Latam Airlines Group slashed its operating costs by close to 7% in 2016, as it pushed through an aggressive plan to get its balance sheet in shape. The cost cuts combined with a strong pick-up in revenues, allowing the group to post its first annual profit last year.
In addition to addressing operating costs, though, the company has pursued a careful financing strategy. That has involved tapping a wide range of sources for funding and capital, as well as replacing older, more expensive financing.
Among the executive team working to turn around the airline’s fortune is chief financial officer Ramiro Alfonsín, who took on the job in July 2016. He joined from utility company Endesa, where he was deputy chief executive and chief financial officer for the utility’s Latin American operations, having started his career in investment banking.
Alfonsín discussed Latam Airlines Group’s efficiency and financing strategy in a recent interview with LatinFinance. Here is a transcript of the conversation, which has been lightly edited for length and clarity.
LatinFinance: Is the main part of your efficiency drive the new model on domestic routes? Are there other aspects?
Ramiro Alfonsín, Latam Airlines Group: There’s much more than that. We have been reducing our costs and increasing productivity for the past three years. We’ve reduced our operating costs since 2014 by 16%. That’s excluding the reduction on fuel costs. We’ve done this in an environment of high inflation in certain countries. So the effort that we have put into that is much larger than that 16%. In addition if you look at the past 12 months, we’ve reduced headcount by 11%. That’s a significant reduction. If we look at what’s coming ahead, we’re also looking to improve our return over assets [ROA] by increasing the utilization of our aircraft and increasing our operational productivity.
The rest of the initiatives are linked to the new business model: the installation of 600 kiosks in over 100 airports. This is already in place. And eliminating the catering that we used to provide on our domestic operations. We’ve switched to a buy-on-board service. Between February and June we’ve implemented this budget approach in Colombia, Peru, Chile and Argentina and we’re targeting Brazil by July.
So for us the focus is on now right-sizing the company in terms of costs. We’re looking at all areas. Some initiatives are linked to the new business model but others are linked to right sizing the company to be as competitive as possible and to provide better fares for our passengers.
LF: Do you have a profit target for the future?
RA: It’s important to highlight the resilience of our margins. Brazil’s been in a very difficult macroeconomic environment the last two years. In spite of that, we’ve been able to improve our profitability. We closed 2016 with a 6% EBIT margin.
This year, we’re expecting that the reduction in headcount, the right-sizing of the fleet and the implementation of the new business model will have certain costs. But including those costs, which will be considered one-offs we have provided a guidance of an EBIT margin between 6% to 8% for 2017. We’re confident that by 2019 we should have a double-digit EBIT margin. This is what we’re targeting.
LF: Regarding your capital markets strategies, do you have a capital raising target for 2017?
RA: We’ve done most of the work for 2017 with the $700 million unsecured bond that we issued in April and other financing that we did at the beginning of the year. So for 2017, we have pretty much covered all our financial needs.
But our roadmap to continue to deleverage the company is clearly established. We believe that our focus today is on right-sizing the company and improving our cash flow generation. We closed 2016 with a leverage of 5.3x and liquidity that is currently over 18%, so we have very good liquidity. We expect to continue improving this. Our goal is to reach a leverage of 4x by 2019. We’re very confident we can achieve that. This is because we’ve seen the resilience of our results. We’re also confident about the strategy that we’re implementing. But in particular we’re confident because in 2016 we reached an important milestone in terms of redesigning our fleet commitments.
We’ve reduced the fleet commitments that we initially published for 2017 and 2018 by over $2 billion. So we’re going to have in 2017 and 2018 a record low investment in fleet assets. We’ll invest less than $500 million in both 2017 and 2018. That’s roughly 25% of what we’ve invested annually in the last four years. We’re very confident that our cash flow generation will allow us to take care of the maturities we have coming in the next few years, and together with the financings that we’ve carried out this year, our capital raising requirements are quite covered for the next few years.
Nonetheless, we continue to always monitor the market conditions. If we see an alternative to diversify or further reduce our costs, we’ll do it.
LF: Would that involve a liability management exercise?
RA: It could, it’s one of the possibilities, certainly. We have a couple of bonds that could be callable, so that could be an alternative indeed.
LF: Tell me more about the EETC and why you added a C-tranche to that.
RA: We always keep a very close look at a well-balanced capital structure. We want to keep our sources diversified and reduce our costs. Our current cost of debt is a little over 4%. Therefore, having an additional tranche on the EETC was convenient for this cost structure, and we decided to move it forward. In this industry, most of the financing is asset-backed. In our case, roughly 77% is secured and the remaining part is unsecured. The EETC is part of that balance that we’re targeting.
LF: Is that the ideal secured/unsecured balance for the group?
RA: We think that [77%/23%] is a fair balance at this point due to current market conditions. Over the past year, with the Qatar capital increase together with this new bond we believe we have enhanced and diversified our access to capital and liquidity. We have broadened both our funding sources and our investor base. So, we have alternatives if we wanted to shift that number.
LF: How did the Qatar capital injection come about, and why did you seek it?
RA: Actually, we didn’t seek it. Qatar approached the company. That was not something we were actively looking for as Latam. Qatar Airways expressed their interest in entering the company at a 45% premium on our prevailing stock price at that moment.
We believe that Qatar Airways recognizes what we have achieved and our unique footprint. We have an unparalleled network and Qatar Airways is very committed to the long-term project that we have. Our shareholders believed there was a good premium at that price and that it was interesting for us to have a shareholder such as Qatar Airways, with which we can continue to explore opportunities of connectivity and is also a very important player in the industry.
LF: Do they give you operational advice? Or are they a silent partner?
RA: They are a financial investor. They’ve appointed one board member, elected in a shareholders’ meeting in April. It’s a financial investment. But of course, we’re both part of the Oneworld alliance and having this stake in the company allows us to discuss further opportunities with them.
LF: What sort of opportunities might present themselves with Qatar going forward?
RA: There are many. Some are to do with fleet: Qatar is a large purchaser of airplanes. They are an important player in the industry in terms of joint purchasing contracts. There are many alternatives. But at this stage, they are just a board member and we are discussing further cooperation with them.
LF: Would you entertain bringing in another strategic partner, if you had such an inquiry?
RA: That’s a decision for the shareholders. At this point from the management’s perspective, we’re not looking to bring in another partner. We’re very confident with the deleveraging process that we have started. We’re focused on right-sizing the company, on containing our costs and our investments going forward, and providing our customers with this new business model that can stimulate traffic. That’s the focus of management today.
LF: Looking at the challenges ahead for the company, foreign exchange moves could be a risk, as could changes to the oil price. How do you deal with those risks?
RA: We hedge part of our fuel consumption. We’ve hedged up to the fourth quarter of 2017. And we hedge some foreign currencies that we have certain exposure to. We use a four-way mechanism to hedge those. But we’ve seen quite stable fuel prices, within a range.
I would say a risk going forwards is maybe that eventually in Latin America we’ll see additional competition. And that’s why we’re establishing this new business model: to continue being a leading player in Latin America. LF