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Edited Transcript of AEROMEX*.MX earnings conference call or presentation 17-Jul-19 4:00pm GMT

Q2 2019 Grupo Aeromexico SAB de CV Earnings Call

Mexico D.F. Jul 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo Aeromexico SAB de CV earnings conference call or presentation Wednesday, July 17, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrés Conesa Labastida

Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director

* Jonathan Wallden

Grupo Aeroméxico, S.A.B. de C.V. - Senior VP of Financial Planning & IR

* Ricardo Javier Sánchez Baker

Grupo Aeroméxico, S.A.B. de C.V. - CFO

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Conference Call Participants

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* Joshua Milberg

Morgan Stanley, Research Division - Equity Analyst

* Matthew Vernon Fallon

Deutsche Bank AG, Research Division - Research Associate

* Mauricio Martinez Vallejo

GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst

* Ruben López Romero

Santander Investment Securities Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to Grupo Aeromexico's Second Quarter 2019 Earnings Results Conference Call. Before proceeding, I'd like to mention that certain comments made during this conference call may constitute forward-looking statements regarding future events or the future financial performance of the company. These statements are based on the current beliefs and expectations of management and the company.

Forward-looking statements are based on management's current assumptions and the information currently available and do not guarantee the company's performance. The timing of certain events and actual results may differ materially from those projected by forward-looking statements due to a number of factors, including, but not limited to, those inherent to our industry as well as commercial, economic and other risks and uncertainties.

(Operator Instructions) This conference call is being recorded. I'd like to turn the conference over to Mr. Jonathan Wallden, Senior Vice President of Financial Planning and Investor Relations. Please go ahead.

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Jonathan Wallden, Grupo Aeroméxico, S.A.B. de C.V. - Senior VP of Financial Planning & IR [2]

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Good morning, and thank you for joining us for our second quarter 2019 results presentation. Speaking on the call today are Aeromexico's CEO, Andrés Conesa; and CFO, Ricardo Sánchez Baker. As per usual, Andrés will open the call, providing insight into our quarterly performance and results, and Ricardo will then address our revenue, cost and cash flow performance. There will be an opportunity for questions at the end of the call. So now I would like to turn over the call to our CEO, Andrés.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [3]

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Thank you Jonathan, and good morning, everyone. This has been a mixed quarter for Aeromexico. We have seen clear structural improvements in the operating profit of the airline due to our continued capacity discipline with reducing unit costs. These efforts have been partially offset by the impact of the grounding of the MAX. In this context, Aeromexico delivered an operating profit of MXN 119 million with an operating margin of 0.7%. This represents a structural improvement of MXN 407 million compared to the second quarter of 2018, in which we benefited from a one-off MXN 939 million hedge benefit. In the market, we continue to see aggressive capacity growth, in spite of a weakening economic environment.

The Mexican economy is showing signs of softening performance as market expectations have been revised downward from 2% growth in January to 1.1% expected growth today. The company is continuing to assess the financial impact of both the grounding of the 737 MAX aircraft in its fleet and the current and expected future delays in delivery of additional 737 MAX aircraft. The company intends to seek compensation for the financial consequences of these events and potentially other remedies. And we inform the markets when it is appropriate to do so regarding financial impacts and expectations and the company's remedial actions.

Today, our expected date for re-entry to service of the 737 MAX stands at early November for the first week of November. Capacity during the second quarter decreased by 2.2% compared to 2018. Revenue per ASK in pesos was broadly flat, with load factors increasing by 1.9 percentage points and yield decreasing by 2.6%. We have continued to see improvements in our ancillary revenues per passenger, in line with our aim of providing our passengers with a more personalized service.

Our continued focus on customer satisfaction is also delivering enhanced results. For the first half of 2019, our Net Promoter Score, NPS, has continued to improve year-over-year, thanks to our outstanding operational performance and our service excellence culture.

From an operational perspective, we continue focusing on what our customers truly value, which is, operational excellence. I am proud to announce that during the second quarter of 2019, we had only 18 cancellations in more than 52,000 flights. Recently, we achieved a run of 29 consecutive days with 100% operational reliability. That is more than 16,000 flights in a row operating without any cancellations. The airline will continue to focus on investing where our customers get real value, with strategic CapEx allocation to enhance our customer experience. We continue rolling out free messaging onboard of all our 737-800 fleet, and we have completed the rollout on all of our 787 fleet. In line with our customer service and brand strengthening, Aeromexico was recently awarded a Gold Cannes Lion award in the Brand Experience & Activation category for our Personas que son destinos campaign launched earlier this year.

Congratulations to the marketing and customer experience team for this fantastic achievement. During the second quarter, we started direct flights from Mexico City to Barcelona, broadening our network proposition to Europe, where we now operate to 5 cities. We have made a decision to increase our operation to our daily service. Firstly, because we have seen strong demand on the route, but also as a response to the Mexican government's disappointing decision to grant fifth freedom flying rights to Emirates, to fly from Dubai to Barcelona to Mexico City, in spite, of the state subsidies, Emirates receives from the UAE government. To provide the additional aircraft we need for the increased frequencies to Barcelona, we have decided to cancel our services to Shanghai.

In addition, as a result of the MAX grounding, we have had to cancel and postpone services to some destinations, including Mexico City to Liberia, Belize, Punta Cana, Guayaquil and Cali. With the grounding of the MAX fleet, we are reviewing our total capacity growth forecast for the year to be negative between 3% and 4% for 2019 as a whole.

With regard to our organizational structure, I would formally like to welcome Nicolas Ferri to Aeromexico, as our Chief Revenue Officer. We are very proud to have him with us, and I would like to wish Nicolas all the best in his new role, which he will assume next August 1.

So to wrap up, on the second quarter of 2019, I would like to take this opportunity to thank all of my colleagues at Aeromexico for their commitments in achieving these set of results in what has been a very challenging quarter. Finally, I want to inform you that following the recent removal of the Chief Executive Officer of PLM Premier, we have written to Aimia regarding what we believe have been irregularities and potential breaches of the relevant contractual arrangements governing PLM Premier. We have advised Aimia that we will take all actions reasonably required to protect our interests and those of our customers.

We have also advised Aimia that given recent events, we are re-evaluating all aspects of our customer loyalty strategy with a view to minimizing reliance on PLM Premier going forward and ensuring a seamless transition away from PLM Premier as soon as possible in accordance with the legal rights and obligations of Group Aeromexico. We are committed to ensuring that our customers continue to receive outstanding service and loyalty rewards. This concludes my remarks, and I would now like to hand over to Ricardo, who will provide more detail on the financial results of this quarter. Thank you for your confidence, and Ricardo, please go ahead.

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Ricardo Javier Sánchez Baker, Grupo Aeroméxico, S.A.B. de C.V. - CFO [4]

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Thank you, Andrés. Good morning, everyone, and thank you for joining us today. As Andrés mentioned, this has been a mixed quarter, primarily resulting from the MAX grounding with a softening economic outlook and continued overcapacity in the market. On the positive side, Aeromexico delivered an operating profit of MXN 119 million, representing a 0.7% operating margin for the second quarter. This equates to a structural year-on-year improvement in our operating results of MXN 407 million. As in 2018, we have a one-off benefit of MXN 939 million due to the unwinding of our fuel hedge position.

We delivered robust cost performance in spite of inflation headwinds and reduced capacity compared to 2018. Adjusted for the unwinding of our fuel hedges in the second quarter of last year, our cost per ASK in pesos decreased by 2.2% year-on-year. That is a reduction of a 0.8% in U.S. dollars. Cost per ASK excluding fuel in pesos decreased by 1.8%, 0.3% in U.S. dollars. This highlights our ongoing focus on optimizing unit costs. On the negative side, economic softness, capacity growth and the temporary grounding of the MAX generated pressures on results. As Andrés mentioned, we will continue to assess the financial impact of both the grounding of the 737 MAX aircraft and the current and expected future delays in delivery of additional 737 aircraft. We will inform the markets once it is appropriate to do so regarding financial impacts and expectations.

During the second quarter of 2019, we recorded a MXN 132 million net expense in our financial costs, recognizing mark-to-market movements in our interest rate hedging instruments. Additionally, the functional currency exchange effects offset the operating currency fluctuations for the period. The company reported a net loss of MXN 1.1 billion.

Coming to our cash position. Our cash flow generation remained strong. We generated MXN 3.7 billion of net cash coming from operating activities during the second quarter of 2019. Net cash flow used in investment activity amounted to MXN 837 million, and an additional MXN 1.4 billion was used in financial activities.

In the first 6 months of the year, we have reduced our gross financial debt by more than $100 million. Even taking this into account, our cash balance at the end of the quarter increased to MXN 10.2 billion, MXN 1.5 billion above the close of the previous quarter, representing a cash-to-12-month revenue ratio of 14.6%.

At the end of the second quarter, our leverage, measured as adjusted net debt-to-EBITDA, stood at 4.8x, an improvement compared to the 6.5x reported by the end of 2018. This ratio now computed under the new IFRS 16, reflects more precisely the actual leverage of the company as compared to the previous industry standard measurement using a capitalized lease calculation.

From a fleet perspective, during the second quarter of 2019, we took delivery of our 9 -- 787-9 Dreamliner, bringing the total operating fleet to 122 aircraft. As Andrés mentioned, we expect ASK contraction of 3% to 4% compared to 2018. This concludes my remarks. Thank you once again for joining us on today's call. Andrés and I would like now to answer any questions that you may have. Thanks.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question here is from Michael Linenberg from Deutsche Bank.

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Matthew Vernon Fallon, Deutsche Bank AG, Research Division - Research Associate [2]

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Everyone, it's actually Matt Fallon on for Mike here. So do you feel like government is supportive of the aviation industry in Mexico? It appears as though several recent policy initiatives have been stacked against you. So how are your government relations teams responding to the new administration's policy goals?

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [3]

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Hello. Do you refer in particular to the recent Emirates granting of flying rights? Or is it something else?

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Matthew Vernon Fallon, Deutsche Bank AG, Research Division - Research Associate [4]

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Just that along with the developments on Mexico City airport, cumulatively it just seems like a lot of policy initiatives have made life a little bit more difficult for Mexico's airlines? I'm kind of wondering, how is Aeromexico responding to these challenges?

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [5]

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No. I mean basically, this is an effort of every day. No, we're in very close contact with our operators and try to tell them and make our case of how they can help the aviation industry be better. If we can have better infrastructure going forward, it will benefit not only the industry but will benefit the country, we make sure that is the case. With the recent announcement yesterday of granting the fifth freedom to Emirates, we were, as I mentioned, very disappointed. We're canceling the Shanghai operation to strengthen our Barcelona flights. We feel that it's not fair, that is not the right policy, and we will, again, do everything in our hands, including taking legal actions to try to reason that not to happen. And this is part of our job what we should do, and we will continue to do. And hopefully, everything improves and we have a better industry going forward in Mexico.

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Matthew Vernon Fallon, Deutsche Bank AG, Research Division - Research Associate [6]

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Right. And just as a follow-up, assuming that, that sort of goes through, what happens to the Barcelona-Mexico City market after Emirates enters it, like how do you stay competitive with an entity that's not beholden to shareholders but rather sort of operates as an extension of the UAE government?

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [7]

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Well, that's precisely the case that we're making, it's very clear that I know. We're not scared about competition. We compete every day against the most competitive airlines in the world. We're one of the few Mexican companies that compete head to head with the best players in the world. And we can do it. We compete with the best U.S. airlines, the best European airlines, Asian airlines, in Central and South America. We have also strong competitors in Mexico.

What we do not like is, we cannot compete with the subsidized airlines that receives all their funds from the government. So it's going to be tough. That's what we are allocating, our best products on our daily service to Barcelona. We just started last month and giving an airline the fifth freedom in a route that is already operated by a domestic carrier has never happened. So again, we've told that to the government, we've made our point. And hopefully, they can revise these policies and not allow Emirates to fly starting December. This is what we will try.

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Operator [8]

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Our next question here is from Mauricio Martinez from GBM.

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Mauricio Martinez Vallejo, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [9]

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I have 2 questions. My first question is regards of the RASK front. What do you think -- if you can share with us, what do you think is the main driver for a weak RASK this quarter? As having this complete contraction and very solid expansion in load factors, one would expect RASK increments this quarter. So do you think -- if you can share with us, what is the main driver there and if there is a market that is not performing well enough? That would be my first question.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [10]

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Thank you, Mauricio, for the question. Regarding the RASK performance, it is strongly associated with the MAX grounding. When -- we have to take the MAXs out of the system, we're taking MAX 8 with 166 capacity, and we have been covering those gaps using the 737-700, the E170s, E190s. So when you replace larger capacity aircraft with less capacity and you get closing to the flying period, you have less opportunity to yield because now you're protecting the passengers of the seats that you've already sold, and they're basically filling all the cabins. So our opportunity to improve our yields as the flight gets closer to takeoff was lower. As -- we have been able to adjust gradually and the RASK has been improving. So RASK for June was better than the one for May, and that one better than April. So we're looking for a solid summer. We have been able again to adjust better.

But one thing that also happened here is, had we known, for example, in March that the MAXs were not going to fly until November then you can adjust better. What has happened is that we have been every month revising and look back at the entry to service starting -- if you had asked me 3 months ago, we thought that the MAX would be flying during the summer and they are. And now last week, we have them in late part of 30 September, and now we have them in November. So these moving targets affects you because you cannot adjust those well, and you need to have the crew to fly those planes. And that has had an impact again on our commercial strategy. We're doing our best. We are, again, optimistic about our summer seasons going well, and we will continue to make every effort to improve RASK. And the guidance I can give you is that it's looking better in the third Q versus what we saw in the second Q.

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Mauricio Martinez Vallejo, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [11]

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Perfect, very, very helpful and clear. And my second question will be on the PLM front. If maybe you can elaborate a little bit more on what are the options that you have or that you are exploring at this moment now that you're saying that you want to minimize the reliance on PLM.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [12]

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Yes. Okay. I mean we -- what we have seen is a number of irregularities in PLM Premier in the corporate government practices. And also we've seen potential breaches of our commercial participation and services agreements by PLM Premier. So -- and because these matters are serious, we have written to Aimia about them. We are conducting an internal investigation for that matter. But we cannot elaborate further in the issues, other than to say that we're taking and we continue to take actions required to protect our interests and that of our customers.

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Operator [13]

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Our next question is from Ruben López from Santander Bank.

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Ruben López Romero, Santander Investment Securities Inc., Research Division - Research Analyst [14]

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I have 2 questions. The first one is on competition. Besides the impact of the MAX, what do you think is the main driver for the decrease in yields? Is it a tougher competition from local airlines like Interjet or Volaris? Is it international carriers? Any thoughts around this would be really useful.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [15]

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Thank you, Ruben. Well, yes, I mean, it's a combination of -- as I mentioned before the MAX grounding doesn't help. But also as I expressed in my initial comments, we feel that it's not sustainable to have double-digit growth close to 20% in seat availability in an economy that is not growing or is growing only 1%. So when you have that, the only way to fill those seats is to put pressure on yields. And that's why the yield environment in Mexico has been tougher versus last year. On the international front, it looks slightly better, challenging, but in the U.S. market, the transborder market has been improving. We're seeing some pressures in Central and South America, but Europe looks solid as well. Asia -- China was not performing very well and that's the reason why we decided to cancel that flight to fund for the investment that we're doing in Barcelona to protect our interests.

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Ruben López Romero, Santander Investment Securities Inc., Research Division - Research Analyst [16]

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Okay. Really useful. And just second one on cost. A couple of quarters ago, you mentioned you would start a cost analysis program. Can you give us any update? I mean what part of the process are you right now? Do you have any initial insights that you could share with us?

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [17]

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Yes. Before allowing Ricardo to take that part, let me just complement my previous answer. The other reason of why we canceled Shanghai, and again, to move that aircraft to Barcelona is, we've been flying to Shanghai now for 11 years. And in 11 years, we've -- we weren't able to secure daily slots for our operation. And what we see here and that's part also of previous questions that are -- that we saw is that Emirates wants to come in and they have received a daily slot in premium time. So it's very difficult to compete against these actions where you need to gradually build your slot portfolio. And you have here competitors that get daily slots to fly in one day. That's also one important consideration. And Ricardo, please go ahead.

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Ricardo Javier Sánchez Baker, Grupo Aeroméxico, S.A.B. de C.V. - CFO [18]

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Yes. Thank you. Thank you, everyone. Yes, we have been working on a very strong pipeline of initiatives to improve our cost performance, and that can be seen in our numbers for this quarter. These initiatives really touch all the major points of the P&L. Starting from -- on the major side, we have been working on optimizing our crew allocations so that we have been reducing our overtime use. On the fuel side, we have now been taking advantage of the energy reform. And we started in March to secure directly our fuel in some of the airports where we operate in Mexico. This has been growing through the year, and now the major airports in Mexico City, in all those airports, we have our own source of fuel that reduces the cost compared to the previous alternatives.

We have also improved on the maintenance side. We're negotiating a -- and improving the cost for engine repairs that have also affected and reduced the impact of engine overhauls particularly for the entire fleet. And also working together with Delta to optimize the cost for the engine repairs of the 737 fleet. We've also worked on passenger service, for example, modernizing on Delta's contracts to improve and make more efficient the cost of all the entertainment that we operate in our planes. So as you see it's really a very broad package of initiatives that we have been looking at and results are showing in. And we're confident, but we still have many things to come and we are very, very optimistic about cost performance in the second half of the year as well.

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Operator [19]

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The next question is from Josh Milberg from Morgan Stanley.

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Joshua Milberg, Morgan Stanley, Research Division - Equity Analyst [20]

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My first question relates to the point that you just made about energy reform. We had understood from one of your competitors that Pemex is imposing additional fees on jet fuel. And I just wanted to hear your take on that development and whether the measures you've taken to kind of develop an independent or an alternative supply has fully addressed that or not. That's my first question.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [21]

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Yes. I mean in some cases we have been able to avoid that extra cost. I think that is correct. Pemex has increased the cost into their logistics opportunity cost that they call it. And in some cases, we are sourcing the fuel directly from the U.S., and importantly, directly with other suppliers. And that has been able -- that has enabled us to reduce the dependency on Pemex fuel. But in other cases, we are working directly with Pemex and basically [by diverting] volume, we are obtaining a higher discount. So in these cases, we're not able to eliminate the impact completely. So it's a mixed balance, I would say, alternative, but we try to develop our -- more and more alternatives to supply our fuel in different airports within Mexico. And we believe [at traveling], we're seeing more alternatives, and this definitely will help us to reduce our reliance on Pemex and on these extra costs that we're seeing on fuel in Mexico.

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Joshua Milberg, Morgan Stanley, Research Division - Equity Analyst [22]

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Okay. So if it's not a full offset, can you give us a sense of what the impact might be of the additional charges from Pemex, thinking about maybe 2019 versus 2018? Or I don't know what might be the easiest way to frame it.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [23]

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Maybe one way to put it, if you look at, for example, the price of jet fuel in Cancun versus in Miami, it's 10%, 12% more expensive. If you look at the price of jet fuel in Tijuana versus LA, it's more or less the similar case. So we have an opportunity to improve in around say between 10% and 15% depending on the airport, and has to do with, as Ricardo mentioned, with logistics because as they are bringing most of the jet fuel -- mainly all the jet fuel using pipes, using carts and various types of trucks, that obviously increases the cost of getting the fuel in the airports.

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Joshua Milberg, Morgan Stanley, Research Division - Equity Analyst [24]

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Okay, that's helpful. And then my second question is -- and you've addressed this in part, but if you could just give a little more color on what's going on in the domestic market. And we saw the sharp decline of your domestic capacity in the past 2 months, and what we wanted to understand, how much of that was the grounding as opposed to competitive factors?

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [25]

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Well, in the domestic probably, [south and south of the] reduction in this case. We have a large part of the MAXs we're trying mainly to win the race. So the grounding affected significantly the level of capacity in the domestic market in that sense. But we also took the decision to change the mix of our network to rely less on the domestic network and more on international front as we were seeing more yield pressure because of the overcapacity in the domestic market. So it's a combination of the 2 things.

And again, and this is a permanent exercise, we are reviewing it day by day. Obviously, most of the capacity will be replenished when we have the MAXs back. But we also need to work, as I mentioned at the beginning of -- in our comments because for 2020, it's not only that the MAX are grounded, but it will take some time, maybe 1 or 2 quarters to have the program access that we have before when they were -- from the flying. So we are reviewing everything not only the rest of the year but also what will be our program for 2020.

But I think to finalize that we're on the right track. We are optimistic about the results for the second quarter, these important structural improvement. But summer, it's looking also good and our adjustment plan is working. And we will sit tight, and obviously, wait now for the operators to unground the MAX, and [that] then obviously support better results with the MAX flying than when they're again in the ground.

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Operator [26]

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(Operator Instructions) If there are no further questions, I'd like to turn the floor back over to Mr. Conesa for any closing comments.

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Andrés Conesa Labastida, Grupo Aeroméxico, S.A.B. de C.V. - CEO & Director [27]

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Well, thank you for joining the call. And we look forward for the next quarter. Any questions that you may have please as always, call Jonathan and Karen and they will be ready. Thank you very much, and have a great day.

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Operator [28]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.