Airline Leader Interview Azul President Abhi Shah

Transcript

Lori Ramson:So, Abhi, thanks for being here.

Abhi Manoj Shah:Great, thanks for being here.

Lori Ramson:If you think about what's happened to Azul during the last year, last May, enter Chapter 11, exit on time in February, 8 days later, a war starts. So Just walk us through that process.

Abhi Manoj Shah:It was a great week. It was a great, great 8 days. We had a great weekend. So actually, it was a year to the day tomorrow. May 28th is when we did our filing. And as you mentioned, you know, 8 months and 3 weeks. And thank God that worked out because, you know, we had like a week of peace. You know, it really was a transformation for Azul. It was a reset much needed over the accumulation of all the restructurings since COVID We tried several times to restructure out of court since the pandemic. And in all of them, while the restructurings worked, we didn't have enough runway to recover from those restructurings. And what we found ourselves doing was growing just to try to outrun our balance sheet. And we were just growing to pay off massive interest burden, to pay off a massive debt burden, to pay off aircraft fleet cost from years in the past. And we realized that it was not sustainable. We decided to go in, and really what made the difference for us, I think, if you look at the other restructurings in the region, Chapter 11, you had Gol at 18 months, you had LATAM over 20 months. We really went in with the exit in mind, and that was the most— the difference in our strategy. We had incredible partners, starting with the bondholders, the owners of the business, the future owners of the business, who really wanted to see a business plan that was strong and resilient and something that was able to withstand the volatility of Latin America, especially Brazil, right? We received the same message from our largest lessor, AerCap, who was fundamental in supporting us when we went in. Because that would drive the momentum on all the fleet negotiations. Then, of course, uniquely, we had support in terms of the restructuring from both United and American. Steve Johnson is here. We thank him for his support. Again, what they all told us was, just show us a business plan that we can believe in. Latin America, Brazil, up and down. It never ends, right? Let's build a business plan that's really resilient, really sustainable. And that's what we did before we actually even filed, right? So that really was the bulk of the work. So we did our filing with the bondholders on board, with our largest lessor, AerCap, on board, and with United and American signing the support agreements at filing. And that really made such a big difference because the rest of the period was just— not just, but was executing the plan that we had laid out. So we actually emerged with a business plan that was very, very similar to what we did going in. A huge reduction in debt, a huge reduction in interest expense, a huge reduction in aircraft cost. We actually reordered our order book. We reduced our order book. Which is very opposite to many airlines around the world. We did that because we just wanted to be very, very resilient and have opportunities going forward. Thank God we did, because in an environment like right now with high fuel, I don't want to be taking 40 aircraft this year. When it gets better, then we have the flexibility to take aircraft whenever we want. It was a huge transformation. It's a very difficult process. Obviously, it's a very challenging process, but the key for us was to have a clear view of what the exit looks like when we entered. That really allowed us to get out so quickly, but also do something that's very, very thorough.

Lori Ramson:I want to touch on the partnerships with American and United because, as you said, it is very unique. Can you just explain to us how that works going forward? Beyond the equity investments?

Abhi Manoj Shah:Yeah, so they each— in fact, each of them will be the single largest individual owners of Azul at about 8%. They have equal rights and everything. In terms of the governance, they each have a seat on what we call a strategy committee, which looks at things like fleet and the business plan, also on the board as well. But we are— we have commercial agreements with each one, right? So we have a codeshare with United. We have a loyalty with United. We've had that for many, many years now. American is currently in the antitrust process, which is going well. So we expect that approval to happen in the next few months. And then we'll engage in commercial agreements with them as well. So it's not exclusive to one or the other. The idea is to really be partners with both. I think what they saw was, again, what they told us, what everybody told us was just, if we see a business plan that we believe in, then we would seriously consider looking at Azul. We really believe that this business plan is the long-term winner in the region. That's the reason for the investment, in addition to the commercial agreements and things like that. We work with both. We will work with both. Having such amazing brands and obviously the size, $56 billion each of them, makes a huge difference in any discussions with aircraft manufacturers, with engines, large suppliers. They really are able to advocate on our behalf. We are a tiny, tiny, tiny brother to those 2. Having 2 really big brothers is great on a day-to-day basis and a validation of the business plan. Fuel prices double, what do you do with capacity? What do you do here? What do you do there? Having them on the board, at least one right now, American to enter soon, really is a vote of confidence on the business plan.

Lori Ramson:There had been some challenges to those investments, but you were just telling me that they were not successful this way.

Abhi Manoj Shah:Yeah, so far.

Lori Ramson:The audience may not be familiar with those challenges.

Abhi Manoj Shah:Each of them has to go through the antitrust process. It's an open public process and competition, everything is fair game. We had a challenge to the United process late last year. in December. We were able to overcome that before we exited. We exited February 15th, I think, 18th, in that range. So United was— we were able to overcome United, and they were part of the exit. American is in the antitrust process now. We had a challenge from GOL and from a consumer institute that we think is funded by LATAM.

Lori Ramson:LATAM.

Abhi Manoj Shah:Probably is. Both of them were rejected as of last Friday. The process is ongoing. Again, competition, we expect that. It's fair game. So far, so good, but we're keeping our focus to make sure we get these across the line because we really want both American and United on our board as part of the governance of Azul to help us execute this business plan.

Lori Ramson:Just to touch on Brazil for a couple of minutes, even before the war broke out, I mean, it was sort of a rational environment from a capacity perspective. It seemed like all the players were behaving. But do you find that that's changing? It's staying the same? I know that Azul's cutting a lot of capacity in the back half of the year. So where do you see that headed?

Abhi Manoj Shah:So actually, one of the key changes we made during our Chapter 11 is we repositioned our growth, right? So we were an airline that's been growing for many, many, many years. Our 5-year plan pre-Chapter 11 was to grow 11% a year, roughly. And we just found out that it was just— you needed everything to go right all the time to make that work. And in a place like Brazil, in a place like Latin America, that's an asymmetric risk, right? You're taking most of the risk, and you're needing everything to go right all the time. And so one of the big changes we made in in our post-Chapter 11 business plan is we brought the growth rate down from 11% a year to 3% a year, right? And that really brought in a layer of resiliency into the business plan. You really have to— you can focus on your best markets, you can focus on your network, and you're not just absorbing aircraft just because you have them. So that already put us at a really, really good starting point for this new crisis, let's say, this fuel. So our growth for this year was only 1%, right, which is a very, very good starting point. We had a huge reduction in interest expense. It reduced by two-thirds, by 60%. Our interest burden came down. Our debt got cut in half as part of the process. Funny anecdote, I guess, is we had to issue trillions of shares not billions, trillions to convert the debt into equity. Now it's been reverse split, so it all makes sense. But that's how much debt we took off the balance sheet. Our leverage went from over 5 to 2.3. We're at 2.3 right now, which for a Latin American airline is very, very good. We're in a very, very good starting point. Physically speaking, we could not be better prepared one week out of Chapter 11 for this for this challenge. But even then, we're being very, very proactive. We have cut more capacity this year, and that's to try to accelerate the revenue recapture because fares have to go up. They have gone up. You will have a part of the demand that will stay. Usually, your corporate closer-in demand. We are seeing some further-out leisure demand sensitivity different from the US. The US, it seems like so far, is Very resilient across the board. That's great. In Brazil, different purchasing power, different demographics, so we have to watch for that elasticity where it is. I mentioned on our earnings call a couple of weeks ago, the close-in demand, the agents' corporate demand, very strong, but the further-out demand, more leisure demand, is still waiting a little bit. We did cut capacity to make sure we can accelerate the revenue recapture and have more confidence, frankly, to keep the fares high because that's what you have to do in this environment. So yeah, I mean, we're in a very good starting point. Obviously, we're not happy that we have to use our chips right away. It'd be nice to have a little bit of time to kind of consolidate on all of the work that we did in Chapter 11, but it's much better to be where we are than not.

Lori Ramson:Does your network help in that regard, the fact that over 80% of your routes you're the only operator? So that's got to help you. And getting some fair traction, right?

Abhi Manoj Shah:Absolutely. So it's our key advantage. Our network is very different. You know, when David first founded Azul, he went to this airport that had 10 departures a day total at the entire airport. And now we alone have 188 departures a day there, right? So we're different by design, and we like to be different. You know, our reason to exist is that we do it differently. We serve a different network. We have different business units. For example, we have the second largest travel agency in Brazil is ours, and we sell a huge amount of vacation packages every year. Logistics, we do all of the e-commerce for Amazon.com in Brazil, marketplace, pickup, delivery, all those kinds of things. Everything we try to do is to extend and create those advantages competitively. The network is by far the largest. And that helps, you know, the customer doesn't have as many choices where we fly. So that gives us a little bit more. It allows pricing and revenue to be in our own— we control our own destiny, right? Of course, demand will always react and the customer will decide, but we don't have to always look to the right or to the left to see what our competition is doing. We can do what we— Yeah.

Lori Ramson:Even though you've cut the E2 order book, I know Azul was very bullish on that aircraft, and one of your competitors, LATAM, is introducing that in Brazil's market later this year. First, are you flattered? And second, what do you think about that?

Abhi Manoj Shah:Yeah, I mean, you know, Brazil, for the— it's a very, very large country. You know, north to south, it's the same as the US's east to west. The north of Brazil is closer to Canada than to the south of Brazil. That's how large it is. When you have such a large geography and such different demographics, for anybody who's been there, São Paulo is a very, very modern city, but you go in a couple of hundred miles, it looks completely different. We always thought it made the right sense to have the right aircraft in the right market at the right time. We have 7 fleet types, from Caravans to A330-900s. GOL and LATAM always had the single fleet-ish between the sizes. It's not surprising to us that they would replicate this a little bit. We're still very bullish on the E2. We have 41 aircraft right now, 45 by the end of the year. It's a great airplane, but like I said, we wanted to cut the order book to give us a lot of flexibility going forward. In fact, you're seeing it now with fuel the way it is. We're getting offers every day now for aircraft, right? Especially on the narrowbody side. The widebodies are still tight, but on the narrowbodies, still aircraft are coming available, and not just because of Spirit, just generally speaking. you're seeing narrow-body aircraft available. So I'd much rather have the option to take aircraft than to be forced to. But yeah, LATAM is going to fly a couple of E2s. I don't know how many this year. I think it'll be very, very late this year. But it's going to connect to their hubs. They have a very large international network. So I think it makes sense for them to feed the hub.

Lori Ramson:Speaking of business models, and maybe just to go back to that point, there's been a lot of discussion here about ULCCs and the viability, but there are ULCCs in Latin America too. Are there differences in Latin America that make it a little more viable there? Yeah.

Abhi Manoj Shah:So Brazil doesn't have any traditional ULCCs, right? You have Sky, you have JetSmart, Fly Bondi in Argentina. Really what you have to think about for a ULCC is what are my structural costs advantages that I can sustain to charge lower fares, right? Because if you can't sustain those lower costs, then, you know, you'll charge lower fares until one day you can't anymore, right? And we've seen that with Avianca Brazil. We've seen that with a local airline called ITA. So in a place like Brazil, that's very challenging. First, you have 3 really well-run competitors. You're not competing against a bloated state-run legacy airline. That doesn't exist anymore. You have 3 really, really efficient airlines. You have pretty low labor costs across the board compared to the US for sure. You have no alternative airports. Rates are the same everywhere. You have currency risk. You have high cost of capital because you're taking Brazil risk. High fuel taxes, high fuel in general. I don't really see any ways of creating a structural cost advantage in Brazil. Even in South America, you have Sky, you have JetSmart, but they haven't really made significant inroads, I don't think, to challenge LATAM, for example. I think it's tough. I think it's a tough market in terms of ULCCs because you cannot really create that competitive advantage that you need on a cost basis to then have the lower fares. Charging lower fares is easy, but that's going to evaporate one day, right? Because you just can't do it anymore. So you have to sustain a lower cost structure. I think that's very, very difficult. Not to mention, Brazil has 2% of the world's departures, maybe 4%, and over 95% of the customer lawsuits against airlines are in Brazil. Right? So all of these things make it very, very difficult to have low fares, frankly, in Brazil, and definitely to have a sustainable lower cost structure.

Lori Ramson:And I also think the bigger carriers that have done their restructurings over the last 5 years, their costs are very low. They've lowered their costs substantially. So I think it, it could be tough for ULCC to compete in that environment, especially when they have Yeah. Premium products.

Abhi Manoj Shah:Yeah, all of us, right? I mean, Gol, LATAM, Azul, all restructured. LATAM was first, then Gol, then Azul. So to the extent that we're efficient, we are efficient, you know, with regards to restructuring. So yeah, it's— and if you're not going to bring any sustainable competitive advantage, you're just going to charge lower fares, and one day you won't be able to do anymore.

Lori Ramson:You mentioned litigation, and I think that's an interesting topic for the audience because it's Very unique to Brazil. Do you see it improving at all? Or what are the airlines doing to try and convince the government that this is not sustainable?

Abhi Manoj Shah:So I would separate it into incoming lawsuits, right? So the, let's call it, maybe culture's a strong word, but the habit of suing airlines, that hasn't changed. Where I think we've made a lot of progress was defending our position. So our win rate— so if Azul delays a flight, Azul cancels a flight, we have all of the customer compensation. That's, you know, whether it's meals, whether it's vouchers, that's fairly standard. But customers in Brazil can sue us for what are called moral damages. So let's say you were going to go for a job interview and we delayed your flight and you missed the job interview. then you would sue us for the wages that you lost because you would have gotten the job from the job interview, for example. Right? We joke that every bag that we lose has a wedding dress in it. Every bag. Magically. Right? So those kinds of things. And Brazil tends to be more of a consumer-favorable country. So, you know, you find a judge or Like, oh, you're a big airline. What do you care? Just, you can pay, right? But it adds up significantly. At the end of the day, the consumer is paying because we're just passing that through in terms of fares or less service. So I think where we made a lot of progress was, and AI, I know people are booing AI at commencement speeches, but we've really improved our defense. So we've gotten a lot better at understanding how we can defend against these lawsuits. So our win rate used to be 25%. We used to only win 25% of the lawsuits. Now we're winning 45% of them, right? It's better. It's not great, but it's still really, really good. We had the Supreme Court in Brazil make a suspension of sort of cases that have weather as impact. So that's helping a little bit. But our incoming lawsuits haven't changed. The culture, the habit. You have fintechs, you have lawyers waiting at airports outside immigration, you have Instagram pages, you have Facebook pages just trying to get people to sue us. So that hasn't changed. I think we're doing a better job of defending, explaining our position, but a long way to go.

Lori Ramson:And There's been a lot of talk about government support here in the US. I think Brazil is offering airlines some credit support, a line of credit. Is that something that you're interested in?

Abhi Manoj Shah:Yeah.

Lori Ramson:And do you think that's a good idea?

Abhi Manoj Shah:Yeah. So it's basically going to be government-backed debt, right? Funded through banks, but with government help, let's put it that way. So what it does is it makes the money more accessible. Right? In this environment, if an airline goes to the open market to borrow money, you're paying ridiculous interest rates either in local currency or in dollars. Like our exit financing was 9.75%, right? Which is historically high, but for an airline in Brazil, it's pretty good. And now if we were to go to the market, it would be double digits easily. The market in this environment is very hostile to new money. Having a government backing makes the money— it's debt, but it makes it a lot more accessible. Yes, it absolutely is interesting because airlines have to power through these high fuel prices. We're going to be looking at revenue, we're looking at cost, all those kinds of things. But if the government wants to make sure that service isn't lost at a scale, then I think it's the right thing to do to put forward these kind of facilities. We expect to take advantage of them in the 3rd quarter.

Lori Ramson:You have several lines of business that I think have helped with fuel and offsetting fuel. Can you describe which arm is doing the best at that?

Abhi Manoj Shah:I'll go back. In COVID, for example, our logistics business was half our revenue. And so we, like many airlines, transformed our passengers and we put boxes on seats. Right now we're pretty balanced. We have a great loyalty program that in addition to kind of attracting the higher-end customer, the corporate customer, loyalty in Brazil is kind of the opposite of loyalty. Any credit card can transfer to any program as opposed to the US, which is which is co-branded credit cards, very, very focused. So in Brazil, you really are fighting for the customer's attention because any credit card you can send to any program you want. We do have co-branded, but it's not as strong. And so you really have to make the best program possible to bring those dollars your way. So the loyalty program right now is really helping us in 2 ways. One is really attracting the high-end corporate customer, right? So we actually introduced 2 new elite tiers. For example, we have one elite tier which has— it's invite only, has 1,000 members where you get a private transfer at the airport, a concierge meets you at the airport, all that kind of stuff. We have another— our second group of elite tier has 12,000 members. where you have 24/7 concierge support via WhatsApp, right? Digital support. So 24/7, change my flight, move my flight, move my seat, misconnects, all that kind of stuff. So those are the kinds of personalized services. And we have 21 million members in our loyalty program. So we're talking about 12,000 top, top tier. The next group is about 400,000, which is one more set of services. So loyalty right now is really helping us capture the high-end customer, which is what we need at this time of high fares. They're the most resilient to these types of things. So loyalty is great. Our core branded credit card, 70% of our core branded card is at the Infinity or Platinum levels. So 0.5% of the GDP of Brazil is spent on our card on an annual basis. Right? So it's a very, very high-end card, which is again helping us capture that demand. Logistics is great because it's steady. And so we have all of the e-commerce from Amazon. We have the e-commerce from Shopee, for example, a Chinese retailer. We do all of the e-commerce for Samsung in Brazil. So that gives us a nice level of stability. And our vacations business is powerful because on weekends, we have a completely different network than we do on weekdays. This allows us to keep the aircraft utilization high and allows us to bring a new customer that wouldn't normally buy Azul. We actually have a network of physical locations where you can walk in and buy a vacations package. That brings that customer into our universe, and then hopefully we cross-sell them to other things. It's all of the above. At a time like this, you need every single tool in your tool belt just to extend your competitive advantages. You need it all right now.

Lori Ramson:Speaking of right now, what worries you the most about the back half of the year?

Abhi Manoj Shah:Yeah, I mean, it— look, it all depends on the curve, right? The curve, the fuel curve is going to the right. So that's adding sort of pressure every single month. Like I said, I think we're in a very, very good starting position with already low growth. We're pushing all of the revenue buttons. We're pushing all the cost buttons. Demand in Brazil is not bad, but the Brazil purchasing power is not the same as the US. We do worry about how long that can continue. Again, being in our position, not having to take aircraft right now, not having to grow right now, adding routes, adding new markets. I remember when we were growing pre-Chapter 11, We were just selling just to sell, just to have cash in the door, just to have volume. Now we're really able to focus on quality and not have to worry about just selling just to pay off interest expense. I think relatively speaking, I think we're in a very good spot, but when fuel doubles, it sucks. It just sucks. It is what it is. I think we have everything there to power through it, and we will. But it's one day at a time.

Lori Ramson:If there's a resolution to this whole conflict by, say, year-end, what's the benchmark for saying, well, now it's time to grow again?

Abhi Manoj Shah:So, you know, that's earn your right to grow, right? That's something we heard from all our partners in our process. Don't worry about growth. Let's reset everything. Let's have a really resilient plan, earn your right to grow, right? So when we get back to, you know, our operating margins, July to March were over 20%, right? Mid-20%. And so when we are able to earn the right to grow, we'll grow again. But the great thing about our plan is we don't have to grow. We don't have to grow just to pay the bills, right? We do it. when we've earned our right and when the market calls for it. Because of our fleet, we have so much flexibility to take advantage of what comes our way.

Lori Ramson:We only have about a minute left. Do we have any questions? We have Slido and we can do a mic too as well if there are any questions. Well, I will ask the last question. Speaking of growth, When do you think you might start building the order book, the fleet out again?

Abhi Manoj Shah:We'll see how it goes. Like I said, I mean, I literally got an email yesterday, somebody offering me A321s, you know?

Lori Ramson:But you don't want A321s, right?

Abhi Manoj Shah:Well, it depends. It depends on the price. Depends on the price and the spec. I think opportunities will come up. So I think right now we're really happy with the position that we're in. And the market's going to come to us, and that's a good place to be.

Lori Ramson:And just from an industry perspective, speaking of these aircraft that are available, do you think that's going to make leasing rates come down on some of these narrowbodies that have been—

Abhi Manoj Shah:We're definitely— yeah, on the narrowbodies, we're definitely hearing that already. On the widebodies, not as much, because there's a lot of widebody demand in the Middle East and China and stuff like that. But we think on the narrowbodies, there's opportunity, yeah. Thank you, Abhi. All right, thanks so much.

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