Copa Holdings, S.A. (CPA) Q1 2008 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Copa Holdings first quarter 2008 earnings call. (Operator Instructions). As a reminder, this call is being webcast and recorded, May 8, 2008. Now, I will turn the conference call over to Joseph Putaturo, Director of Investor Relations. Sir, you may begin.

Thank you very much, and welcome everyone to our first quarter earnings call. Joining us today are Pedro Heilbron, CEO of Copa Holdings and Victor Vial, our Chief Financial Officer. First, Pedro will open up with an overview of our first quarter highlights, followed by Victor, who will discuss our financial results. Immediately after, we'll open up the call for questions from analysts. We kindly request if you could limit yourself to one question with a follow-up so we can accommodate most questions. In today's call, we'll discuss non-GAAP financial measures. A reconciliation of non-GAAP to GAAP financial measures can be found in our first quarter earnings release, which is posted on company's website. In addition, our discussion will contain forward-looking statements, not limited to historical facts that reflect the Company's current beliefs, expectations or intentions regarding future events or results. These forward-looking statements involve risk and uncertainties that could cause actual results to differ materially and are based on assumptions that are subject to change. Many of these risks and uncertainties are discussed in our Annual Report filed with the SEC. Now, I would like to turn the call over to our CEO, Pedro Heilbron.

Thank you, Joe. Good morning and thank you for participating in our first quarter earnings call. First of all, I would like to thank and congratulate all of our co-workers for another fine quarter. Their continued focus and commitment what sets us apart in this challenging environment for our industry. Let me now briefly go over our first quarter results, among the main financial highlights for the quarter, Copa Holdings reported net income of $39.5 million, or diluted earnings per share of $0.91, despite a $21.7 million related to additional fuel cost. Revenue growth came in more than 20% above first quarter '07, on traffic growth of 13.4%. Higher yields and strong growth factors resulted in an almost 10% increase in unit revenues. And we ended the quarter with $367 million in liquidity, which translate to more than 33% of last 12 months revenues. On the operation side, Copa Airlines once again delivered leading on time performance and completion indicators. With on time performance in excess of 90% and a flight completion factor of 99.8% for the quarter. In March, Copa Airlines continued its network expansion by launching direct service from the Hub of the Americas in Panama City to Port of Spain, Trinidad and Tobago, the Airline’s 41st destination. In less than two years, Copa Airlines has increases its scope of its network from 30 to 41 destinations, while continuous to deliver outstanding profit margins, world-class service and exceptional operational performance. Also, at the end of March, KLM began direct service from Amsterdam into our hub in Panama. Our code share alliance is conveniently enabling passengers of both carriers to travel more easily between Copa's extensive Latin American network and Europe. We are two of the world's most convenient hub, Panama City, Hub of the America, and Amsterdam Schiphol. More recently, in April, Copa Airlines took delivery of its 12th Embraer-190 Aircraft, bringing its fleet total to 38 aircraft, with an average age of less than four years. Copa Holdings consolidated fleet, including AeroRepública, is currently composed of 51 aircraft. Also in April, AeroRepublica was certified under IATA's Operational Safety Audit (IOSA). The certification places AeroRepublica, as well as Copa Airlines, among a select group of airlines around the world, which meets the agencies international standard for safety. I am also pleased to say that economies in the region continues to do quite well. In fact, the latest forecast for Latin America, calls for an aggregate GDP growth rate of 4.9%, with Panamas Columbia expected to grow about this average, at 8.5% and 5.5% respectively. What’s more, Panama is expected to be once again the fasted growing economy in Latin America. All these have resulted in high demand for air travel our region, which for the first quarter resulted in an average load factor for Copa Airlines of 81% and 63% for AeroRepublica, which showed an 8% point improvement over the first quarter of '07. Looking at the remainder of '08, we expect domestic regions remain strong contributing to healthy load factors, which together with pricing and revenue management initiatives, take into mitigating fuel cost should result in higher unit revenues. However, as reflected in our revised guidance, which Victor will discuss in more detail, despite an effective tough increased fuel prices through fair increases than fuel surcharges, we do currently expect a slight operating margin dilution, having increased our two-year cost of fuel forecast by approximately 25%. Nevertheless, we are confident we can continue to produce industry leading margins. Thanks to healthy demands, very competitive unit cost, a defensible business model, and a world-class team. As a result, at this moment we do not see any significant changes in our operational plans for 2008. Positive regional demand and the continuing need for better service and connectivity in Latin America create unique growth opportunity for Copa on a profitable and sustainable basis. Furthermore, we maintain a very solid balance sheet with ample liquidity and adequate leverage, so although the industry as a whole faces a difficult situation, we are well positioned to weather the storm and come out ahead, always ready to take the advantage of any particular opportunities that may come up along the way. With regards to AeroRepublica, load factors and revenues are being positively impacted by their transition towards modernization and more efficient fleet. As well as from higher domestic serve, growth in the international operations and a stronger local currency. AeroRepublica continues to implement initiative to consolidate its position in the Columbian market and be profitable on a consistent and sustainable basis. They have made progress and we are encouraged by their contribution to the consolidated network though their growing international operation. But we do realize there is still much room for improvements. AeroRepublica for the quarter recorded a close to $700,000 operating loss, although topline growth were very healthy, driven in large part by the strength of the Columbian currency, the airlines operating results were effected by timing of major overhaul events, related to the MD-80 fleet, which as we have mentioned before will be phased out by next year. Given the dynamics and seasonality of the Columbian market, as well as our new fuel cost assumptions, we expect AeroRepublica will record an operating loss for the first half of the year, and be profitable for the second half and full year 2008. AeroRepublica’s 2008 operating plan calls for flat capacity growth, mainly as a result of their transition from an MD-80 to an Embraer 190 fleet. With this free transitions already well underway AeroRepublica capacity Brazilian Embraer aircraft during the first quarter reached 60% versus 16% in the first quarter '07. With regard to their international expansion, a key factor in AeroRepublica’s strategy, year-over-year international capacity doubled, reaching 15% of total capacity compared to only 7% in first quarter '07. Furthermore, for full year 2008 this percentage will increase as we continue to expand international capacity to and from Columbia's most important cities. Among other important developments disclose today, were the declaration of our annual dividend of $0.37. This dividend will be paid on June 15th to stockholders of record as of May 30th. Additionally, (inaudible) recently agreement in principle to give an earnings release to the shareholders, shareholder and strategic partner Continental Airlines on the remaining stake in Copa Holdings. There is lock up clause for a period of two years and was scheduled to expire next month. I want to assure our shareholder that this event in no way affects our long standing relationship with Continental. Our alliance and agreement, both but more importantly the mutual benefits behind them are stronger than ever. So to recap, Copa Holdings first quarter was marred by healthy demand and capacity growth, strong yields for both Copa and AeroRepublica, a challenging fuel cost environment and continued execution and strengthening of our business model. Looking ahead, although we expect margins in the second quarter to be affected as a result of recent record fuel prices and the fact that its traditionally low season quarter for both Copa and AeroRepublica. We believe the outlook for the year is still very positive. As I mentioned before, we remain confident on our ability to continue driving unit revenues higher to mitigate this adverse fuel cost environment. This will be driven in all small part by healthy demand environment and the continued preference of our network for Intra-Latin America travel. Thank you. Now, I will turn it over to Victor, who will go over our first quarter financial results.

Thank you, Pedro, and good morning everyone. Thanks again for joining us today. Once again, let me begin by joining Pedro in thanking all of our co-workers for their hard work congratulate them on another strong quarter. I'm pleased to report that Copa Holdings net earnings for the first quarter of the year reached $39.5 million, which translate to diluted earnings per share of $0.91. The results were achieved despite $21.7 million in additional fuel costs as a result of a 35% increase in the all-in average price per gallon of jet fuel, which mitigated its average $2.82 in Q1 '08 compared to $2.09 in Q1 '07. In terms of capacity Copa Airlines, which accounted for 83% of Copa Holdings total available seat miles delivered another quarter of strong growth with 17% year-over-year increase in air trends. Healthy overall demand for travel as a result of strong economic growth in Panama and through out the region contributed to higher unit revenues at Copa Airlines where revenue for available seat mile or RASM increased more than 3% year-over-year with low factors remaining healthy at 81.2% and the outcome in strong showing 4.3% increase compared to Q1 '07. AeroRepublica, which accounted for 17% of Copa Holdings totally jumps with the quarter, decreased available seat mile is almost 10% compared to Q1 '07. As a result of the company's ongoing transition to (inaudible) from an MD-80 to an Embraer-190 fleet. This resulted in capacity (inaudible) with a 3.7% increase in traffic led to an 8.1 percentage point increase a low factor to 62.5%. Unit revenues AeroRepublica increased 46% mainly due to strong in yield which came in 23% above Q1 '07, approximately half of this fuel gain was result of strengthening of Columbian currency against the US dollar with the other half due to higher domestic fares and growth in higher yield in international runs. Strong yields and healthy growth factors during the quarter led to higher operating revenues for Copa Holding, which for the quarter generated $296 million in operating revenues for our 22% increase over Q1 '07. On a segment basis, Copa Airlines operating revenues increased 20% or $40 million while AeroRepublica delivered at 32% or $14.9 million increase. Passenger revenue for Copa Holdings, which accounted for 95% of operating revenues saw an increase during the quarter of 22% or $50 million from $230 million Q1 '07 to $280 million in Q1 '08. Turning to the expense side, operating expenses increased 34% year-over-year or approximately $62 million. By unit cost or cost for available seat mile capital increased 21% year-over-year to $11.08. Ex-fuel CASM increased 14% year-over-year to $7.7 mostly driven by additional aircraft and engine maintenance events related to our AeroRepublica MD-80 fleet, a stronger Columbian currency and in respect of downgrading to an Embraer-190 fleet. Now turning to Copa Holdings main operating expenses compared to the first quarter of '07, fuel expense increase 51% driven by an 11.7% increase in gallons consumed and a 35% increase all-in average price of fuel net of hedges. Salaries and benefits increased 28%, mainly as a result of an overall increase in upgrading headcount to support increased capacity and the effect of the Columbian currency appreciation against the U.S. dollar. Passenger servicing increased 30% driven by an increase in passengers carried by Copa Airlines, more international service offered by AeroRepublica and the effect of the Columbian currency appreciation. Commissions increased 15%, for more part a result of a 22% increase in passenger revenue, partially offset by a lower average commission rate in both Copa Airlines and AeroRepublica. Reservation and sales increased 21% mainly due to more passengers carried and additional costs associated with global distribution systems at AeroRepublica. Maintenance, materials and repairs increased 55%, mainly due to more scheduled major maintenance events at Copa and AeroRepublica. Depreciation increased 25% due to additional aircraft repairs. Aircraft rental decreased 16.5%, driven by an additional needs in Embraer 190 at the AeroRepublica and flight operations net increase rent was combined, increased 34%, mainly as the result of increased capacity and higher crew related expenses including simulator rental related cost. Other operating expenses increased $1.6 million or 14% year-over-year inline with capacity and other non-operating income and expense totaled net expense of $8.1million in Q1 '08. The main component of which are net interest expense of $7.7 million and a gain of $1.8 million related to fuel hedge contract mark-to-market. Looking now at the company’s earnings Copa Holdings first quarter earnings before interest, taxes, depreciation, amortization and rent EBITDAR decreased 4.6% to $75.9 million. While EBITDAR margin decreased 7.1 percentage points to 25.6% mainly as a result of higher Jet fuel prices. With respect to Copa Holding operating earnings higher Jet fuel prices lead to 15% year-over-year decreased in operating earnings and 7.6 point decreased in operating margin for 17.5%. It is worth nothing that although with unprecedented fuel prices did impact our margin, Copa Holdings continue to deliver one of the highest margins in the industry. With respect to fuel hedges, Copa Holdings had 18% with first quarter volume hedged at our US Gulf Coast price of $2.16 per gallon and currently holds fuel hedge position for the rest of the year as follows. 17% for the second quarter at $2.25, 13% for the third quarter at $2.34 and 9% for the fourth quarter at $2.49. Moving on to the balance sheet, assets and shareholders equity at the end of the quarter reached $1.7 billion and $577 million respectively. While debt and capital leases totaled $1.1 billion. Bad debt at the end of the quarter totaled $836 million, 45% of which if you were taking back this. 41% of our total net values have been fixed for a period of 12 years at the average blended rate including fixed and veritable rate debts for the first quarter came in at 4.3%. Lastly, Copa Holdings liquidity continues strong increasing during the quarter to $357 million, which translates to approximately 33% of net gross revenue. So in summary Panama region as a whole continue to benefit from consolidate economic growth resulting strong a demand for a travel. We delivered another quarter of strong top line growth with healthy load factors and higher yields. We continue having a very strong liquidity positions, and we remain focus on profitable growth and what we expect to remain a very challenging fuel price environment for the remainder of the year. Looking forward to the rest of 2008 and based on our revised outlook for jet fuel prices, which increase from our previous guidance of $2.38 per gallon US Gulf Coast to $2.98. For full year 2008 we are updating our 2008 guidance as follows. We are revising our year-over-year capacity growth to 15% from approximately 7.9 billion in 2007 to quarter minus 9.1 billion in 2008. This adjustment relates for the most part Copa Airlines growth, which under a new guidance reflects a year-over-year growth of plus or minus 18%, as we look to optimize the earnings in a very challenging fuel price environment. We are maintaining our load factor guidance at 75% up from approximately 74% in 2007. We continue to see a healthy fair environment of world travel in the region is expected to remain strong and as such our RASM guidance has been revised to plus or minus $14.02 compared to $0.13 in 2007. We expect the unit cost as a result of our revised capacity guidance we are revising CASM- ex-fuel up for $7.5 compared to $7.1 in 2007. And lastly talking of margin we are revising our operating margin guidance to a range or between 15% to 17% compared to 19.2% for 2007. With that I will turn it over to Pedro for closing remarks.

Thank you, Victor, and again thank you all for joining us today. At this we will be happy to open up the call for questions.

(Operator instruction). Your first question from Daniela Bretthauer with Goldman Sachs.

Hi. Good morning. Question on your results today and more importantly well you changed your guidance and you disclosed that Continental is well, free to sell their stake. I wanted some clarity how soon are we talking about on the timing for this for the sale and what exactly, can you confirm the Continental stake lets say latest the position?

The confidential stake is 10% in all currency and the company with respect to the timing the company is currently working on the documents for the registration as we mentioned in Columbia the market deal and the registration processes should be pretty straight forward after going Continental to entire issues they will be able to sell when they see it. Well again, the registration process should be pretty straight forward.

Right, I understand that and I was wondering as the result of lets say they exited completely their stake in Copa, does that change anything in terms of your relationship or some of the agreements that you had with Copa? How do those agreements remain following lets say their sale?

Yes, nothing changes. When they went down from 49% to 10% nothing changed. Our relationship is strong as ever and will be stronger as always been after remaining 10% if that was to happen. It is based on the mutual benefit we both get out of it. It is based on the contracts, within contracts which make sense for both. The alliance was renewed in 2005 and it does not really have an expiration date. It can be canceled after 2015 but it really does not have an expiration date. So it is still very good for both of us and we really expect no changes in our relationship.

We will go and take our next question from Mike Lindenberg with Merrill Lynch.

Yes, good morning all. I guess a couple of questions on the AeroRepublica piece where I think Pedro you indicated that, the percentage of capacity I think last year was 7% and this year was 15%, what is that number look at year end? Would you talk about some of the international expansion with AeroRepublica that may be outside of the Panama. There was something up here that indicated that there may be some new service to Venezuela from some of the Columbian Cities, any color that would be great?

Okay. The international capacity, I think it is going to be a little better than 15%. It depends on when the Venezuela capacity you just mentioned and some additional international client that they have not yet announced, a committed line. It may happen towards the end of the year, so it will not have a great effect on that percentage. It will have a greater impact in 2009, of course, but not in this year. They are all planning a flight to Venezuela, I am not sure how much has been disclosed and I think they are going to be making an official announcement the minute there is a fixed date for that start-up.

Okay. On that international service, as you move into some of these markets where maybe there is more of a business component or maybe a passenger connecting onto the Copa system, as AeroRepublica maybe has more of its market or more of its capacity in the international markets, thoughts on just the configuration on the airplanes, whether or not you would be in a position where you would have to offer first class product?

Yes, we do not think that is the case as of yet, most of the flying is still a short haul, even if it is international, it is one-hour segment and the configuration on the Embraer is actually quite comfortable with a two-and-two seating, leather seat, a very comfortable pitch. So, for one hour segment, I do not think -- we do not feel there is a need in changing the configuration.

We will go and take our next question from Ray Neidl with Calyon Securities.

Yes. Once again the maintenance costs were a little bit higher. Going forward, can we expect to see that? I think with AeroRepublica with the transition I thought maintenance cost might be coming down because you are using new aircraft there?

Yes, maintenance cost will be coming down but this year what you are seeing is AeroRepublica is basically more engine event related to the MD-80 fleet, which we are exiting and also more C checks. So if you look at it on a year-over-year basis, last year in terms of events the AeroRepublica had two C checks and this year they are going to have five C checks and that is in terms of engine event. So, you have three engine events this year, you are looking more at about 11. However, it is related to the MD-80 fleet that we are exiting and that is something that will be reflected in '08 results which you will see in coming results when you have a whole brand new fleet of Embraer 190s.

Okay. The tax rate going forward, what will be a good average tax rate to use, about 11%?

It is an effective rate of around 10% to 11% for the year.

Moving on, we will go ahead and take our next question from Tatiana Feldman with Morgan Stanley.

Good morning, gentlemen. Just wondering if you could comment a little bit on CASM ex-fuel, obviously the revised guidance is a little bit stronger at 7.5, but you did 7.7 this quarter. So, I am wondering is that just the capacity growth that is going to bring that down or is there anything else to look for?

It is exactly that. It is the capacity growth that is probably coming in the second, third, fourth quarter is what is going to bring us down to the guidance level that we provide.

Thank you so much.

(Operator Instructions) Next we will hear from Steve Trent with Citigroup.

Good morning, gentlemen. Just two questions from me. The first with respect to the jet fuel environment and what you might be seeing on a competitive level is you seeing any big movements either positive or negative from some of the regional competitors that might or might not be pulling back on certain routes just because profitability has gotten tough in this oil price environment. My second question, I am not sure if you are able to share with us buried within the RASM-CASM guidance, what might be your expectations the Colombian Peso exchange rate by the end of this year? Thank you.

Thanks, Steve. On the competitive side, we haven't seen any significant changes. It is as expected, Latin America is growing quite nicely, traffic in Latin America. So, we are not seeing any pull backs. We are not pulling back either. What we are seeing is a willingness from most airlines in the region to match their increases in fuel surcharges in most cases. I will let Pedro answer your other part of the question.

Yes, Steve. With regard to the question about the Columbian Peso, as you probably know the Columbian Peso has been strengthening against the US dollar and we expect that to continue till the year but at the end of the day we are looking at a Peso against the US dollar by the end of the year in the range of somewhere between 1700 Pesos to 1800 Pesos to $1. Yesterday it was around 1750 to 1800. It was a little bit high for the first quarter, so we do not expect it to strengthen significantly more in the remainder of the year at least that was embedded in our guidance for the year.

Okay, very clear. Thanks, gentlemen.

Next, we will hear from Jim Parker with Raymond James.

Question for Victor. Back in January when you had your investor get together in Panama City, your oil assumption was $85 and I think you indicated at that point that higher fares and surcharge had offset that 94% of that where are we now say that oil at 120, how much of that have you offset?

If you look at the fuel surcharges that we have implemented right now to date and looking at oil prices in the future and current oil prices, what we are looking at is a coverage we will be doing 70% to 80% for that includes not only again fuel surcharges, but also includes fare increases that we have implement and that is how we look at and that is how you have to look at because depending on the market, we may focus more on fuel surcharge the other market we may focus more on the fares, but we are looking at yields and RASM and from a combined fares and total charges we are looking at 17% to 20% coverage.

Okay. Thank you.

We will go back to Ray Neidl with Calyon.

Yes. I just wanted to clarify one thing on the growth rate. You are strong yet down this year because of high fuel costs, even though demand remains strong. I am just wondering why you are able to get through the RASM increases and demand strong while slowdown growth despite the risk of higher fuel? Would you expect that trend to continue into next year 2009 a slower growth rate.

Ray its, Pedro. We are talking about our flight adjustment mainly during low season. If we have four or five daily frequencies or destinations under days or weeks, when we can reduce one or two during low season based on fuel and consolidate revenues recapture in our remaining flights we operate to do. So it is more than really pulling back capacity and changing our growth. By the end of the year our network, our schedule, our capacity should look pretty much the same as it being predicted.

Okay. To follow up on Jim's question. You are able to pass through less of the oil price increases now than you were earlier simply because oils prices are going crazy you might say. If oil were to go to $150 a barrel with that percentage of increase pass through, would you think that would go down even further as a percentage?

That is why we accomplish this growth rate. If you had asked me back few months ago when oil was at $85, $90, which would keep asking fuel surcharges at $120, $130, may be I would have said, may be not. We are actually pushing and the magic stock in the region and we have seen in the past that we have been pretty successful. So we will keep pushing and we will see how it goes. So I am not ready now to say or predict not that percentage will go down because fuel will rise, we will keep doing what we have been doing and with demand strong we should be able to really manage price and fuel surcharges up.

Okay. Good. Thank you.

We will go to Tatiana Feldman with Morgan Stanley.

Yes. Hi, just a follow up. Wanted to know, I know you mentioned that demand has been strong in the region. I just wanted to know if any comment you have on were you seeing some US steel side of demand has that shown any signs of weakening or? Thank you.

Our presence in the US relative to rest of our network is not that large. So even if the US had slower demand it would not have a great impact. However, so far we have seen we are pretty much where we expected to be in the US. We haven't grown that much in our US market, so obviously we do not have that much pressure to fulfill our strategies, but we have not seen a significant change in our US projections.

Thank you.

(Operator Instructions) We will hear from Mike Lindenberg with Merrill Lynch

Yes, I just, if we could get a little bit more detail on -- I know you indicated that you are also strong across the region but just some of the competitive across the region, what you are seeing from the competition, I mean, I know, I guess Delta did start service from Kennedy, four times a week, and I know that they have pulled that service I do not know long that was in the market, maybe what you are seeing out of Fort Lauderdale from Spirito I think they may ramp that service up to Delhi, so anything just on the competitive and even anything that you are seeing out of Central America vis à vis ?

With that caveat I would not do any free advertising for any competitor. We are not seeing anything out of the ordinary, you mentioned a couple of examples we have one pulled out, the other one is talking about increasing it to Delhi. We were not seeing anything that significant enough to impact our projections, our guidance. We are always keeping an eye or both eyes on our competitors but obviously we are worrying about our own performance about fuel cost about being very efficient, and about satisfying our customers. I think that is why we are going to keep on doing in the future.

Okay. Very good, thank you.

At this time we have no further questions coming in. Mr. Heilbron I will hand the conference back to you for any closing comments.

Okay, thank you. Thanks again. Rest assured, our team remains focused on the opportunities and challenges ahead and we look forward to have you back for our second quarter earnings call. Have a great day. Thank you.

This concludes our conference, again thank you all for your participation. We do hope you enjoy the rest of your day.