Air New Zealand Limited (OTCPK:ANZFF) Q4 2020 Results Earnings Conference Call August 26, 2020 6:00 PM ET

Company Participants

Leila Peters – General Manager, Corporate Finance

Greg Foran – Chief Executive Officer

Jeff McDowall – Chief Financial Officer

Conference Call Participants

Andy Bowley – Forsyth Barr

Andrew Steele – Jarden

Owen Birrell – Goldman Sachs

Marcus Curley – UBS

Nick Mar – Macquarie

Operator

Welcome to the Air New Zealand 2020 Annual Results Call. During the presentation your phone lines will be placed on listen-only until the question-and-answer session.

And with that, I will turn the call over to Air New Zealand’s General Manager of Corporate Finance, Leila Peters.

Leila Peters

Thank you, and good morning, everyone. Today’s call is being recorded and will be accessible for future playback on our Investor Center website, which you can find at www.airnewzealand.co.nz/investor-centre. Also on the website, you can find our annual results presentation, shareholder review, financial report, media release and relevant stock exchange disclosures.

Speaking on the call today will be Chief Executive Officer, Greg Foran; and Chief Financial Officer, Jeff McDowall.

As we do every year, I would again like to remind you that our comments today will include certain forward-looking statements regarding our future expectations, which may differ from actual results. We ask that you read through the forward-looking cautionary statement provided on slide two of the presentation.

I would also like to draw your attention to the fact that a number of prior period comparative figures had been re-stated throughout the presentation to reflect the retrospective dis-establishment of aircraft fair value hedges, which we disclosed to the market earlier this year. The Group has also adapted NZ IFRS 16, the new leasing standards from the 1st of July, 2019. In accordance with the transition provisions of the standard comparatives have not been re-stated. I urge you to read through these statements on slide three.

Within the presentation there is also a supplementary information section that include slides that we will not specifically address during the webcast. These slides provide key financial and operational details, and we recommend that you take the time to review that information.

With that, I will now turn the call over to Greg.

Greg Foran

Thank you, Leila. Kia ora, and good morning, everyone, and thanks for joining us on this morning’s annual results call. To say it’s been an incredibly challenging six months would be putting it mildly. The result we are presenting to you today is clearly not reflective of the path we were on when we reported our interim results to you in February, nor is it the results of any decisions or choices that we have made. Rather, it is a reflection of the worst operating environment the aviation industry has ever experienced.

I’d like to take a moment now to thank the Air New Zealand fan. The large majority of whom have made a significant personal sacrifices to help ensure that we can emerge strongly from this crisis.

Scaling down our operations, revising our flying schedules on a daily basis and operating in an environment with new regulations and added complexity is a tough ask at the best of times, let alone in the midst of a global pandemic. Out people were operating in these tough conditions during a period of national lockdown and significant uncertainty.

They have shown a level of resilience that, frankly, is quite astounding and I want to thank each and every one of them for all that they do. And that includes those that have, unfortunately, recently left us.

I will come to the result shortly, but to provide you with some context, within the course of a few short weeks, we went from transporting more than 330,000 passengers a week, to various ports around New Zealand and internationally, to transporting just 8,000 customers a week in April. That’s just huge to have an airline that basically can’t perform its fundamental purpose of flying people to and from their desired location.

And so we find ourselves really with a story of two halves. After a strong start to the financial year and an interim profit of $198 million, we are today reporting a loss before other significant items in taxation of $87 million.

This result is better than what we had guided to earlier in June due to stronger than expected domestic demand and increased cargo flying. However, it is still substantially lower than what we were forecasting at the start of the year and is the first loss that we have reported in 18 years. Including the impact of other significant items, which Jeff is going to talk to you about in more detail shortly, we reported an overall loss of $628 million before taxation for the financial year.

We ended this crisis in a fundamentally strong position and moved quicker than most in the industry to significantly and structurally reduce our cost base, and to secure additional liquidity in the form of the $900 million standby facility we arranged with the New Zealand Government in March.

These actions were important to ensure we are in a strong position as we emerge from this crisis. Although, we have not yet tapped into the standby facility, we expect to do so in the coming days. You can see that even with $1.1 billion in the bank at the start of this crisis, significant cost reductions and careful cost management, when you cannot operate significant parts of your network, airlines are fundamentally quite expensive businesses to operate.

Our Board is focused on the future capital structure and assessing the options to ensure strong financial resilience as we look ahead. Jeff will go into some more details on that shortly.

With the outlook for future passenger demand clearly uncertain and highly dependent on the removal of travel restrictions both here in New Zealand and globally, we are expecting Air New Zealand will be a smaller airline for some time to come. That means that our priority for today is ensuring our businesses right size to deal with the current reality that faces us, whilst retaining flexibility to scale up when required.

We have seen some green shoots in the past few months, notwithstanding the return to lockdown in August. In July, we operated almost 70% of our pre-COVID domestic capacity and we are seeing even higher demand in August prior to the lockdown. Our Cargo business with the assistance of the international air freight capacity scheme is also performing well, which I will go into more detail on shortly.

Now I know that at this point it almost goes without saying, but I think the graph on the left really clearly depicts that the magnitude of the COVID-19 crisis far exceeds anything the aviation industry has seen or experienced before.

Crisis like SARS, the GFC, 9/11 and swine flu, all individually are very serious events in their own right, but they quite simply pale in comparison to the impact of COVID-19 on demand for air travel. To have such a sudden decline in revenue in every market in the world led to a situation that no airline could have foreseen.

Well, no one really knows what the recovery will ultimately look like, six months into this crisis; it is certainly not looking like it will be a V-shaped recovery. Rather, at this stage, it’s looking like a gradual recovery, which may have quite a long tail.

Like many of our airline peers, we had benefited greatly from being able to fly additional cargo services in the second half of the year. But the graph on the right-hand side shows that globally, this additional flying is quite small in comparison to the decline in passenger numbers.

We know that there are always lessons that we can learn from the past and while the dynamics of this crisis are still playing out, our experience suggests that demand will come back eventually, and we will be ready when it does.

If I think back to late February when we reported our 2020 interim results, we had just suspended services into Shanghai and Seoul, and made other tweaks to capacity in a few markets where we thought there might be some small secondary impacts from the COVID-19 outbreak.

What has transpired has been far more significant, following widespread transmission of the disease, our government here in New Zealand initially took the approach of trying to flatten the curve to take pressure of our healthcare system. That plan very quickly pivoted to an elimination strategy with a very strict nationwide lockdown that lasted around seven weeks.

While the lockdown was very effective at slowing the spread of COVID-19, the impact on demand for air travel was swift and brutal. As you can see on this graph, with the blue representing the 2020 financial year, and purple representing the 2019 financial year, from late March through to the end of April, demand reduced to almost zero, which resulted in Air New Zealand operating less than 5% of our total network capacity. Never in our 80-year history have we had to reduce network capacity to the 16th.

Once the 14-day mandatory isolation period was introduced in mid-March and the true extent of this crisis started to become clear. We knew we had to act quickly to ensure the resiliency of our airline. We quickly shifted our focus away from capacity and revenue to our cash flow and liquidity requirements as credit markets began to tighten up. Even for investment grade airlines such as Air New Zealand.

Jeff and Leila flew down to Wellington to secure a short-term liquidity solution in the form of $900 million standby facility with the New Zealand Government, we felt that it was necessary to obtain this funding and obtain it quickly to maintain continuation of our operations.

But securing additional funding was simply not enough on its own. Faced with such a sudden and drastic decline in demand, we took the unfortunate, but necessary steps of canceling the 2020 interim dividend that we had announced in February and initiating a deep review of our entire cost base.

This was in the knowledge that at least for a time, we would need to be a much smaller airline. As most of you know, we run a very tight ship here. So believe me when I say that it was no easy feat to pull out the level of cost and spend that we have done in the past few months.

As an example, we have deferred or cancelled any non-critical CapEx spend and critical had a very high bar. This will save us $700 million between now and December 2022. We also reduce spend across all areas of the business and sadly took some significant steps to structurally adjust our labor cost base to reflect the scenario that the airline will be smaller for a time as we exit this crisis.

What I really want to make clear here is that although it’s easy to focus on the tough situation we are facing at the moment, we are incredibly focused on the future. The actions we have taken to-date, albeit painful, will set us up for continued success on the other side of this crisis. That is also why the executive and I have been working to define Air New Zealand strategy and set a course for our future in parallel to managing our way through this crisis,

As we expected, the results of our strategy refresh show that we are very strong, very efficient airline. We are not moving the dial 180 degrees here, we are making numerous tweaks and refinements based on hard data and facts, as well as exploring some exciting prospects within the loyalty, digital and sustainability spaces. I am excited to share more with you in a little over a month’s time at our Annual Shareholders Meeting.

One of the things that has surprised me the most over this time and what gives me confidence that demand for air travel will eventually return is the fact that we saw some really fantastic demand as we emerge from Level 3 on the 13th of May.

We initially intended to put less than 10% of our usual domestic capacity back online during Level 2, just to get a feel for what demand looked like, given there was still some restrictions in place.

As you can see in blue on the chart, which depicts domestic passenger bookings per day, demand ramped up quite strongly and relatively quickly from late May onwards, which resulted in us putting around 20% of our capacity back onto the schedule.

In mid-June, we even saw a year-on-year increase in passenger bookings and with incredibly strong demand from customers booking flights to visit friends and relatives, and high volumes of leisure traffic as the July school holidays approached.

We ended up putting almost 70% capacity back on the network from early July. Demand was particularly high for jet routes, such as Queenstown and Christchurch, with Queenstown in particular performing well ahead of last year. Prior to our move back into lockdown in early August, we were also starting to see the return of our corporate customers at around 65% of pre-COVID levels.

This tells me two very important things. Firstly, the Kiwi still have a fundamental desire to travel. And secondly, and probably most importantly, they feel safe enough to travel with us. This is crucial in terms of our long-term recovery.

The other thing that I think puts us in a comparatively stronger position is the fact that we have such a strong core domestic network. When compared to other countries around the world, you can see that our movement towards recovery really stands out, particularly in Australasia. Not only were we operating almost 70% of our pre-COVID domestic capacity in July, we had average load factors of around 80%. Meaning not only were we flying, we were flying at or around optimum capacity. We know that this is not necessarily the case with some of the flying that has happened in other jurisdictions.

Like the rest of our business, the Cargo story in the 2020 financial year is really a game of two halves. As we spoke about it the interim, the Cargo business that face some significant challenges in the first half of the year, predominantly driven by trade tensions between the U.S. and China, which led to reduced demand and increased price and competition, which put pressure on yields.

In the second half of the year, particularly in the early days of the COVID-19 crisis, we saw very strong demand for cargo chatters, ensuring that key goods were still flowing in and out of New Zealand.

In May, we were awarded more than 50 cargo flights a week under the Government’s International Air Freight Capacity Scheme, moving crucial goods from New Zealand to Asia, Australia and North America. This has been a vital source of revenue over a time when much of our passenger network is not operating and is also enabled us to take a leading role in getting the New Zealand economy back up and running. The IAFC has recently been extended, which will ensure we can continue to operate this match valued service.

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In more recent news, we have also agreed terms with the Australian Government to run a similar service between Brisbane and the U.S. This is, again, thanks to the tireless effort of our Cargo and operational teams.

The green shoots on our domestic network and within our Cargo business have certainly been very pleasing and important over the past few months, as they have allowed us to generate revenue and much needed cash flow at a time when international travel is almost non-existent.

We are even seeing some substitution effect with Kiwi who would once holiday overseas now exploring our own beautiful country. However, without making significant additional and long-term changes to our business model and strategy, these green shoots are not enough on their own.

The number one determinant to our long-term recovery is reopening of our global borders and there is simply too much uncertainty as to when that will ultimately be. While we have no control over when our borders will reopen, and in turn, when passenger demand will come back, our focus must be on protecting the foundation of our business. And by that I mean, our people, our customers, our core domestic network and our cost base. We have to remain as nimble and agile as possible, so we can ramp up a network of profitable flying as soon as demand returns.

Between the executive team and our Board, we have a huge amount of knowledge and experience in this industry. We have been through tough times before and while COVID-19 is in a class of its own, we know what needs to be done and I am confident we will come out of this stronger than ever.

I will now hand over to Jeff to discuss the financial results.

Jeff McDowall

Thanks very much, Greg, and kia ora and good morning to everyone on the call. Turning now to some of the key financial numbers for this year, operating revenue of $4.8 billion was down 16% on the prior year. If you think about the fact that we reported interim revenue of $3 billion a few months ago in February, it’s clear that the second half of FY 2020 has been very challenging.

You can see in the call out box below the graph, the earnings for the first half of the year were relatively strong. Prior to the introduction of mandatory 14-day isolation requirements, and ultimately, the closing of New Zealand’s borders to all foreign nationals, we had been tracking well to deliver profit in line with the earnings guidance we provided the interim results and that was between $300 million to $350 million. But overall at the end of the year, we now reporting a loss before other significant items and taxation of $87 million. So if we look at the statutory results, we are reporting a loss before taxation of $628 million.

As a reminder, in mid-June, we provide an update to the market around our expectations for several items that would be classified as other significant items for the 2020 financial year. These items which total $541 million are largely non-cash in nature for this financial year. I will give a breakdown in some more detail on that in the coming slides. Net loss after-tax for the period was $454 million and we ended the financial year with $438 million of cash.

Now turning to our profit waterfall chart on slide 17. I won’t go into each of these, but you can see that the huge different profitability is largely a result of the $1 billion decline in passenger revenue, which was only partially offset by Cargo and other revenue.

Our labor costs reduced by $154 million, due to a range of things such as reduced headcount, cancellation of incentive payments, as well as $115 million wage subsidy payment we received from the New Zealand Government.

Fuel costs declined $306 million, driven largely by the 21% reduction in capacity for the year. The average fuel price net of hedging also declined significantly, as the fallen global demand for air travel resulted in a drop in the pricing for Singapore jet.

Maintenance, aircraft operations and passenger services costs decreased $132 million, reflecting the 21% reduction in capacity for the year and the resulting decline and variable operating costs.

This next slide shows our other significant items for the 2020 financial year, the large majority of which are non-cash. The actual results for these items are consistent with the guidance we provided to the market in mid-June. Most significant of this by far is the aircraft and payment charge of $338 million on our Boeing 777-200 plane, which we expect will remain in long-term storage for the foreseeable future.

We have also recognized $140 million from redundancies and other reorganization costs, as well as $105 million relating to the de-designation of hedges following a significant decline in expected revenue, operating expenditure and fuel consumption.

Now, between Greg’s earliest slides and the market updates we have provided regularly in the past few months, much of the information in this slide won’t be new to you. So I am not going to go into every one of these areas. But I think it’s clear that from the very beginning of this crisis, we have taken swift and decisive action to reduce our cost base and preserve liquidity.

The most significant of these cost reductions is in our labor cost base, where we have reduced our workforce by about 30% or more than 4,000 people. This is expected to result in annualized savings of around $350 million to $400 million or approximately $30 million per month.

Another significant area where we have pulled out costs is in terms of our forecasted capital expenditure, primarily across our properties, digital and infrastructure spend.

We have also deferred delivery of some of that incoming fleet, which I will talk about shortly.

As of 25 August, we have remaining short-term liquidity of around $1.1 billion. This is inclusive of the $900 million standby loan facility from the government, which as Greg mentioned we have not yet drawn on but we will do so in the coming days.

If we turn now to our operating costs, I think, these two charts show that our actions to reduce cash outflows have been very important and significant. Operating costs excluding fuel have decreased 50% compared to the same quarter last year and 60% compared to July last year. This is compared to reduction of capacity of 75% for the quarter and 65% for July.

We have also managed to reduce our cash burn from around $175 million per month over April to June, down to $85 million in July. We expect our go-forward rate of cash burn to reduce further to be between $65 million and $85 million per month. This range includes average loan amortization of approximately $25 million per month.

It’s also, obviously, prefaced on a number of key assumptions, including that out domestic network continues to operate around the 70% mark that we were seeing in July and with no social distancing requirements on Board.

It also assumes a similar degree of Cargo flying to what we had been doing in the past few months under the IAFC arrangement and that the cost reductions we spoke about earlier continue. It is also on the basis that we expect to have reduced levels of refunds, redundancies and hedge losses as we move forward. We have also outlined the key downside risks to this range on the slide as you can see.

As I mentioned in one of my earlier slides, one of the most significant ways in which we have reduced costs is due to the substantial reductions we have made across our labor cost base. In Phase 1 of these reductions, which is now largely complete, we reduced headcount by more than 4,000 people as we structurally reset our cost base.

In Phase 2, we are pulling out further costs, but only on a temporary basis, governed that until global borders reopen, we expect to be largely domestic and cargo business. While the decisions we have made have been very difficult, they are the right ones to ensure that we emerge from this crisis in a strong and competitive position.

One thing I do want to point out is that the cost savings we have made have been achieved by a number of pathways, not just headcount reductions. Every workgroup across the whole business has been impacted in some way. Over 3,500 people have lost their roles, a further 600 took voluntary redundancy and more than 400 others are working reduced hours or taking leave without pay. Others still who have purchased additional leave have been temporary redeployed or have elected to go on furlough with the first right to return when demand picks up.

That’s why you can see in this chart that our labor costs are expected to be 40% lower in FY’21, even though headcount has reduced by around 30%. This has been very difficult for everyone involved. I want to acknowledge the personal sacrifice that has been made by so many of our people across the business.

In the table on the next slide, we have set out a few key liquidity and gearing measures. As you can see, the net debt position has increased due to the rate of cash burn through June 2020. However, as a result of the actions we took to negotiate the Crown facility, we ended the 2020 financial year in a relatively strong liquidity position.

The Board continues to assess the airline’s capital structure and funding needs with the goal of ensuring long-term financial resilience. We are pleased that the New Zealand Government has recently reaffirmed its commitment to maintaining its majority shareholding in Air New Zealand and the Board is engaging constructively with the Crown and our capital structure and funding discussions.

Now I know that dividends are a really important topic for investors, we are incredibly disappointed to cancel the 2020 interim dividend, especially given it was the first time since 2005 that we have not paid a dividend.

However we knew it was a necessary action to help preserve our long-term liquidity through this challenging period. The cancellation of the dividend was also a condition of a standby loan facility agreed with the government. Due to the financial pressures that we continue to face, the Board has determined that it will not declare a final dividend for the 2020 financial year.

Turning to hedging, the significant reduction of flying due to COVID-19-related travel restrictions resulted in an over hedged position, which means that we had to close out a substantial amount of fuel hedges for the fourth quarter and FY’21 period. We did this predominantly in March but also some in April and May as the fuel price increased a bit, which helped mitigate some of our cash costs.

Our cash cost related to fuel hedges was approximately $95 million, which was partially offset by a $30 million benefit from the foreign exchange hedges related to our foreign denominated debt. The net cash impact was approximately $65 million.

From a P&L perspective, the impact of ineffective hedging resulted in $105 million charge recognized within other significant items.

Looking at the current financial year, our hedge profile is not significantly committed. Our hedges are generally around the level of volume flown in the month of July, which reflects domestic volumes and international flying related to cargo. As you can see from the table on the right, we currently are expecting a skew in our hedge losses to the first half of the financial year, which will improve as we progress into the second half.

Given the uncertainty around network level and subsequent fuel volumes and foreign revenues, the Board has approved a temporary exemption to define hedging parameters outlined in our Group treasury policy.

We continue to closely monitor market pricing and when it makes sense, we may add some new fuel hedges into the fourth quarter and beyond. But those will be based on relatively low volume estimates.

In the charts on slide 26, you can see the expected phasing of our updated aircraft capital expenditures through to 2024, which totaled approximately $2 billion based on an exchange rate of $0.65. We haven’t previously shown this forecast out to 2024, which is why that number seems bigger than you have seen in the past. But as you can see, it’s still substantially smaller than our historical spend.

Based on the actions management has taken in the past six months to respond to COVID-19, you can see that we have deferred around $200 million in expected aircraft CapEx across the 2020 to 2022 financial years. We must focused on that near-term CapEx peripheral given FY’20 to FR’22 are really the crunch years in terms of lower expected demand.

From FY’23 we get the first of our new Boeing 787 Dreamliners. But depending on the timing of recovery and demand, we do have flexibility to amend delivery dates of the subsequent aircraft. At this point, we have not made any formal deferrals of the 787 aircraft on order,

You can see that we have reflected some timing changes on our expected delivery of NEO aircraft for the domestic market as well. We have deferred the arrival of five A321neo aircrafts, each for about one year.

I will pass you back over to Greg. He’s going to discuss outlook and leave you with some closing remarks.

Greg Foran

Thanks, Jeff. I want to be upfront about the fact that we are facing a difficult road ahead of us. It feels like COVID-19 and the resulting impact on demand for air travel will be with us for quite some time yet.

As such, we are focused on those things that we can control, which is structuring our organization for the current reality that faces us and building a solid foundation for the future, so we are in a competitive position when demand returns, which we know will.

For at least the first half of the FY’21, we expect to be a largely domestic airline with a solid cargo business and hopefully some flying to the Tasman and Pacific Islands. As you know, our domestic business represents about a third of our total revenue. And although, cargo was performing incredibly well, we are not structured to be a largely domestic business. That is why we have worked hard to ensure that every action and decision we have made, no matter how tough will set us up to emerge strongly and competitively from this crisis.

That is also why we have been working to define Air New Zealand strategy and set a course for our future, as I spoke about earlier on this morning’s call. I will provide further detail at the Annual Shareholders Meeting in September this year.

Given the uncertainty surrounding travel restrictions and the level demand as these restrictions lift, Air New Zealand is currently not able to provide specific 2021 earnings guidance. However, each of the scenarios we are currently modeling suggests we will make a significant loss in 2021.

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So with that, can I say thank you very much for listening. I know you will have lots of questions. So, Operator, please open up the line.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions] Our first question comes from Andy Bowley from Forsyth Barr. Please go ahead.

Andy Bowley

Thanks, Operator, and good morning, Greg, Jeff and Leila. I have got a couple of questions. The first of which is, I guess, for you, Greg, around particularly the outlook commentary, and the reference to the various demand recovery scenarios that you are looking at and all suggesting a loss for the year ahead. I am really keen to understand how you are thinking about those scenarios, maybe the most optimistic and the least optimistic. Can you give us a sense of what those scenarios look like?

Greg Foran

Yes. Good morning, Andy. I don’t want to get into all the details, because as you can imagine, we run several sort of a low, a mid and a high. All of them would indicate that if they play out, there will be a loss next year. The degree of that loss is sort of dependent on what happens initially with short haul and how quickly we can get something out running in terms of Cook Islands in particular in the Tasman.

In the immediate term, of course, we are dealing with social distancing on planes right now, and that has an impact, it’s not dramatic, but if it went on for a long period of time, it would certainly be impactful. We are not really assuming that we are going to see anything long haul, anytime at this financial year, so we are not assuming we are going to be back into America or anywhere else.

And my final comment there, and Jeff may want to add some things in is that cargo was assisting us. We are doing about 50 flights or so a week with cargo. And the scheme that we have got in place with government, which has just been extended out to I think November is beneficial, and it’s beneficial because it assists in terms of the cash flow in the business.

It’s beneficial because obviously we are doing something good for the country and moving some freight. And it’s also good because we can get some customers moving. So, basically, scenarios are linked around what sort of restrictions we get put in front of us in terms of travel. And as I said, we have got a low or medium high, but all of them would indicate a loss.

Andy Bowley

Jeff, anything do you want to add to that?

Jeff McDowall

That was pretty good summary. I think, I mean, I guess the only thing to build on that is that if you look at what we had in July, which was the domestic business operating kind of ballpark 70% of pre-COVID levels in the international cargo operation going then that puts us in a position if you assume that that carries on for a period of time before the international borders reopen. Then we are in a position where we have got a positive operating cash flow when you — when the big chunk of returns is behind us. So that at least gives us a good platform to build from.

Andy Bowley

Maybe if we just kind of stretch out the question to beyond for the next 12 months, and thinking about a full recovery of air travel. I recognized you have made a lot of decisions in terms of reducing the size of the business by 30% or so for kind of the expectation that would be 30% lower in terms of size and demand in two years time. What are your expectations in terms of the — say the median scenario over the medium term in terms of full recovery of the business or full recovery of demand I should say?

Greg Foran

Yes. It’s a question we often ask ourselves, Andy, to be honest with you and it’s clear that not just Air New Zealand, but any airline is operating in the toughest conditions that we found ourselves since sort of flying commercially began.

We have made decisions around the 777-200s taken a write down on those. And by that you can see that we are assuming we are probably not going to require those aircraft anytime soon. And 777-300s are packed offshore with the exception of a few that we will keep here because we have got some maintenance to do on them.

We are not assuming at this point unless there’s a dramatic change in border restrictions that we need those anytime soon. So, we will just have to wait and see what happens medium term. There’s a lot of unknown around this virus in terms of vaccines, how effective they will be the distribution of those vaccines, what will happen in terms of different countries employing different strategies. So, we are trying to keep our powder dry here.

I often liken it to I am driving down the freeway and I am not sure whether I need to take an exit on the left or the right. So I like to sit in the middle. And when I get a bit closer to where I need to make the exit, then hopefully, I can know whether I need to move into the left lane or the right lane. So we do expect to be smaller for sure.

We absolutely aren’t seeing a V recovery or even a U recovery, it’s more like an L. And it’s just a question of how long that bottom of the L takes to ramp itself back up. But medium term powders dry, we are in a position to move if we need to. And as each month goes by, we learn a little bit more about the virus and we can make some better decisions. Jeff, what do you want to add to that?

Jeff McDowall

Yes. I totally agree. I mean, one thing we have been careful to ensure is that particularly for our wide-body fleet, we have got really good flexibility to recover to different extents as we see demand emerge.

And the other thing I guess is worth pointing out is that we were surprised on the domestic network about how rapid the demand response was once travel restrictions were lifted. So now who’s to say what that will be like on international bets, we had previously thought it might take some time and be a fairly gradual recovery, but actually it recover quite quickly. So we need to be prepared. Yes, we need to have flexibility both ways.

Greg Foran

And it was encouraging to on domestic to see that it just wasn’t school holidays. So, there was a desire and still as a desire, and we see it even today as we deal with the fact that we have got social distancing on planes. There’s a desire by New Zealanders to get out and travel. And we are even encouraged by what we are seeing with business. So, we do feel that the domestic network sets us up. And as we emerge from this, we should be able to emerge in a good strong position.

Andy Bowley

Great. Thank you. And look final question for me is around the cash burn situation. You have done a great job in terms of lowering that cash burn in terms of the 65 to 85 that you referenced in the presentation. But in kind of the worst case scenarios, how long can you persist without a level of cash burn without taking further cost actions? And I guess, again, it comes back to those scenarios, which I don’t know, you don’t know and nobody knows in terms of how they think this really plays out, but at what stage do you have to make sort of the hard decisions?

Jeff McDowall

Yes. I mean, we have disclosed, as you see in the pack, the liquidity we have available and the level of cash burn. So you can sort of see what runway that provides if you assume that we only operate domestic and cargo for a period of time. I mean, the challenge, I guess, that we would need to balance up is that in a significant further changes to cost take longer to build back.

So we need to — we are trying to maintain a good balance between flexibility to respond when demand does pick up in short-term and short-term cash — sorry short-term cash burn. So as a continuous balancing and as I guess more information emerges, we need to continually reassess it. But we feel we have got the balance about right at the moment.

Greg Foran

And, of course, that cash burn is dependent obviously on us getting social distancing removed on planes and domestic back up and running well.

Jeff McDowall

Yes. I mean, that’s a really important point with social distancing in place on the domestic network. That has a — it’s very challenging commercially. We can sort of cover our costs at that level, but we are not really able to make any meaningful contribution to our fixed costs. So, yes, that is a challenge, but within you like that won’t be with us for long.

Andy Bowley

Great. I appreciate that guys and good luck for the next six months.

Greg Foran

Thank you.

Jeff McDowall

Thanks, Andy.

Operator

Our next question comes from Andrew Steele from Jarden. Please go ahead.

Andrew Steele

Good morning, everyone. And just the first one for me is I guess the follow on from Andy’s first one. When you look at your scenario modeling, if you were to — I am just trying to get a sort of sense on the impact of the Tasman market, on sort of a monthly basis, could you get back to sort of a breakeven profit position? And any of your scenarios on Tasman comes online, or do you need long haul as well?

Jeff McDowall

Yes. Good question. I mean, it depends a bit on the scenario. So one of the scenarios, for example, is that we are contemplating is that if you are in a world where Australasia is open for travel within its borders, its broader borders, while international travel is not available, then you can imagine. I mean, we have seen this flood of Aucklanders wanting to go to Queenstown.

You can imagine a flood of Australians wanting to come to New Zealand. And yes, in that scenario, you could see well where the Tasman is strong enough that we get back to a profitable position under that strong demand from Australia. But as you probably heard from that answer, it’s a bit speculative. So it’s not something that we can give you any definitive guidance on.

Greg Foran

It helps a lot getting the Cook Islands open and getting Australia open. But there are once again a lot of assumptions in terms of how much people will travel and how much they would be prepared to pay and what the level of competition would be. So you have to make a whole bunch of assumptions.

But we know that we can have a reasonable domestic business here and we know that before the 11th of August, we were tracking circa 70% of pre-COVID levels. If you then layered in something around the Tasman and the Cook Islands, it would go a long way to assisting the financial position of a New Zealand.

Andrew Steele

Great. Thank you. And just on your comments on the strength of the demand you saw particularly in July, could you give a sense for the bounce back by different customer groups versus a pre-COVID baseline, so I guess that would be leisure travel, corporate travel and government travel?

Jeff McDowall

And yes, sure, we saw leisure travel recover faster. And in fact, when I say recover, it actually got for or some parts of networking for some weeks. We were seeing more leisure demand than we had seen for the same time in the previous year. So it was beyond the recovery really, which I think is a sign of people choosing to holiday in New Zealand when they can’t holiday elsewhere.

The corporate market was and corporate and business, including government, was a bit slower to recover that got to about two thirds of pre-COVID levels during July. And obviously the other big segment is inbound tourists, which obviously weren’t there.

Greg Foran

You know, I think another important part of this was that the use of credits during that period. And it wasn’t as if we saw everyone using credits to fly. I think roughly around about 25% of the tickets were credit, people utilizing their credit.

But the other key point is that a lot of those people were actually then buying up on that. So, I think once again that that made us feel pretty good about what’s going to happen when we get ourselves back up and running here on level one.

Andrew Steele

And just again to go back to sort of some of the July numbers you presented. If we were to extrapolate out the July operating cost basis ex-fuel. Would that be a reasonable proxy for your cost base in a sort of domestic and cargo only environment as for the entirety of FY2021?

Jeff McDowall

There were still some labor transition going on during that period. So, probably — it’s probably not a fair proxy entirely, but we can get you a bit more detail of what that looks like after the call.

Andrew Steele

Okay. Great. Thank you. And just one final one for me. You provided some comments on how you are thinking about your fleet. I just aware that you do have some early lease exit options coming up I think [inaudible]. Are you going to be looking to sort of flex down some of those leases in the financial year? Or is that sort of too soon before you want to sort of make a need of major decisions on fleet?

Jeff McDowall

Yes. That’s an ongoing conversation with our leasing partners. And there’s some — yes, there’s some tradeoffs. There is clearly — the lease — there’s a surplus of aircraft in the fleet globally. So most leasing companies are quite keen not to get aircraft back.

So that provides — that’s one ingredient to the negotiation, the other is that the process of returning aircraft requires some reinvestment and their condition. So if you bring lease exits early, then the cost associated with exiting the aircraft comes early as well. So it’s just balancing those things up.

Andrew Steele

Thanks guys. That’s all for me. Thanks, guys.

Greg Foran

Thanks, Andrew.

Jeff McDowall

Thanks, Andrew.

Operator

Our next question comes from Owen Birrell from Goldman Sachs. Please go ahead.

Owen Birrell

Hi, guys. I would just — just a quick question. I think, firstly, just thanks for the cash burn numbers. It provides a lot of clarity I think for us in terms of looking at the — at how your outlook plays out. I just wanted to drill down into that a little bit more. The $65 million to $85 million cash burn per month that you have sort of highlighted going forward. I think you said it was around about $25 million a month in loan amortization there. I am just wondering of the remaining $40 million to $60 million in cash burn, how much of that is operating losses? How much of that is CapEx? And is there any working capital movements in there as well?

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Jeff McDowall

The rough numbers, CapEx would be — it would be similar numbers I think is the debt amortization. Is that fair?

Leila Peters

A little bit north of that for CapEx on an on average.

Jeff McDowall

And then the rest would be — and when we say operating cost, the rest is — it’s really our fixed cost. The flying that we are doing — and this is — the way we put the estimate together was based on the world in which we operate, domestic and cargo. And the costs associated with that operation well and truly offset by the revenue, we are making a positive contribution there, but then it’s the fixed cost base that creates the difference.

Leila Peters

And then Owen, as it’s highlighted in the slide deck, our cash burn does include everything, so that includes assumptions on refunds, redundancies, fuel hedging losses.

Owen Birrell

Excellent. I am sorry 20 — roughly $25 million at the moment in terms of CapEx per month operating is breaking the…

Leila Peters

No, sorry, a little bit north of $25 million for investing cash flows.

Owen Birrell

Okay. So the rest is all just the refunds redundancy in working capital movements.

Leila Peters

Correct.

Owen Birrell

Excellent. And in terms of, I guess, the CapEx, looking forward, I am not sure did you provide CapEx guidance. I am not sure if I missed that.

Leila Peters

We provided — we provide aircraft CapEx details, which Jeff went through in the prepared remarks. As you know, there is non-aircraft CapEx as well, which includes engine overhaul, so capitalized engine maintenance for owned engines, properties and infrastructure spend and digital investments.

Those are included in the CapEx deferrals that we spoke about both today and to the market back in May and in June. The difference with that is that they are quite fluid as it relates to how the network is operating. So things such as engine maintenance will change, potentially, if our network is comes back faster than anticipated or slower than anticipated.

Owen Birrell

Yes. Understood. And how much of that can you defer? And is there a portion of that sustaining CapEx that can be deferred for a longer period of time and so they pushed back into FY2022?

Leila Peters

Yes. Potentially, I mean a lot of — some of the infrastructure spend, for example, is related to Auckland Airport and other sort of airport spends. And, as you can imagine, a lot of these areas across New Zealand are thinking through their long — their medium and longer term master plans. And so that is the best that we know now, but it certainly is subject to change.

Owen Birrell

And actually just that’s probably segue to my final question in terms of your relationship with Auckland Airport and whether they have been able to give you any deferrals on payments?

Jeff McDowall

The ratio with the Auckland airport has been really open and strong for a long time. And if anything this environment makes it even more so because we will go very similar incentives to make sure that the investments are appropriate for both the environment and the rate of recovery that we see. So you know that like is really constructive and gave anything to Greg’s.

Greg Foran

I have been extremely helpful across a number of aspects from packing planes to bill relief to a whole bunch of things and we have thanks them for that and continue to work well with them.

Leila Peters

Owen, I might also add and I can take it offline with you in New Zealand. There was some aviation support bill relief through August from March through August which included the relief of landing charges and passenger levies related to operating flights so that was also part of the improvement, but not specifically negotiated with Auckland Airport or any other airport per se.

Owen Birrell

That’s fine. Will go to offline. Thanks.

Leila Peters

Great.

Operator

Our next question comes from Marcus Curley from UBS. Please go ahead.

Marcus Curley

Good morning, guys. Just a couple for me to just you — when you look at your cash burn, it looks like it increased to close to $190 million in August, obviously operating conditions changed. But I just — could you just provide a little bit of color? Yes, what’s in between the target and the 190 in August is that obviously its list flying. Yes, you mentioned social distancing? Yes, how big a component was that and do you expect that to continue under level two?

Jeff McDowall

You said there was a number of moving parts. There was the redundancy and refunds costs as part of the story and they taper quite quickly as you get into the more go forward position that we have indicated. And as you say, the domestic network was really only operating for half the month. And August, so…

Leila Peters

Sorry, Marcus, I think you are thinking of the June 30 balance to current balance of 245. So that’s July and August. So 190 numbers represents effectively two months, not one month. Because as we stated July cash flow was 85.

Marcus Curley

Yes. And then I looked at what the cash — yes, liquidity position was at the end of August and took the difference being what happened in August. Yes, which looks like a significant increase over the 85?

Leila Peters

It’s about 108.

Marcus Curley

Okay.

Leila Peters

Sorry. And the differences I think Jeff was alluding to is we started getting a slowdown and incoming receipts of cash as the restrictions in Auckland came into being.

Marcus Curley

And so in a situation you are in at the moment, which potentially repeats, yes, when we are in lockdown. And with social distancing on aircraft, yes, what is the downside number on cash burn at the moment as you would see it?

Jeff McDowall

I can’t give you a precise number, but I can tell you is that we are social distancing in place for domestic. We can make a small cash profit, but it doesn’t — but it’s not — it’s not meaningful. Whereas when we are operating before the domestic margins were similar to pre-COVID levels. So yes, it’s a fairly significant difference and one that’s really not sustainable.

Leila Peters

Agreed, which is why in our cash burn assumptions for go forward, we are assuming level one with no social distancing as per July.

Marcus Curley

And Jeff can you just talk to when you are looking at your capital options, your first and foremost what your target gearing or your metrics that you are looking at in terms of where you want to position the company?

Jeff McDowall

And yes [Technical Difficulty] longer term then the capital management framework and distribution policy that we have been working to for a while I think it’s still where we would start, nothing is still pretty valid with the three key metrics and they are around gearing of 45 to 55 gross debt-to-EBITDA is 3.31 to 3.3 and the liquidity target, which a minimum of 700. So, I mean that’s the framework that we would start with. Yes, I think we would have you with moments that’s still appropriate.

Marcus Curley

And then secondly what do you think your approach is going to be in terms of sizing the recapitalization or do you think you are going to target a worst case scenario? I do notice this morning that the PM has talk to the fact that she believes a vaccine is not available for two years in New Zealand? Or do you think you might take an approach of doing one part now and potentially looking at revisiting the capital structure get next year if needed?

Jeff McDowall

I mean, it was sort of premature to speculate on what they might look like. But, yes, I mean, obviously, the two halves of the thought process as one as you know, what does resilient look like in terms of the capital structure, which is that was kind of describing earlier thinking on that it’s pretty consistent with what it was pre-COVID.

And then what scenario are you preparing for? And I mean, it’s really a question of what is a reasonable downside case? Obviously, you can’t pay for absolutely everything. But, yes, what is the reasonable downside case that provides a prudent level of resilience.

Marcus Curley

And you are still working through that at the moment?

Jeff McDowall

Yes. That’s right. I mean, the board continues to think about long-term capital structure. And as we said in the releases have been engaging constructively with the Crown on it.

Marcus Curley

And have that in terms of timing. Yes, I suppose some people might be surprised we — yes, we didn’t see something today on it. And can you give us any view on terms of how long you are willing to leave this before you come to a conclusion?

Jeff McDowall

Yes. I mean, I can do really go back to what I have said there’s — that we are — yes, continuing to review there to engaging constructively with the Crown. I can’t really provide much more comment in that.

Marcus Curley

Does the election have anything to do with the timing?

Jeff McDowall

That’s not really something for us to comment on. I mean — I think you have to refer that really to the Crown to answer.

Marcus Curley

Okay. And then just when there is finally — yes, when you think about flexing your long term capacity, what is the actual plans — yes — for the 777 200s. Will they be exhibit from the fleet, or will they be available in the medium term if demand comes back fast and expected?

Jeff McDowall

Both are available as options so that they can be bought back in as we see a strong return of demand. But we are also competed for the scenario under which they are not and yes that’s probably fairly likely.

The way we have thought about it is that the 787 order that we made for just over a year ago was originally designed to be a replacement for that 777 200 fleet, that has significant flexibility within the order which allows us to spice out the deliveries further and to substitute [inaudible].

So, in a world where we don’t need the 777 200s of that’s the way it plays out. We can essentially use that 787 order as 777 300 replacements and pace out the timing of those deliveries with the exit of the 777 300s think of us and really significant degree of flexibility over how that wide-body fleet grows.

Marcus Curley

And so, but you still some time away from making that decision on the 777s?

Jeff McDowall

Yes. We have got them. Yes, long-term storage at the moment. So there’s not a — we have got good flexibility of that. %there is not a particular milestone by which a decision needs to be made. So we are just trying to retain as much flexibility as we can.

Marcus Curley

Okay. Thank you.

Operator

[Operator Instructions] Our next question comes from Nick Mar from Macquarie. Please go ahead.

Nick Mar

Hi, guys. Just a quick one on the debt side and with there any kind of other options considered, between I guess, steps in the government loan facility, and I guess, from when you are going to need to draw on it very shortly. Are there any other options in terms of lower costs that we looked at?

Jeff McDowall

There was a time that we consider them and when we were looking at the way in which this whole thing played out and what was it early March I guess. We were actively looking at commercial data as a solution, but as the older restrictions became more and more strict in the kind of turning point was when all inbound arrivals had to go into their own little back then it was self-isolation, but essentially two weeks of quarantine that almost overnight the prognosis changed both from our perspective and from vendor’s perspective. So at that point, it really became, we really started focusing on the Crown as the lender.

Nick Mar

But as it stands today, do think there are options available given how the domestic businesses running and cargos kind of give me a positive contribution there.

Jeff McDowall

It’s difficult right now under the way the Crown loan is structured. But, yes, as we start to look about what our longer term capital structure looks like then certainly those options open up.

Nick Mar

Okay. It makes sense and then just kind of more broadly can you give us some color on how you guys are thinking about kind of running the domestic business, there is always that kind of balance between adding capacity versus taking kind of price.

And at this point in time, there is probably a bit more pricing it could be taken around lack of competition and the likes. And can you just talk about how you are kind of optimizing that at the moment?

Greg Foran

I guess we were expecting to say as we were beginning to see in July really strong demands and also we would expect to see a competitive position that’s not dissimilar to pre-COVID levels. So we had good stuff flying in July and prior to the lockdown had been planning to and publishing a schedule, which was quite similar to the pre-COVID levels, as we were so we exit the lockdown we were planning to get to 80% 90% of pre-COVID capacity quite quickly. So it’s just about providing a network that supports the resurgence and demand that we were seeing.

Jeff McDowall

Mix changes a bit. Because it’s unlikely that you will see business and corporate return quite as quickly to what it was pre-COVID. So that changes a little bit. And we have reflected that in some of our fee structures a little bit less sale activity. And, as you see Jetstar, we are operating at 90%. And we hope they do get back soon, but that will be dependent on how quickly we can deal with social distancing.

Nick Mar

That’s clear. Thanks a lot, guys.

Greg Foran

Thanks, Nick.

Leila Peters

Thanks, Nick.

Operator

Thank you. We have no further questions. So I will hand back for any final comments.

Leila Peters

Just wanted to thank everyone for joining us this morning. If there is any follow up questions, please contact Kim or myself throughout the day and have a good morning.



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