today about it's going to be the best job of your life and I think that's what we have for the majority of our crew members. And we intend to extend that to 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 and that's what's been five years. It’s indistinguishable.
You don’t know who is Azul and who is Trip because we've been able to assimilate them into our culture and it's been amazing to watch, so we don't think that's anything different with the crew members from Avianca who is trying to compete. And Dan back to your other question on reform.
Something is going to get passed. I think is it going to be 100% of what everybody wants?
Probably not, but something's going to get passed. It's all -- anybody is talking about at the government level.
And I think that the government is hyper focused on it. And I think that we're looking forward to the reforms that take place and I think you're seeing the military and everybody is kind of onboard 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. And any time you have a business plan that depends on the government is not a good business plan.
And so what I would tell you is we're going to continue to expand margins in light of what happens from a macro perspective, but 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.
And so at least the government is focused on the right things right now and that gets us excited.
Q – Dan McKenzie
Thanks for the answers guys.
Operator
The next question comes from Savi Syth, Raymond James.
Q – Matt Roberts
Hey, 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 have with some of the overall cost trends thinking about that through the year?
David Neeleman
Yes. Sure.
Sure Matt. So as you saw, we gave guide on continuing our CASK reduction in 2019.
It should go down between one to three percentage points. Obviously that's mainly from our fleet transformation, right?
As you know the -- and we've mentioned many times that CASK -- and the new aircraft goes down between 26% and 29% compared to our current aircraft, right? It's important to know that 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? So that should reduce volatility to FX.
So, 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 1.
And so that adds additional costs to our salary lines. So, you'll see that starting Q1 that line is going to be bigger, but that's included in our one to three cap 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.
Q – Matt Roberts
Great. Thanks, David.
David Neeleman
Sure.
Operator
Our next question comes from Lucas Laghi, Citibank.
Lucas Laghi
Good morning, guys. Thanks for taking my questions.
My question is regarding the next step of the joint venture with Correios and the CASK approval, when we could see any impact after this JV in these numbers? Thank you.
David Neeleman
Yes. So we received CASK 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 Correios in the last 12 months.
And so anytime government changes, there's new leadership in that area. And so, for now, we're focused on Azul Cargo growing that business as quickly as we can.
Still very optimistic about the opportunity. But unfortunately, we can't give you much more update that this time, because we're now kind of working with the new leadership team and what the new joint venture would look like jointly with them.
And so, they need to take some time to get up to speed as well. But that's the latest we have.
Lucas Laghi
All right. Thanks again.
Operator
[Operator Instructions]
John Rodgerson
Okay. I guess, that's it for the questions.
Again, we'd like thank everybody for joining us and look forward to talking to each one of you. If you have any questions, our team is available always and -- but we really are excited on our business and we're excited about the direction going forward.
And we'll see you next quarter and we expect that hopefully things will continue to improve and we'll do our part. So, thank you very much everybody.
Operator
Ladies and gentlemen, that does conclude the Azul audio conference for today. Thank you very much for your participation and have a good day.