Air New Zealand Limited (AIR) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Air New Zealand's Liquidity and 2020 Earnings Update Conference Call. [Operator Instructions] I would now like to hand the conference over to Air New Zealand GM of Corporate Finance, Leila Peters. Please go ahead.

Thank you, and welcome to the Air New Zealand Liquidity and 2020 Earnings Update Call. The duration of this call will be approximately half an hour. Your phone lines will be placed on listen only while Air New Zealand's Chief Financial Officer, Jeff McDowall, makes a brief opening statement. We will then open the lines for a question-and-answer session, so please refrain from asking questions until that time. It should be noted that there is no Investor Presentation accompanying this call. However, it is recommended that you read the announcement that was released to the stock exchanges earlier this morning. Please also note that comments made on today's call contain certain forward-looking statements. These statements are based on management's and director's current expectations and assumptions regarding Air New Zealand's business and performance, the economy and other future conditions, circumstances and results. As with any projection or forecast, forward-looking statements are inherently susceptible to uncertainty and changes in circumstance. Air New Zealand's actual results may vary materially from those expressed or implied in the forward-looking statements. And now I'll hand the call over to our Chief Financial Officer, Jeff McDowall.

Thanks, Leila, and good afternoon, everyone. We really appreciate you joining us at such short notice. I'm going to keep my opening comments brief given the announcement we released this morning is fairly comprehensive. And I also want to allow a decent amount of time to answer your questions. While it's only been 3 short months since we reported our 2020 interim financial results to the market, that now feels like a lifetime ago. On the 21st of March, New Zealand went into a nationwide lockdown in order to get our country a fighting chance for slowing the rapid and devastating effects of the COVID-19 pandemic. This has had an unparalleled impact on the economy as a whole. But for the aviation and tourism industry specifically, the impact of COVID-19 has been so significant that even a pessimistic black swan scenario could not have envisioned the situation in which we find ourselves today. For a period of approximately 6 to 7 weeks, Air New Zealand was operating at less than 5% of our total network capacity and making substantially less revenue. While the move to Alert Level 2 is really positive in that we have been able to get more of our domestic business up and running, we're still only operating a small fraction of our normal network. Over the course of the past few years, we've been focused on building significant resilience into our balance sheet, and this put us into a strong starting position. We acted quickly to shore up our liquidity. Firstly, by arranging a $900 million loan facility with the New Zealand government; and secondly and probably most importantly, by taking swift and decisive action to make both short-term and structural reductions across our cost base. With total revenue coming in, these actions to reduce our fixed costs have been vital in ensuring that we will be in a strong position when we emerge from this crisis. Most significant of these cost reductions is in our labor cost base. We have had to make the decision to further -- to reduce our labor force by approximately 30% or around 4,000 people. This is expected to result in annualized savings of around $350 million to $400 million. To say we've agonized over this would be an understatement. We know that it's our people who make Air New Zealand the great company that it is, but we've had to face up to the reality that the landscape of that business has changed. And importantly, the majority of the actions outlined in our release today have already been implemented, and we see our average monthly cash outflows reduced by $50 million to $60 million throughout the 2021 financial year. Let's move to Alert Level 2, we are seeing some positive early signals in terms of domestic demand. So we are cautiously optimistic that the domestic engine will gradually pick up over the coming months. We also know that the New Zealand and Australian prime ministers have been in discussions regarding the trans-Tasman bubble, positive. However, there's no real sign of international borders opening up beyond that anytime soon. Accordingly, we've had to make some really tough decisions to get our cost down, recognizing the fact that Air New Zealand may still be only 70% of its former size in 2-year time, and we need to ensure our cost base is aligned with that. As we said in the release this morning, we've tried to manage the fine balance between removing cost from the business and ensuring we're in a strong position to ramp up as demand recovers. This morning's disclosure also provides a range of estimates for the items that will be reported within other significant items in our 2020 annual financial statements. To be clear, these are our current best estimates and is still subject to review both internally and by the Board and our external auditors. So with that context, thank you very much for listening. I know that you have many questions. So operator, please open up the line.

[Operator Instructions] Your first question comes from Andy Bowley from Forsyth Barr.

I've got a couple of questions. The first of which is around the cash burn. You've talked about reducing the cash burn by $50 million, $60 million per month, which is great. But what are you reducing it to? And could you give us an idea of what that would be from an OpEx versus CapEx split?

So the -- I mean the reason why we have expressed it that way is that the cash burn is obviously a product of cash coming in and cash going out, and the cash coming in is just highly uncertain because it's driven by the scenarios that we've sort of been modeling in. As we've only been selling into level 2 for a couple of weeks now. We're seeing actually pretty strong demand, looks stronger than we expected. But we feel it's a bit premature to sort of net that and give you a cash burn figure. So we thought better just to tell you what we can tell you with a degree of a bit more accuracy and focus on the reductions that we've made.

Maybe you can talk about it and I just thought -- sorry, Leila.

Sorry, Andy, you broke up there?

I was going to say -- sorry, you go, Leila?

With this -- month to month, there's clearly variation in our operating cost base and in our cash outflows so we sort of talk about a range of $150 million to $200 million depending on timing, interest payments on debt, lease payments, certain CapEx. So you can take that and take off the $50 million to $60 million. The other thing that I'd mention is that in terms of the reduction of approximately $50 million to $60 million a month, more than half of that would be made up of operating costs if you think about labor that Jeff mentioned. And then -- so a little more than half would be operating costs, including labor and the remaining amount would be related to CapEx.

Great. And then the second question around the significant items and dig down particularly into the hedges. I'm sure there's going to be some questions around the impairments as well. But in terms of hedges, can we expect any de-designation of hedges that prolong into fiscal '21 as well? Or is that it in terms of what the positions that we had will be all encapsulated in fiscal '20?

So the de-designation of hedges relates to the accounting impact of our fuel and foreign exchange hedges, Andy. The -- and that includes de-designation of FY '21 hedges as well. There is a degree of uncertainty in a portion of that estimate, which is why we've given you a range, but I would say about 70% of those de-designations have been crystallized, and the remainder would be subject to revaluation to the end of the year. In terms of the cash outflows related to fuel and foreign exchange, it is less than the accounting recognition, so it would be about $60 million of cash outflows to date, and we do not expect materially much more close outs to occur.

Great. And then maybe lastly, just following on from the hedges. What are your -- how is your approach from a fuel hedging point of view now knowing that there is so much uncertainty in terms of EBITDA and outlook?

Yes. I mean, it's really a good question because the tenets of our treasury policy is that we've hedged a proportion of our future consumption and if the future consumption is highly uncertain, it does make it difficult. So we've taken a pretty conservative view on that. And so we're looking to bring our overhead position down, which is what you're seeing in this disclosure, to a relatively conservative view of consumption. And although fuel price is low, we are -- we're conscious that there's an opportunity to lock in some low fuel prices for the future, but we're also conscious that the level of consumption, if you go out 12 months, is highly difficult to forecast. So we're just being very measured about that.

And I guess, will you provide your quarterly fuel price update over the coming weeks?

Sorry, Andy, I couldn't hear you. Could you repeat that?

You'll provide your usual quarterly fuel hedging update accordingly to give us more specifics around that financial situation in time and clearly, how you're approaching it?

Yes. So we normally, as you know, as you touched on, we do a quarterly fuel hedging disclosure. We are not going to do that this month, Andy, because the purpose of the fuel hedging disclosure is to be helpful and provide you with an update to our expected consumption. And as Jeff just mentioned, that is highly uncertain at this time. When we do have a better forecast understanding of what consumption will be like into the future, we will most likely reinstate our fuel hedge disclosure, but you would not -- I would not expect to get one this month.

Your next question comes from Owen Birrell from Goldman Sachs.

Just a couple of questions for me. Just looking at -- I just want to draw you out on that comment around being 70% of your pre-COVID size in 2 years. Can you give us a sense of how that differs between international and domestic just so that we can get a better sense of how you're planning your -- I guess, your fleet and your operations right now for 2 years' time?

Yes. Sure. So we are expecting the short-haul parts of the network to recover sooner, so led by domestic as we're actually are starting to see followed by Tasman and Pacific Islands, then eventually our long-haul destinations. And so kind of when you get to 2 years from now, the shorter-haul parts of the network have had longer to recover than the longer-haul ones have. So if we kick that far enough, I'm not sure that I would give you a view of which will be higher and which will be lower, but certainly by 2 years from now, the long-haul network would have had less time to recover. We also think there's -- if you think about the Pacific Islands as a destination for New Zealanders, there will be a period of time, assuming that New Zealanders can travel there that -- yes, if it's the only place they can go outside of Australia and New Zealand, it's going to be enormously popular. So you could see that actually recover quite quickly.

Well, I guess let me ask it a different way then. In terms of the domestic volume recovery profile, I mean, by the end of this year, do you have a sense of how much volume you think will come back on in terms of -- you obviously have to prepare your business for it?

Yes. I mean we're sort of in a scenario of a pending mode rather than forecasting mode just because it is so difficult to forecast. We're conscious that the recently significant proportion of our domestic volumes, sort of circa 20%, is driven by inbound tariffs, the net inbound tariffs from long-haul destinations mostly. So to the extent that we're not flying internationally at the end of this year, then you would see that impact on domestic. And obviously, the economic conditions in New Zealand will have an impact. As well, potentially some of the ways of working that people have switched to over the past couple of months with increased use of video conferencing. So we're not expecting domestic to recover to where it was by the end of the year by any means, but we do expect it to recover soon as other parts of the network. And as I say, we have actually been pleasantly -- I wouldn't say surprised, but we've been -- it's been good to see the level of demand that has picked up in the last couple of weeks since we've been on Level 2.

Okay. And just a second question for me. Just on the labor cost. Just trying to marry up the labor cost reduction of 30%. With your expectation of being 30% smaller in 2 years' time, does that mean for the next 2 years, you're essentially going to be carrying quite a significant amount of labor cost that is essentially being unused?

So that's -- you make a good point because the focus is still we have taken, in the first couple of months, which we're reporting on here, is getting our labor base, yes, fit to where it needs to be for the longer term, and that means making permanent steps to reduce our labor costs, and that's the 30%. And as you say rightly, that that's correlated to the 70% position we say we're going to -- we think we might be or could be in 2 years from now. What's actually interesting as a bit of an upside is the New Zealand legal framework around labor doesn't have a concept of furlough. And so there are some airlines in other parts of the world who have kind of been able to move quickly and take some of the cost off their books really quickly, which has been a good thing for them, and we haven't had that opportunity. On the positive side for us is that has forced us to move quickly to get our permanent costs to where we need them to be, so -- and I think you could say that when we get to a stabilized point at the end of this, and we're stable and growing, but still smaller, we'll be in a really strong position because we've moved now to take those costs out, whereas other airlines have essentially not had to do that yet and still have that chance ahead of them. Then to your point, though, about -- so what do we do between now and then, that's the focus that we have now. So there is a level of flexibility that we need to maintain, obviously, as we go through that period. And it's not like we go from -- we felt like we're at sort of nothing now and we will start to gradually pick up, so we do need people. But we are looking at other opportunities to reduce labor costs during that lower point. And that means engaging with our union partners and our individual employment agreement work groups to find ways of reducing costs during that temporary period. So when we talk at the release actually about further areas of cost reduction, that's one of the key things we're talking about.

Yes. So essentially what you're saying is those discussions are ongoing and you're still looking for further ways to reduce the cost in the interim with where you can do it/

Yes, that's exactly right. Yes. Yes. Yes, that's right.

And just a final question for me. Just on the cash burn comments, you talked about the level of liquidity you've got at the moment. Did you envisage you're going to need to use the $900 million government facility? Or is it just really a safety net?

Owen, so the way we thought about that is that we'd start drawing it down when we get to around the $200 million, $250 million range in our own liquidity. So yes. So it's there for a purpose. So we do think it's important to have it there.

[Operator Instructions] Your next question comes from Marcus Curley from UBS.

Just -- Jeff, I just wondered if you could start with giving us a little bit of a color on what's happening with prepaid ticket balances and refunding.

Yes. Sure. So we -- I can't give you specific numbers, but we have been -- we've been dealing with flight cancellations through a combination of refunds and having people opt to hold their funds and credit, and we've actually seen a good proportion of people choosing to hold their funds and credit. We've been investing in digital tools to make it easy for them to do that. And the other has been -- that has proven to be a good option. So the rate of refunds has been mitigated quite a bit because of that.

And now that you're starting to reintroduce flying, are you seeing a disproportionate amount of the credits being used? In essence, do you think there will be sort of an impost in the future on the business to start up?

Yes. So to answer -- to answer your question, not a disproportionate amount, sort of in line with what we had expected. But to your point, the whole concept of a credit is a timing thing. It doesn't -- it means that we don't make a refund today, but we do -- but that credit goes to paying for travel in the future, so it is purely a timing thing. So that will mean that you see that as we start to climb out of it.

Okay. Could you talk a little bit more specifically to CapEx in the next 12 months? I know that you've done a good job pushing out the $700 million. But what does that mean for the absolute numbers in the next 12 months?

I mean this thing for FY '21, probably the biggest component is the 3 domestic A321s, which have been moved from delivering in 2021, delivering in 2022, so that's the biggest single component. We can -- we've got some more detail which we can work -- share with you after the call, if it's helpful, but that's probably the biggest component in there, some movement in some overhauls and some non-aircraft CapEx as well.

Yes, Marcus. So if we think about of our total CapEx, there's aircraft-related CapEx, which is, as Jeff mentioned, the fleet-related stuff, engine overhauls for our owned engines. And then we have some degree of non-aircraft CapEx which really relates to properties and infrastructure investments as well as digital investments. And so we've managed to push out over the sort of FY '21 period roughly around $250 million to $300 million. That's obviously a portion of the $700 million in the wider release in terms of 2.5 years. But I would say that it's quite -- every part of those CapEx contributors has been pushed, and we continue to look for additional opportunities. So no area of the business has been left untouched in terms of either deferring or deciding that we actually will just exit and not do that CapEx point blank.

Okay. And then could you talk a little bit about how you see the profile of operating cash flow once you start flying? Like, for example, in the domestic business and the Tasman, do you see the ability to restart flying being a big boost to the cash burn situation? Or is it more progressive than that?

Certainly it's a big boost. I mean, the key thing, obviously, is the proportion of flying that there's demand for. So I sort of have to give you a precise answer to that. But the flying that we're doing right now on domestic into Level 2 is producing incremental cash and obviously, a strong positive thing as is the flying that we're doing under the cargo RFP that we have with the government. So they're both -- both of those things are contributing to our cash position right now. And as domestic ramps up further, hopefully, as we move to Level 1, we don't have social distancing, being that will ramp up further, and then Trans-Tasman bubble would be the next step-up from there. So all those things help. And they -- and you do get -- to the extent that you get the ability to anticipate it, then revenue start to come in before the cash gets burned because people, obviously, book in advance.

Okay. And then finally, I just wondered, looking longer term, what do you think -- have you given some thought in terms of what you think the balance sheet metrics need to look like when the business sort of restarts, if you like, in an open skies environment? And when do you think you'll sort of be in a position to sort of tackle that?

Yes. I mean as we start to learn more about what's the environment going to look like and as we start to firm up our view on which scenarios, we need to be prepared for and which are more likely, then inevitably, the question becomes what financial position does that place this on over the next 1, 2, 3 years, and what does that mean for our capital structure? So yes, we will need to tune our mind to that. And I can't give you anything specific right now but it's certainly something that we will tune our minds to.

Do you think that's more a question for the end of this calendar year than anytime soon?

It's really up to the Board. I, mean, as Jeff mentioned, it's something that they're thinking about, but we can't comment on that at this time.

And then sorry, just a supplement to that. Obviously, you reduced the value of the fleet. Do you think that, that's the extent of it? Obviously, that -- the asset downgrades has an impact on your gearing ratios and potentially where you feel happy. But do you think that's the extent of the potential for the write-downs?

Although -- I mean there's more work to do on there, obviously. And as part of the order process, we will go through that with a fine-tooth comb. I mean what we're seeing at the moment is that if you think about a 777-200s, we were due to have them start coming out of the fleet, kind of end of -- from the end of 2022, mid- to late 2022. So yes, we're now saying that we are thinking that we may still only be 30% of our former size at that point in time. So there's clearly a case in which we wouldn't need those aircraft again, which is why we've moved to impair those, we're in pain for impairing those now. If you think about the rest of the fleet, though, we do need it when we're at that sort of size. So it's really a different situation, different question.

[Operator Instructions] Your next question comes from Nick Mar from Macquarie.

Good afternoon. Most of my questions have been asked by now. But just kind of following on from the impairment. How is that going to kind of impact your depreciation? Are you making any changes to how you're depreciating the aircraft going forward, given lower utilization for the foreseeable future?

I mean the main impact will be the depreciation on those specific aircraft on 777s, including actually the accounting depreciation, if you like, on the right of use assets, the 777 on the balance sheet now under IFRS 16. Generally, our approach for aircraft depreciation is based on the sort of straight-line approach rather than the utilization driven approach. So not at the moment of the mind to change that. And as a certain kind of -- I mean the biggest aircraft that we won't be using a 777-200s, and we kind of dealt with through that impairment.

Okay. And then in terms of your leased aircrafts, are there any that you are planning to return early?

Sorry, could you repeat that, Nick, about the leased aircrafts?

Just in terms of the lease aircrafts, are there any that you're planning to have early returns on?

Well, yes. So we've got some early termination options on a couple of 777-200s, that's something that we'll consider as we think about the fleet plans over the next 2, 3 years. So we do have some flexibility there.

But nothing in the immediate term, Nick.

Okay. Great. And then just lastly, kind of -- a bit longer term in the picture, but you kind of -- how you think about ROIC following the write-downs and everything like that in terms of the long-term target that you had out there?

Yes. I mean it's a good question. We will -- again, it's not something we've tuned our minds to yet. I mean I think sort of fundamentally, the ROIC model still makes sense. And yes, you can sort of debate, I'm sure, and as I'm sure many people will be at what the right WACC is. But yes, it's not something we've tuned our minds to in great depth, but as a fundamental model, I think it still applies.

There are no further questions at this time. I'll now hand back to Mr. McDowall for closing remarks.

Thank you. And I'd just like to thank everyone listening on the call for their time and also for your ongoing interest in Air New Zealand. If you'd like to schedule a call or if you've got any follow-up questions, please direct those request through to Kim and our Investor Relations team. Thank you.