Transat A.T. Inc. (TRZ) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Transat conference call. This call is being recorded. I would now like to turn the meeting over to Ms. Andrean Gagne, Senior Director, Communications and Corporate Affairs. Please go ahead, Ms. Gagne.

Thank you. Hello, everyone, and welcome to the Transat Conference Call for the Presentation of the Financial Results of the Third Quarter ended July 31, 2022. I'm here this morning with -- Annick Guerard, President and CEO; and Patrick Bui, Chief Financial Officer. Annick will provide comments and observations on the current operational situation and commercial plans for the future. Patrick will after review the financial results in more detail. We will then answer questions from financial analysts. Questions from generalists may be answered offline. The conference call will be held in English, but questions may be asked in French or English. As usual, our investors presentation has been updated and is posted on our website in the Investors section. Patrick may refer to it as he presents the results. Today's call contains forward-looking statements. There are risks that actual results will differ materially from those contemplated by those forward-looking statements. For additional information on such risks, we invite you to consult our filings with the Canadian Securities Commission and on Cedar and are incorporated through this statement. Forward-looking statements represent Transat's expectations as of September 14, 2023, and accordingly, are subject to change after such date. However, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, other than as required by law. Finally, we may refer to IFRS and non-IFRS financial measures. In addition to IFRS financial measures, we are using non-IFRS measures to assess the corporation's operational performance. It is likely that the non-IFRS financial measures used by the corporation will not be comparable to similar measures reported by the other issuers or those used by financial analysts as their measures may have different definitions. The measures used by the corporation are intended to provide additional information and should not be considered in isolation or as a substitute for IFRS financial performance measures. Additional information on non-IFRS financial measures, such as their definition and their reconciliation with the more comparable IFRS measures, are available in our quarterly reports and our investor presentation. With that, let me turn the call over to Annick for opening remarks.

Good morning, everyone, and thank you for joining us. We're very pleased with Transat's financial performance in the last quarter in which we generated record adjusted EBITDA for the third quarter. We also delivered a net income of $67.3 million, $1.49 per share, representing our first net profit since the end of 2019. Third quarter revenues were 6.8% above 2019 prepandemic level, reaching $746 million, while our record adjusted EBITDA of almost $115 million with nearly 85% higher. In addition, Transat generated a positive free cash flow over the past 12 months. This gives us confidence in our ability to further improve our capital structure by reducing our debt. Patrick will further discuss our financial position in a few minutes. These impressive results demonstrate strong overall execution as well as our ability to meet sustained customer demand in a cost-efficient way. They also reflect the strength of our brand as a carrier of choice for leisure travel, which was recently confirmed by winning Skytrax World Best Leisure Airline Award for the fifth time. This award is the result of the hard work and dedication of our 5,000 employees who embrace our values and vision. I thank them all for their contribution. Once again, demand for leisure travel was robust. Together with firm pricing, these favorable market conditions produce a yield 29% above those of 2019. Transat achieved these remarkable results despite available capacity nearly 14% below 2019 levels, showing further strong execution by our team. Demand has remained solid in the early stages of the fourth quarter. Booking velocity continues to mirror that of 2019, but at significantly higher prices. Yield is tracking at 26% above 2019 levels. Looking further ahead, early bookings for 2024 winter season suggests that consumer demand should remain healthy. Sales velocity is currently above that of winter 2023, with higher load factors on a comparable basis. More importantly, yield is about 7% higher than last year, which bodes well for the start of the new fiscal year. For the winter, we're looking at a 23% increase in available seat miles compared to last year as we continue to methodically expand our fleet while also seeking to maximize productivity by increasing aircraft utilization. From an operational point of view, Transat is ready to deliver this greater capacity. This includes having the crews to operate the aircraft and all the record workforce to provide customer and logistical support. Supporting this increase, we received the 3 additional A321 LR aircraft during the summer, which are not part of our price schedule. With the trade expansion, we plan to operate 40 aircraft during winter 2024, which is 5 more than last year. This enables us to open new promising risks to relaunch or extend the seasonal character of others and to increase frequency on our best performing sun destination routes. Regarding our routes, we announced in August a program expansion with direct flights to Lima, Peru from Montreal and Toronto starting in December as we continue to grow our presence in South America. In addition, you may recall that we announced earlier this summer year-round service to certain destinations in France, including Lyon and Marseille and the extension of others deeper into the winter season. To sum up, we're pleased with the overall progress we are making in executing our strategic plan. We look forward to providing you with a more comprehensive update on our plans during our year-end conference call. In conclusion, third quarter results clearly prove that Transat remains on the right path to sustain profitable growth. We're very satisfied with the progress accomplished to this date. Consumer demand remains solid despite inflation. Canadians continues to make travel a priority for their well-being. The Canadian airline sector continues to benefit from pent-up demand. The market is still catching up, especially on international travel. Future demand will also be supported by strong immigration as the Canadian government has increased its immigration target. Assuming the economy of the top lending, we believe the demand will remain strong, while carefully looking at supply constraints for the near future. These favorable market conditions should continue to drive solid bookings and healthy pricing. Meanwhile, our teams are continuing to manage our measured expansion strategy while further optimizing our cost structure. In parallel, we're keeping an eye on certain factors that could impact our activities such as the higher price of fuel, unforeseen delays in aircraft deliveries and the continuing supply chain challenges, including engine shop visit, turnaround times and the inspection situation with [indiscernible]. If required, we will rapidly adapt to any situation with a clear objective of protecting our operation and our profits. Transat is determined to offer customers the best value proposition and service for the travel experience. We thank them for their confidence. With that, I turn the call over to Patrick, who will review our financial performance in greater detail.

Thank you, Annick, and good morning, everyone. Our robust third quarter results reflect strong customer demand for international leisure travel, higher pricing and the disciplined execution of our strategic plan as we continue to move closer to or even surpass operating results of 2019. Total capacity in Q3 of 2023 represented 86% of that offered in 2019. Our yield was 29.1% higher while the load factor was similar at 88.8%. As Annick mentioned, we delivered adjusted EBITDA of $114.8 million, reaching new heights in profitability for the third quarter, and our free cash flow for the past 12 months was positive. Based on historical patterns, we expect to consume cash in the fourth quarter, but we remain in a strong position to generate a positive free cash flow for the full fiscal year. This was one of Transat's key financial objectives as it puts us in a better position to continue the deleveraging process. On that note, on August 31, we announced the closing of the sale of our land property in Puerto Morelos, Mexico, to Finest Holdings for USD 38 million. Net proceeds of approximately CAD 50 million from this transaction will be used to reduce debt. With these cash infusion and a better operating environment conducive to a stronger cash flow generation, we are confident about our ability to further reduce our debt as we continue to diligently work on a refinancing plan. Now let's turn to our third quarter results. Revenues increased to 46.8% to $746.3 million. This increase reflects the full resumption of operations and a strong customer demand. Recall that in the early stages of Q3 2022, Transat's revenues were still recovering from an earlier sharp decline in demand and massive booking cancellations following the emergence of the Omicron variance. Adjusted EBITDA was $114.8 million, representing a 15.4% margin compared to a loss of $57.8 million last year. In addition to sustained demand and our focus on cost containment, we benefited from a 23% year-over-year reduction in fuel expenses due to a 41% decrease in fuel prices partially offset by more aircraft movements due to greater capacity deployments than last year. Net income totaled $57.3 million in Q3 of 2023 compared to a net loss of $106.5 million in Q3 of 2022. Adjusted net income, which excludes items that affect comparability also significantly improved, reaching $42.3 million compared to an adjusted net loss of $120.9 million last year. Moving on to the balance sheet. Cash and cash equivalents amounted to $570.6 million at July 31, 2023, up from $411.3 million a year earlier. Cash and trust or otherwise reserved mainly for travel packages also improved year-over-year, reaching $293.3 million, up from $244.7 million a year ago. Unrestricted liquidity, which consists of cash and cash equivalents plus undrawn funds from credit facilities, stood at $670.6 million, which is 31% above last year's level. Customer deposits and deferred revenues amounted to $819.9 million, which constitutes a new all-time high for a third quarter. This figure is up 40% from July 2022. In terms of indebtedness, long-term debt remained at $863.2 million, and we made repayments of $40.4 million on our lease liabilities during the quarter. All balance sheet agreements, excluding agreements with suppliers, decreased by more than $180 million during Q3 to reach $896.8 million at the end of July. The decrease was primarily due to the delivery of 2 Airbus A321 LRs and one A321 CEO and to the appreciation of the Canadian dollar against the U.S. dollar during the period. These were partially offset by the impact of higher interest rates on future rents. Turning over to cash flows. Free cash flow was -$52.1 million in Q3 of 2023. It represents a significant improvement from -$96.9 million in Q3 of 2022, mainly stemming from the positive impact of this year's net income on operating cash flow as opposed to last year's net loss. It was partially offset by a negative net change in noncash working capital balances and higher repayment of lease liabilities compared to last year. On a rolling 12-month basis, free cash flow is $152.7 million. As I mentioned earlier, we expect to conclude fiscal 2023 with a positive free cash flow position. Also of note, given our significant improvement in operating profitability and cash flow generation, we have removed the going concern and certainty from our financial reports. This constitutes another positive step forward on our path to a full recovery. Turning to our outlook. We are raising our fiscal 2023 adjusted EBITDA margin target to 7.5% to 8% on the strength of solid results for the first 9 months and our expectations for the fourth quarter. Previous range was between 5.5% to 7%, and it was initially set at 4% to 6% at the beginning of the fiscal year. The lower end of the range is a scenario in which fuel prices stay or increase from the current levels. The upper end of the range is a scenario in which fuel prices recede from the current levels. Given our year-end target and our achievements to date, this implies that our fourth quarter adjusted EBITDA will be healthy but less than our record third quarter performance. Although demand and yields remain solid, we do not expect fuel to be a tailwind this quarter. Our main assumption in updating this guidance include moderate growth in Canada's GDP, an exchange rate of CAD 1.35 to USD 1, an average price per gallon of jet fuel of CAD 4.25. In summary, we are very pleased with our financial performance so far this year. We are generating a significantly higher yield. This has a direct and positive impact on operating profitability, and we also remain focused on tightly managing our costs. We are confident in our ability to further improve margins and to continue growing free cash flow on a rolling 12-month basis. With this renewed strength, Transat is in a significantly better position to refinance its capital structure. We are actively working on a refinancing plan, and we look forward to sharing the details with you in due time. This concludes my comments. We will now open the call to questions.

The first question comes from Kevin Chiang from CIBC.

Congratulations for putting up some strong results here in the fiscal Q3. Maybe I'll focus on the capacity growth you have. I think you talked about 23% for the upcoming season. I get the demand is strong and you're not seeing any real signs of weakness here, but obviously, there's broader concerns in the economy and maybe over the health of the consumer. Just if you can frame what looks to be a very large capacity increase within an economic backdrop, as you pointed out as being pretty modest, at least in terms of your assumption maybe the risks that you see to overcapacitizing the market if you do see a weaker consumer.

Yes. Yes, for 2024, we continue to methodically expand our fleet, while also seeking to maximize productivity by increasing our aircraft utilization. So we plan to operate 40 aircraft during winter -- next winter, which is 5 more than last winter. As we explained, we received 3 additional A321 LR this summer, which are now part of the winter schedule. It enables us to open new routes. It allows us as well to relaunch or extend the seasonal character of other and increased frequency on the best-performing sun destination. And from an operational point of view, we are very ready to deliver on this greater capacity. That being said, it's plus 23% ASM compared to last year, but it's plus 15% compared to 2019. So that's important to say. We continue to see strong booking momentum for next winter. As we've explained, we're ahead in terms of booking curve, ahead of load factor, ahead in yields. So we're confident about the fact that the Canadian airline sector continues to benefit from pent-up demand. So what we see today, despite inflation, we are pretty much comfortable that that's the right capacity to deploy to make sure that we position ourselves well in the market and strongly.

That makes sense. And I'm just wondering as you look at the booking curve now, are you -- I get the overall demand environment is strong, but are you seeing any changes in terms of where people want to fly to, to reflect some of the broader concerns that the consumer has. Are you seeing people fly to less expensive resorts? Or has that behavior not changed as you flown into this winter season versus what you saw last winter when there was an extreme amount of pent-up demand to travel?

No, we haven't seen strong changes versus last year. Of course, on our side, we have deployed more capacity on the transatlantic market, which is performing very well for next winter. So we're pleased about that. We've extended some of our programs out of -- on the France regions. So that's going very well. And otherwise, on the sun destination, we're still seeing strong demand for 5-star, 4.5-star packages. So that's encouraging as well.

No, that is. And maybe just last one for me. Obviously, strong yield performance as well. Just wondering, and I know this might be difficult to kind of parse out. But if you have to look at some of your internal initiatives as driving yield, whether it's your broader revenue management program, ancillary services, maybe some of the adjustments to your product offering as you've come out of the pandemic versus just a mismatch between the demand and supply driving fares higher. Is there a way to think about how much of this yield do you think might be sticky for lack of a better word, just based on internal initiatives that you're pursuing or have been pursuing as you've been building through this recovery?

Well, it's difficult to say, but one thing's for sure is that -- and we talked about that during previous quarters, we've improved our revenue management practices with the implementation of PROS, the airline revenue management tool that is one of the best in the market. We've changed the team as well. We have high qualified people with high skills in revenue management. And we strongly believe that this has made a big difference this summer and for the years to come.

Your next question comes from Cameron Doerksen from National Bank Financial.

Yes, I guess maybe my first question is just around the change in the margin expectations here for the full year. I'm trying to square this because it feels like even the high end of your new full year margin target is pretty conservative even if we assume that the fuel price that's spiked higher recently has stayed the same for the rest of the quarter. So maybe you could just detail a little bit more about what your expectations are for Q4. Is there something around where you're hedged relative to Q3. Just if any additional color you can provide here because it does feel like your implied Q4 is maybe significantly weaker than Q3, which given the booking trends doesn't really seem to be what I would have expected.

Cameron, I'll take that one. From a demand perspective, we still see Q4 being a constructive demand environment. And as Annick said, we see that continuing into the new year. You're correct also in pointing out the Q4, we're expecting Q4 to be weaker than Q3. There's a host of reasons, but we'll generally bucket that in 2 categories. One, I think we need to recognize the exceptional performance in Q3. So we're coming off of a very, very strong third quarter. And the second factor, and you wouldn't be surprised hear, is that in Q4, we have entered into in a fuel environment that is much more volatile, higher than Q3. We are hedged against a sustained increase in prices. But yet again, it's not a perfect hedge either. So there are implications on the cost side. So when you look at those 2 factors, that explains the delta between Q3 and Q4.

Okay. Are you able to detail where you're hedged and what percentage of your fuel needs are hedged for Q4?

Yes. So generally, as we previously said, it's a quite volatile environment. So we have -- we're happy to have a robust hedging program. If you look at Q4, we're roughly 70% hedged on fuel needs and consumption. And roughly speaking, from a jet fuel perspective, we're hedged approximately USD 2.85 around that range for Q4. We're also hedged, as I mentioned, on going forward. We're going to roll this book forward into 2024 at a lower strike price, and we're also hedged on the U.S. dollar compared to Canadian dollar.

Okay. Okay. That's helpful. Maybe just my second question just around the -- you mentioned this on the opening remarks, just around the engine issues with the GTF engines that are used on the A321neo LRs. Have you gotten any indication from RTX that this is going to be any issue for your fleet? Maybe you can just describe what your expectations there and then what scenarios you're planning for?

Yes. So of course, we're well aware of the situation. We've been working closely with Pratt & Whitney to better assess the challenge of the issues. But based on our understanding so far, the impact we estimate will be minimal and manageable for 2024. This will give us time to work on contingency plans for 2025. So we'll be in a better position to understand the impact once Pratt & Whitney has issued its service built in. So we're still in discussion and waiting to hear more from them.

Okay. So if there is an issue where you have to take engines off the plan for an extended period, it's more of a 2025 event, not 2024?

Yes. So we have -- and we need to consider as well that we have spare engines. So we are able to -- we will be able to mitigate at least for 2024 most of the impacts.

And how many aircraft would potentially be impacted?

We're looking -- we don't know exactly yet. It's regarding the A321 LR. So we're still waiting for -- to hear more information, to receive more information. We don't know the exact number, what we're talking about at this point.

Your next question comes from Konark Gupta from Scotiabank.

I echo the congratulations on a pretty good set of results. The first question I wanted to ask about was on the yield. Looking at the Page 7 of your presentation, it seems like the yield has been down then up recently. How should we understand this? Does it reflect a brief period of discounting to stimulate demand followed by maybe the fuel-driven fare increases?

Well, the yield for the third quarter was, as we mentioned, 29% higher than Q3. Q4 is still currently at plus 26%, which is very strong. And as we explained early indication, but it's very early still for winter, indicate that we're still ahead of plus 7%. So we're not -- so it's still growing. So the increases in yield are still growing. You -- of course, in terms of stimulating winter bookings, we always have strong promotions during spring, early summer. So this effects on a short period our yields, of course, but we always see this from one year to the other. But overall, yields are increasing. So we're pretty satisfied with that.

Okay. And is there any big lag effect in adjusting the yield or fares for fuel, like I think you guys are seeing some rebound in the fuel price now. I mean, obviously, you're hedged in all that, but the industry is seeing the same thing. Can you adjust the fares a little bit higher here, you think in this macro environment? Or you think demand is a little bit fragile if you raise theirs?

Yes. I think what's driving price is it's really -- you really need to think about the demand and supply environment. You won't be surprised to hear that demand remains very strong. And at the same time, there are some constraints on the supply side. So we'd say in this cycle, really the supply-demand factor is driving higher yields. And even if fuel prices recede as we see in Q3. Looking even forward to Q3 when fuel prices were lower, yield still remains pretty strong.

And I could add with that, that as pent-up demand is still unsatisfied and it will be for a couple of years. And with the supply-demand on balance, we think that yield could stay up for some years now from now.

Okay. That's helpful. And then on the balance sheet side, it seems like you're still ending the covenant holiday in October. And it seems like the interest rate on some debt maturities will increase in the coming months. What's your most immediate priority, Patrick? To repay the high yield debt with the incremental cash you have on hand now with the hotel proceeds and all that? Or do you want to refinance the debt for a longer maturity curve?

Yes. So priority #1, and it's really linked to the capital structure is really improving the financial performance of the company from a margin perspective and mostly from a cash flow generation perspective. So for us, the best remedy to achieving a more sustainable capital structure is really simply generating more -- a better cash profile. So -- as we mentioned, we're looking to be cash flow positive for the full year. So we're definitely on the right track with respect to that. Secondly, you would have seen we've sold the land in Mexico. The transaction's closed so the proceeds are with us. And in terms of priority, we'd like to repay the senior facilities that are close to $200 million, which are higher yielding debt. So that's a priority when you think about the tranches of debt. And then in parallel, as we've said in the past, we're actively working on a refinancing plan. We'll share more details at the right time. But one thing I note is when you look at the progression of the company with respect to its margin profile, financial profile, cash flow profile, we're certainly in a better position today to be working on a refinancing plan with conditions that are more -- that are better to Transat as compared to a year ago. So you mentioned something about covenants, I also believe in your question: that some covenants are coming online in Q4. There's no concerns whatsoever with those covenants. We should be meeting them very easily Konark.

Your next question comes from Benoit Poirier from Desjardins.

Congratulations for the very strong results. A quick one. You talked about, obviously, the engine issues, and I was curious to know a little bit more about the contingency plans and the potential maybe to contract out more planes, assuming that some engines need to be retired. I assume that there is enough supply to -- in terms of contingency?

Yes. As mentioned, we're still assessing the situation. But in terms of contingencies, we will look at potentially flying more of our A330s, flying more of our A321 LRs. We also use, as you know, ACMIs when we need more airplanes. We might order earlier aircraft that we have planned to have later in future years. We're looking at -- and we use spare engines. So there's different at this point where we're very comfortable with the different plans that we're putting in place. And so it's going to take -- and we have time, we have time to plan because -- so not everything is going to happen in -- we have a year ahead before we need to make those -- put their contingency plan in place.

Okay. That's great color, Annick. And in terms of capacity, obviously, you stated the 23% increase with 4 more planes this winter. And looking at the peers, it looks like the winter is bullish. But when we look at Air Canada, Flair and Lynx, they will be increasing offering also by a significant amount of seats. So it seems that the industry is getting more disciplined maybe, but how would you say the market dynamics evolve overall? You made great color about the pent-up demand that will be there for a few years, but what makes you confident that the industry will stay disciplined given the increased capacity and new players in the Canadian market.

So of course, we're looking more precisely in the markets where we operate, so especially in Quebec, Maritimes and Ontario, we see big increases in Western Canada, with WestJet-Sunwing. Flair has developed in Western Canada as well. On our side, we're focusing on our key niche routes. This is where we are deploying most of our capacity where we know we can win, both on South and Europe. So we don't see overcapacity for next winter. We're pretty much comfortable that our program is going to be able to generate good results. And it's still -- there's still movements happening in the market right now, and we saw movements even during summer over the last month as some players lack of aircraft. So we'll see what's going to happen. There's still movement, and we'll see. But overall, we see that there's an unbalance between demand and offer.

That's great. And assuming, obviously, a very solid yield for this upcoming winter and also taking into account the capacity increase, how should we be thinking about the margin outlook for fiscal year '24 given that you raised the profile to 7.5% to 8%. Just wondering what could be achievable, let's say, with still a very constructive outlook for fiscal year '24, given what you could report in fiscal year '23.

Benoit, we -- as we previously guided, we think this company will achieve double-digit margin in the medium term. If we're thinking precisely about 2024, we're looking forward to sharing more color on our next quarterly call. But obviously, when you look at where we'll end up this year, again, we're talking about 7.5% to 8%. And then you could draw the line between there and where we'll achieve. But we'll provide greater color, Benoit, as we enter Q4.

Okay. And last one for me. There has been some reports that Canadian airlines are having trouble hiring pilots. So can you talk more about how this compares versus the historical range?

Yes. Well, pilot shortage, of course, is an ongoing challenge for the industry. We are -- on our side, we are actively hiring pilots primarily to support our growth ambition, of course, and to fill in for upcoming retirements over the next years. Things are going well so far. And in addition, we are also currently reviewing and revamping our pilot recruitment and training programs to make them more attractive, more competitive. But so far we've been able to manage this challenge, which, as I said, is an industry challenge.

[Operator Instructions] Your next question comes from Tim James from TD Cowen.

Just want to think about capacity for fiscal 2024. Just in general terms, do you see the allocation of capacity by market next year, tracking somewhat in line with what you will do for fiscal '23. And I'm thinking specifically about the pie graphs that are on Page 6 of the current presentation where you show some destination trends, Atlantic transborder and domestic and you give kind of the share of capacity. If we kind of look forward to fiscal '24, would that pie graph and the allocation of capacity look pretty similar? Or do you see one particular market attracting greater growth in capacity when you think about next year?

Yes. Well, we're seeing -- when we look at the share per market, we're seeing a very similar picture to 2019. So we haven't seen big changes from one market to the other, it's pretty similar.

So for example, I know like transborder is running your transborder capacity. In other it's very small. I'm just using that as an example here, but transport capacity is up dramatically versus 2019, at least in Q3, it was. Sun destination is up, transatlantic is down 19%. So the allocation is clearly in this quarter is somewhat different than it was in '19. Is the current allocation continuing forward? Or do you think these differences versus '19 will be eliminated as we go into fiscal '24?

Well, the domestic and the U.S. market are very small for us. So any changes in percentage, of course, is not extremely meaningful. Our main focus is really and it has been since we've relaunched the operation for pandemic to increase first on the Atlantic market, which is our key market, our most profitable market, and this is where we will be increasing in terms of percentage. This is where our growth will be for next year in the upcoming years. We're also increasing our presence in the south market, especially in shoulder season to reduce seasonality and increase overall aircraft utilization. So everything -- in the way we deploy capacity, everything is around making our network and the use of our assets more efficient. And this is how we make our decisions around the network development.

And there are no further questions at this time. I will turn the call back over to the presenter for closing remarks.

Well, very well, thank you, everyone. Let me remind you that our fourth quarter results will be released on December 14, 2023. Thank you, and have a nice day.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.