Earnings Transcript for ANZFF - Q2 Fiscal Year 2019

Operator: Welcome to the Air New Zealand 2019 Interim Results Call. [Operator Instructions]. And with that, I will turn the call over to Air New Zealand's Head of Investor Relations, 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 Centre website, which you can find at www.airnewzealand.co.nz/investor-centre. Also on the website, you can find our interim results presentation, financial report, media release and relevant stock exchange disclosures. Speaking on the call today will be Chief Executive Officer, Christopher Luxon; and Chief Financial Officer, Jeff McDowall. I would 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 2 of the presentation. In addition, the appendix of the presentation has a number of slides that we will not be specifically speaking to, which provide key financial and operational details, and we recommend that you take the time to review that information. With that, I will turn the call over to Christopher.

Christopher Luxon: Thank you, Lelia. Kia ora and good morning, everyone, and thanks so much for joining us on today's call. Earlier this morning, as you've seen, we've released to the market our financial results for the first half of 2019 financial year. Those results were solid with $211 million in earnings before taxation achieved in spite what I think is a very challenging operational cost environment. We experienced strong demand levels across our network, particularly in our domestic market for the majority of the period. That demand, in conjunction with our targeted capacity growth and pricing actions taken across parts of our network, drove high-single digit revenue growth, which helped partially offset the headwinds of fuel and higher operational costs. However, as we saw the results of our December revenue and looked into the remaining 8 months of the year, we identified softer levels of demand, indicating revenue growth in the second half of this year will be lower than what we saw in the first half. Now the areas where the change in demand is most visible from a forward bookings perspective is domestic leisure travel within New Zealand, although we continue to see robust demand for corporate and business travel. [Indiscernible] some impact to our inbound, long-haul network, which is seeing slowing rates of tourism growth compared to recent years. So to provide some context in the 2018 calendar year, New Zealand's inbound tourism growth was 3.5%, which is in line with our own long-haul growth this year. However, it is much lower than the average growth over the previous 5 years of approximately 8%. We're closely monitoring our other markets in various distribution channels for additional changes in demand, but we have not seen a notable shift. And as a result of the revised revenue forecast, the updated earnings outlook provided at the end of January was necessary, although it is disappointing not to be able to deliver on the financial commitment we made to our shareholders earlier this year. Now in light of the demand levels we're observing, announced in late January that the airline has commenced a review to determine what adjustments need to be made across our network, across our fleet and ultimately our cost base. It is clear that some aspects of our business that made sense in a high-growth environment will need to be reconsidered and adjusted as we enter a period of lower growth. Now [indiscernible] been able to adapt quickly to changing market dynamics, whether that be natural disasters, significant shifts in the competitive landscape, like through the demand slowdowns, and this time will be no different. Agility is really embedded in the DNA of this airline and its people, and I think it is one of the core competitive advantages we have in the smaller airlines that enables us to effectively compete with some of the largest airlines in the world. Now the review is making good progress, but the work is ongoing, and we expect to be in a position to provide an update in due course. I am confident that the actions we are taking, along with the continued education focus of our phenomenal people, will support a return to earnings growth and ROIC improvement in this lower revenue growth environment. Now going into a bit more detail as to what we're seeing in the domestic market, I thought it would make sense to provide some more context. For the past year, our domestic network has experienced average revenue growth of around 8%. And over that period, revenue has grown either as a result of high levels of fare seat growth, stronger yields or a combination of the two. And supporting that growth has been really robust underlying demand. And as we mentioned on our 2018 annual results call in August, that growth has come from a combination of strong business travel, really good inbound tourism, which as you know results in additional domestic travel once tourists arrive in New Zealand, and lastly, domestic leisure demand from New Zealanders choosing to travel throughout the country. And as I already mentioned, our December revenue results for the domestic segment came in a bit softer than our expectations had been. And as you can see on the chart on the right hand side of the slide, the January growth is also softer. And as we progress month to month through the end of the year, I would expect to see some variability in the [indiscernible] domestic revenue growth as it relates to the prior comparable period. But we believe the trend will continue to demonstrate low to mid-single digit revenue growth, which is a good result, although it's much lower than the high-single digit growth that we had previously been experiencing. Even though we're expecting a slower rate of growth going forward, it is important I think to point out that our domestic network is extremely strong with a market share position that has grown in the past 12 months. Over the years, we have built out this business to have tremendous resilience with significant investments both on the ground and in the air and we'll continue to do so now. You will have seen that we announced earlier this year that we would be investing $60 million in our domestic and regional lounges throughout New Zealand over the next few years. And we have made some exciting progress on this, opening up our new Tauranga lounge in December. And you know that there is huge demand for air lounges, and it is that sort of investment that really enhances that customer experience before they've even boarded the plane. Now last year, [indiscernible] environment of rising fuel prices, and I spoke about the playbook that we follow and the levers we would pull in this part of the cycle. Similarly, we have huge amounts of institutional knowledge, and we know what levers we need to pull to address the solid growth environment we have seen. Now the first step is adjusting our supply to be more in line with demand, and that is through reductions in capacity growth across the network. We've made a series of changes to our schedule, the net result of which has brought our capacity plans down to around 4% compared to our original plan of 4% to 6% growth for the year. The second step is transforming our domestic fare structure. And you will have seen earlier this week we announced the biggest overhaul of the airline's domestic pricing structure in over a decade. We're now offering lower entry level fares, or latent fares as we call them, to make domestic travel more affordable than ever. And our customers will now be able to find domestic fares for as low as $39 each way. We believe simplifying the fare structure will help stimulate domestic travel for New Zealanders and international visitors. And while this may result in some impacts to the load factors or average fares, we will continue to focus on maximizing total revenue. And finally, with the first two components right sized, we're working on driving increased interest in travel and stimulating demand for a series of market development activities, which differ market to market. And this includes utilizing our data analytics capability to drive more targeted offerings to our customers, increasing the uptake on our various ancillary product offerings, as well as specific marketing campaigns that aim to stimulate new visitors to the country. For example, we continue to partner with Tourism New Zealand to drive increased awareness of New Zealand for international travelers in Asia over the low season, which is going really well. Then if I can, I'd like to remind you of our core purpose of the airline, which continues to be to supercharge New Zealand's success. That is our mission and that's what motivates me and my management team every day. Part of that mission is to economically supercharge New Zealand by promoting tourism and trade, and we will continue to significantly contribute to these industries. Our focus will be always on profitably connecting the world to New Zealand throughout our Pacific Rim network and connecting New Zealanders to each other through our powerful domestic network. Now our decision 6 or 7 years ago to redesign our network around the growth potential that we saw and continue to see in our major long-haul markets has stood up in tremendously good sid through changing macro environments. We are well-positioned with increased sale across a diversified set of markets, and importantly with the skills and ability in each of those markets. We've also been able to partner with other outstanding airlines to offer greater connectivity around the globe for New Zealanders. To put it simply, we had some tremendous competitive advantages, and we will leverage them to the best of our ability to continue driving value for our customers, our staff and our shareholders. Now I'll hand over to Jeff who will discuss the details of the results.

Jeff McDowall: Thanks very much, Christopher, and kia ora to everyone on the call. I'll start by walking you through some of our key financial highlights for the interim period. Our operating revenues were $2.9 billion, and that's an increase of 7.1% on the prior period. And it's a strong result against the backdrop of some tough operational conditions that we faced this year, which Christopher has already touched on. We delivered earnings before taxation of $211 million. And although this is a decline of 35%, you'll see shortly that this was largely the result of a significant increase in fuel prices. Net profit after tax for the period was $152 million, and we maintained a strong operating cash flow of $475 million. Now as mentioned earlier, revenue for the period was strong, and that was driven by really good levels of demand across the network, as well as the targeted capacity and pricing actions that we've undertaken. If we look at passenger revenue in particular, we saw an underlying increase of 5.1%, reflecting high capacity as well as unit revenue growth. Despite this, earnings were hugely impacted by $131 million headwind from increased fuel prices. That $131 million net impact was driven by $146 million, or 31% increase in the average price of jet fuel from USD 67 to USD 87 per barrel, which was then partially offset by an additional $15 million in gains from our fuel hedging program. To put the size of the fuel increase into context, the net impact of $131 million for the first 6 months of the financial year compares to a full year impact in 2019 of $135 million. So we really have seen a significant jump this year. So if we were to look at our 2019 versus 2018 first half earnings on a comparable fuel basis, we actually delivered a 10% increase in earnings. There's a detailed waterfall in the appendix which shows the breakdown of each components, contributing to the overall $179 million net increase in fuel cost line in our P&L, but you can see that it really is driven by those couple of points that I just mentioned. If we move now to Slide 11, this provides further details on both the revenue and cost side of our business. As I already mentioned, passenger revenue increased 5.1%. This reflects increased demand, as well as unit revenue growth, particularly on the North America and domestic rates. Demand was up 5.3% on capacity growth at 4.3%, and RASK increased by 0.8%. Our cargo business also delivered strong volume growth and good yields, resulting in a 5.1% increase in revenues. This growth has moderated somewhat compared to previous periods, including the operational disruption that was experienced with our Trent 1000 engines. However, we have still seen good volumes and revenue from North America, Europe and Japan and strong yields from an improved product mix. Turning now to our operating costs, CASK adjusted for the impact of fuel price, FX and third party maintenance grew 1.6%. This growth reflected price increases and costs incurred in the period to ensure greater operational resilience, which is partially offset by economies of scale and efficiencies. In the first half, we saw lower economies of scale and efficiencies than was reported in the past due to inefficiencies around our network schedule, as well as timing related to setting up new rates in the entry of NEO aircraft into service. Looking forward, we expect a stronger underlying CASK performance in the second half of the year. We've generated strong operating cash flow again this period of $475 million. Although this is largely flat compared to the prior period, it reflects strong working capital cash flow offset by lower earnings. The timing of tax payments also had a positive impact on cash flow. The airline continues to maintain a stable investment-grade credit rating from Moody's of Baa2. Gearing was 56.4%, slightly above the announced target range and an increase from 52.4% as of the end of 2018 financial year, reflecting investment in our fleet as the current fleet program nears completion. Going forward, we expect gearing levels to return to our previously communicated target range of 45% to 55%. Finally, our strong balance sheet has helped us deliver sustainable ordinary dividends to our shareholders. The Board was pleased to announce a fully imputed interim dividend of $0.11 per share, reflecting the Board's commitment to its distribution policy that looks through short-term earnings volatility to provide a consistent and sustainable ordinary dividend. On the chart on Slide 14, you can see the saving of our updated aircraft capital expenditures through to 2022, which totaled approximately $1.2 billion based on an exchange rate of $0.67. This figure includes the commitments we made last financial year for the domestic A321 NEOs, but does not include any assumptions on CapEx relating to the Boeing 777 replacement program as aircraft selection is still in progress. As a reminder, we're still expecting to announce our selection before the end of the current financial year. Turning finally to fuel and our outlook for the remainder of the financial year based on our hedging program. To be helpful, we've provided an outlook of estimated fuel costs for the second half of the year with an assumption of average jet fuel at USD 75 per barrel. Based on the makeup of our hedges, we've also provided an approximation of moves up or down in fuel price would impact our fuel cost for the second half of the year. At USD 75 per barrel for jet fuel, our fuel cost in the second half would be approximately NZD 596 million, which would bring our full year fuel cost to approximately $1.3 billion. Now let me turn the call back to Christopher to discuss the outlook for the rest of the year.

Christopher Luxon: Well thanks, Jeff. And turning to Slide 17, I'll briefly provide some perspective on expected capacity and revenue dynamics, looking out to the rest of the financial year. As I spoke about earlier, we believe that there are signs of significant shift in demand, and we are now moving to a period of more moderated revenue growth from the high levels that we've been experiencing over the last few years. The table on this slide shows you our capacity growth for the first half and where we see the growth opportunities across the remainder of the financial year. You can see to the far right, the initial expectations that we had when we announced the 2018 annual results in August last year. There's easily been a shift in our expectations, and we want to be really clear here. We believe that there are still growth opportunities for us to pursue, and that this new environment runs us more in line with what our global peers are seeing in their home markets. Now turning to the outlook for the remainder of the financial year, as indicated in late January, we have started to see a slower rate of demand growth from previous years. This in turn will result in revenue growth and profit that is lower than we had originally anticipated at the beginning of the financial year. This is true even though jet fuel prices have come back a bit compared to what we experienced in the first half. We do, however, continue to see demand and growth opportunities, and based on this and current market conditions, we are reaffirming the full year guidance that we provided to you at the end of January 2019. And that is, assuming an average jet fuel price of USD 75 per barrel for the second half of the financial year, 2019 earnings before taxation is expected to be in the range of $340 million to $400 million. Now this assumes an average jet fuel price of USD 81 per barrel for the 2019 financial year as a whole. What we really want to communicate to you all today is that the alignment is still fundamentally strong, but the rate of growth in the immediate market is slowing compared to previous years, but that is in fact now more in line with other developed markets such as the U.S. We realize that we need to adapt and we need to use the agility that we indeed even pride ourselves on to continue to supercharge New Zealand's success and to provide the strongest possible return to our investors. Accordingly, we're in the process of undertaking a review to show that our network, our fleet and our cost base are better optimized to reflect the new environment that we are now operating in, and we will be updating you and the market on those plans in due course. So can I say thank you so much for listening. And we know you'll have lots of questions, so operator, please open up the line for the questions that you have.

Operator: [Operator Instructions]. Your first question comes from Andy Bowley from Forsyth Barr.

Andrew Bowley: Couple of questions. So I'll kick off firstly with the dividend. And Christopher, maybe you can speak on behalf of the Board here. I'm conscious that a number of issues will impact your ability to sustain or even grow the current dividends. We've got gearing now towards or above the top end of your target. Then we've got the CapEx holiday in a couple of years for a couple of years. But can you talk about what you would need -- what would need to change for you to require you to cut the dividend relative to the current forward expectations that you have for the business?

Christopher Luxon: On the dividend front, look; you've seen us maintain a favorable dividend here. That's, as we've said before, we're looking through into the medium term and we feel incredibly confident with where we are as a business. And as a result that's what we're -- why we've [indiscernible] the dividend -- actually we are. But you know how we think about -- I think we've been pretty transparent about how we think about this, but I think we feel very confident going forward around our ability to pay the dividend. Jeff, would you have anything else to add?

Jeff McDowall: The only thing I'd say, Andy, is that as you probably heard from our remarks, we're not satisfied with the earnings of where they are, so we're very focused on gaining, restoring, gaining trust in the company. So on that basis and knowing what our dividend policy is, we're very comfortable with the dividend [indiscernible].

Leila Peters: And Andy, it's Leila. Just to note, in the last 15 years there's only been 2 times when we've cut the dividend, and that's been the Christchurch earthquake and the GFC. So, clearly we're not forecasting anything like that looking forward. We're just looking at slower growth environment, so still pretty strong. That's all I got.

Andrew Bowley: Great, thanks. So second question around the cost base, unit cost growth in this period of 1.6%. That compares to what you talked about at the Investor Day last year where you suggested you'd be able to negate unit cost increases given economies of scale. And recognize that there hasn't been as much capacity growth as maybe you would have expected, and there's been a fair bit of indirect cost growth, given the network disruption during the period. But were there any other cost base issues at play in the first half? And what cost levers do you have in the second half, notwithstanding your comments, Jeff, around being a better CASK outcome in the second half relative to the first half?

Jeff McDowall: Andy, the main thing really is the operational difficulties that were faced in the past half year. You see the growth rate's down a little bit and that's contributed, but it's really the both direct and indirect consequences of the operating environment that we've had. And there's some direct costs associated with the Rolls Royce issue that we talked about at the guidance in August. [Indiscernible] we've been able to mitigate those. But there are still quite significant kind of hidden costs for the [indiscernible] and with new line associated with, for example, making changes in aircraft, kind of life in the planning cycle, which is really inefficient. And some of it's consequential. It's something that's actually proactive where we've actively held more staff, for example, so that we can make the schedule more resilient and provide our customers with a better level of support when they've seen disruptions. All of those impacts will start to ease as the Rolls Royce situation improves, which is what we now think we're expecting that to be a better picture as we go forward.

Christopher Luxon: Maybe I can give you some confidence around that, Andy, around the Rolls Royce situation. Through this half that we're reporting on and when we hit up to 5 aircraft on the ground, currently we have 2 aircraft on the ground from the first cycle. We'd expect that to be 1, and by the first of September, we expect to be fully resolved. So we are expecting to start to work our way through those additional indirect costs that were a part of the first half result and as we go through the second half and certainly into 2020.

Andrew Bowley: So in terms of your comments, Jeff, with the better CASK outcome through the second half, is that really a reflection of just Rolls Royce, or were there any other issues at play? And I guess you've got your broader cost and network and fleet review ongoing, but I'd imagine the benefits of that will flow more through fiscal 2020 than fiscal 2019 second half.

Jeff McDowall: Yes, that's right, yes. The main difference in the second half will be the easing of those operational disruption issues.

Andrew Bowley: Great. Thank you.

Operator: Your next question comes from Andrew Steele from First NZ Capital.

Andrew Steele: Just the first one for me is on the domestic slowdown. From your assessment, would you say this is largely a consumer cycle driven effect, or are there competitive or company-specific issues that are related to that? And I guess also what are you seeing in the forward data which gives you confidence that January is the low point for this growth profile?

Christopher Luxon: You are right. What we're seeing is -- and it's a difficult situation because we as a business are actually living in the future, and we obviously seeing 6 months out, and we are in fact I think a leading indicator for what's going on. There's 2 big bits of it. We're seeing lower growth driven firstly by lower levels of inbound tourism. So if you think about recent years, inbound tourism you see growing around 8%. The last 12 months, even December, it's about 3.5%. That's across the board. That clearly is linked to a global slowdown. The second piece we're seeing is obviously domestic leisure travel, and that manifests itself in lower site visits to our sites, which typically seem to be leisure travelers and even some small/medium drivers. What I'd say is that our corporate and our government and our business traffic is holding up incredibly well and is in good, stable position. And what we're talking about here is moving to a lower level of growth of around 4%, which is still pretty -- these are pretty good levels of growth. So, certainly as we came through at the end of January and we reviewed the closeout periods and then we looked at our forward projection, we saw softness in that leisure travel component. And as we have sort of gone through January, we're seeing some stabilization of that.

Andrew Steele: Okay, great. Thank you.

Jeff McDowall: To add to that, Andrew, is that the booking trends that we've seen in the past sort of 4 weeks [indiscernible] guidance, it was very much in line with what we expected and when we provided that update. And so, yes, based on what we're seeing at the moment that would put us pretty much in the midpoint of the range that we talked about.

Christopher Luxon: And Andrew, another from some of the commentary is that there's no doubt about it that it's a market issue. I can reassure you we are not losing market share to our competitor, that we're gaining market share over the last year. So this is something happening in underlying demand with leisure travelers.

Andrew Steele: That's great. Thank you very much. And just the next one for me is in terms of thinking about your previous guidance on the impact that Rolls Royce has had on earnings, how should we think about the normalization of that impact looking forward into really I guess the FY 2020 year, given the updated demand profile, and in particular given the capacity changes that you've put through into the Tasman and Pacific Island markets?

Jeff McDowall: Just in terms of the Rolls issue, Andrew, I just simply -- we intend the range of $30 million to $40 million in August. We're now have been able to mitigate that. So if you were thinking a hit to next year, and just thinking of those direct costs, I couldn't give you a precise number, but sort of in the low-double digits. But that's not the full story. As I was talking to the other guys about, there is quite significant hidden costs as well, which are the key reason why our efficiencies are lower this half. So it's that direct cost that goes away next year, but there's also those indirect costs that go away next year.

Leila Peters: And sorry, Andrew. I didn't understand the second part of your question related to the Tasman capacity. Could you repeat that again?

Andrew Steele: I guess given I guess a recently material shift in the Tasman/Pacific Island capacity guidance for this year, factoring in I guess is probably a lower run rate in that market going into 2020, should we be thinking about I guess a lower benefit from Rolls Royce normalization going into 2020 as well?

Jeff McDowall: That wouldn't be a significant driver to that market. The one thing I'd -- a different point I'd point out is that a lot of the growth that we're seeing in the fourth quarter and heading into the first quarter of next year is going to be the additional effects on the A321s coming into the fleet, which come in at a very low kind of incremental cost.

Andrew Steele: Okay, great. And just a last one for me is given the change in capacity to Tasman and Pacific Island, could you just provide a few comments on what you're seeing, which has really driven that pull back?

Christopher Luxon: Yes, maybe -- I'll just take the Tasman. I mean, it's certainly a bit forty at the moment, but that's to be expected post the withdrawal of our lines with Virgin. But what I'd say to you is we still look at that dynamic and say that's a lot better than when Emirates was on the market. Certainly we're seeing Virgin struggling big time in terms of adding up capacity, lowering prices, having low levels of load factors. And I think none of you have probably had a hamburger served to you while you've been doing that. And on the Pacific Island, it's really been -- we've put a lot of growth in over the recent 18-month period, and it's just making sure we get that moderated and right.

Leila Peters: Yes, that's really just the lapping and moderation of the shoulder season capacity on the Pacific Island and the Tasman. The Tasman capacity, really, it's still an increase. I think we're up 7% for northern summer season. So that's still quite a lot, but in targeted areas that play well to our strengths.

Andrew Steele: Great. That's all for me. Thank you.

Operator: Your next question comes from Owen Birrell from Goldman Sachs.

Owen Birrell: Just a couple of questions for me. Just drawing on that Tasman and Pacific Island capacity again, it's a big reduction in that second half [indiscernible]. I'm wondering if you could split the difference between what you're doing on the Tasman versus Pacific Island.

Jeff McDowall: Yes. So on the Tasman, it's still growing, but I think in the second half of the year, and as I've mentioned into [indiscernible], a big chunk of that comes from the extra seats on the A321. So that, as I said, it comes at a really low cost. We're actually seeing pretty healthy revenue growth against that backdrop. So that's looking pretty good, notwithstanding the fact that it's a highly competitive market. As Leila kind of alluded to, the Pacific Islands we're actually reducing capacity year over year. Having said that, we had extremely high capacity growth this time. Last year, we saw an opportunity with the part of the year that's typically off peak for the rest of our network means that we had aircraft available that we could deploy into the Pacific Islands to build on the strong growth that we saw at a kind of low incremental cost. And we still see that opportunity this year, but we are dialing it back a bit. It was 20% to 30% growth this time last year and we're just dialing that back a bit.

Owen Birrell: So there's actually a contraction in the capacity overall for the second half in the Pacific Islands? There has to be if --

Leila Peters: Contraction in the longer sector Pacific Island market. So Hawaii and Bali are clearly the longest sectors, and that's where we put about that 20%, 25% growth in last year. So that's where you're seeing the proportionality impact on Tasman and PI, Owen, but other Pacific markets are growing, most of them. Just it's the mix factor of the lengths.

Owen Birrell: I was going to say, is it because passenger demand hasn't grown in line with your expectations, or are you removing capacity to improve your RASK on those routes?

Jeff McDowall: Really, we're moving capacity just a bit to better match supply and demand to ultimately give a better RASK result.

Owen Birrell: Okay, excellent. Can I ask also then I guess on the other international markets, you're adding some new routes on those and sort of drawing on a couple of the I think it was the San Fran and LA routes. I was just wondering what gives you confidence that the new routes that you're putting on are going to be incremental to the broader international platform, given they are very new.

Jeff McDowall: We think back to Taipei and Chicago that I think you're referring to, we're seeing both of them perform extremely well. Actually better than we had anticipated now, internal business cases for them. And if you take Chicago -- Taipei was always going to be incremental. We took very little [indiscernible] via other gateways in our network from Taipei in the past, so that is genuinely incremental traffic for us. Chicago, there was always the chance that some of that demand would come from other gateways in the U.S., whether it be Houston and San Francisco. We're actually seeing that perform a lot better than we thought from that perspective. We're seeing the vast bulk of the traffic originating in the U.S., coming from the surrounds of Chicago itself without any connecting flights, which leads you to the view that that is us tapping into new pools of demand there rather than stretching out the same demand space.

Owen Birrell: Okay. Just one final question for me on the relationship between how we should look at domestic growth versus international. And obviously international is a big driver of the domestic market. But do you have a rough rule of thumb as how you look at that? Even international is growing at 5%. What incremental does that add to the domestic market?

Jeff McDowall: Both have whether -- so our international business coming from [indiscernible], excluding Australia. There's roughly 2 domestic trips for every passenger. So you see that flow through straight through to our domestic business. So that I think gives you kind of the rough rule of thumb. The other gut to that is as a consequence, 20% to 25% of our domestic passengers have originated offshore where they're directly connecting or they bought a ticket [indiscernible] and are here on a vacation.

Owen Birrell: No, that's good. That's useful. Thank you.

Operator: [Operator Instructions]. Your next question comes from Wade Gardiner from Craigs Investment Partners.

Wade Gardiner: Going way back to the very first question on the dividend. You've got a target gearing of 45% to 55%, and you're sitting at 56% at the moment. You're paying out sort of $250-odd million in dividends per year. I've always assumed that as we hit into the 777 replacement cycle that you're going to want to get that gearing down towards the bottom end of that range. Is that a fluid target, given that if we have a protracted or a greater downturn here in your earnings, I'm potentially lower for longer. How comfortable are you that you can continue to pay out that dividend, and how flexible is that gearing targeting?

Jeff McDowall: We've always said that the gearing target is a target rather than a straightjacket. We always expect at this point in time, which is the end of the peak CapEx period, that it was going to be at the top of the range. In fact, 2, 3 years ago we thought it would be past the top of the range. So, relative to what we have seen, that's pretty good. Having said that, financial resilience is always going to be our key number one priority when we start considering distributions. But we look at that. We look at how we resolve on improving earnings growth. We're very comfortable with where the dividend policy sits. And as you know, there's a significant period of CapEx reduction coming up, so we're very confident about where that's sitting.

Wade Gardiner: Okay. So if we did have a period of lower earnings, you'd be quite happy for that -- for gearing to come in that upper band as we go into that 777 replacement cycle, if that's what was needed?

Jeff McDowall: Like I said, we're very resolved on not having a period of lower earnings. But yes, we certainly do want to make sure that we've got plenty of capacity to get through that next CapEx cycle in good shape. But the gearing range is not a straightjacket. Resilience is always our core point. But yes, we do still see potential there and particularly given our focus on restoring earnings growth. One sort of point I'd just illustrate, as you pointed out, the earnings at the half year was -- sorry, the gearing at the half year was at 56.4%. There was a movement there. If you look at the movement from where the gearing was 6 months ago to now, there was a movement there of just over 1 percentage point, which was driven by the fuel price at balance time being very low -- it was in the low 50s -- and that means that there was a change in our hedges there, which reduced the equity and brought gearing back up a bit. That was purely, though, with fuel being at a really low point at balance time.

Wade Gardiner: Okay.

Leila Peters: We adjusted for that, Wade, we'd be sort of just above 55%. So, right in that target range anyway.

Wade Gardiner: Okay. Another question. Your first half was down 35%, and the guidance that you've given implies that the second half is going to be down the midpoint by a sort of similar sort of level. And yet when you changed your guidance in January, from the discussions that we had at that point, it seemed to me that you didn't really see the fall off in demand until sort of December. So I was therefore expecting first half that would be better and the second half that would be -- the implied second half would be a lot weaker. Can you just try give me a bit of color and try to reconcile that sort for where you had your guidance prior to when you actually saw the decline and why -- and therefore why we should expect the second half that is similar sort of down to the first half?

Jeff McDowall: There's a bunch of moving parts there, Wade. So for example, it does -- the operational cost disruption to be less impactful in the second half we expect. The -- you've seen in the fuel analysis that the year-over-year fuel headwind lesser in the second half, but the rate of revenue growth's lower as well. So it's -- there's a number of moving parts that drives [indiscernible] of the two halves.

Leila Peters: Right. The stronger revenue in the first half, offset by inefficiencies in the cost base, which Jeff has already spoken to. In the second half, those cost inefficiencies will alleviate. Fuel will alleviate on a year-on-year basis, but revenue will come in a bit softer. And that's really what's driving the first half/second half mix there.

Wade Gardiner: Okay. That's all for me.

Operator: Your next question comes from Marcus Curley from UBS Investment Bank.

Marcus Curley: Just a few for me. I just wondered whether you're able to actually call out the magnitude of the, I suppose improvement in the 787 disruption issue. Then to the second half, obviously it underpins your belief in an improved cost performance. Could you give us any color of what you think that is in terms of number?

Jeff McDowall: I can't give you a precise number. One thing we've been focused on is that there's a slide in the pack that shows the efficiency year over year on the CASK side, and you compare that with that same slide from this point last year. But also the big chunk of it is due to the operational cost disruptions that we're seeing. I know it's not a precise number, but that does give you I think the magnitude of the impact.

Marcus Curley: So you're confident you have these quite large increases in aircraft operating costs and passenger costs relate to that issue as opposed to other issues which could be longer lasting?

Jeff McDowall: Yes. That is the biggest single driver that we can point to. There were a couple of other things I was talking about earlier in the remarks which relate to things like the oneoff cost associated with the new reach that we entered in that period, the oneoff cost associated with the A320 NEOs, for example, or A321 NEOs. So those contributed to the picture as well. So the operational efficiency is not the only thing, but the predominant thing.

Marcus Curley: Okay. And then just couple questions on airfares. So within your guidance, doesn't look like you're incorporating any yield impact from the lower entry level fares on the domestic in the second half?

Jeff McDowall: Yes, that is an accurate analysis, Marcus. Only that bit of fare change is really designed to stimulate leisure travel. So we're confident that that will be a positive move for us from a revenue and commercial perspective. And as well as stimulating leisure travel looks like -- because that would give management team a benefit of [indiscernible] to manage the performance of flights.

Marcus Curley: Okay. And I just wondered if you'd comment on what you're seeing in airfares post the Chinese New Year on the Asian routes. And also more recently on the Tasman, doesn't sound like it's in any signs of the economic slowdown impacting traffic post the peak season.

Jeff McDowall: From a time perspective, yes, Chinese New Year was couple of weeks earlier this year. So you saw the -- you see a little bit of the strength associated with that come into January this year versus [indiscernible] last year. But to your question about once you go through that peak period, have we seen a softening in bookings that's greater than we saw before. Not really. You always heard a lot about tourism from China being weaker, and yes, we certainly do see that. But if you look at our Shanghai rate, for example, we do compete in a slightly different way than the other airline flights to China. We've got a more premium niche that we target at the Shanghai end, and we've got a much bigger market share, ex [indiscernible], which includes a good premium market share. So if you look at the performance of our flights, yes, we're seeing really strong performance in our premium cabins. We're seeing a little bit of softness in the economy cabin, which is consistent with what we're seeing in inbound tourism arrivals. But overall, the flights are doing pretty well because we compete in a slightly different market than most of the carriers.

Marcus Curley: And on the Tasman more recently, as we enter the off season, any signs of weakness there?

Jeff McDowall: Well, the growth rate has moderated a bit. We're seeing more competitive intensity, which Christopher referred to. But actually, despite all that, the revenue growth is staying quite solid. It's a little bit difficult to unwind because there's a lot of different dynamics going on. We've got some additional capacity, so we're getting a bigger market share as a consequence of that. Got Virgin competing independently and having quite low load factors. And then you've got what's going on with the underlying market demand being the third factor that impacts performance, but that's quite difficult to unwind each of those individually. You saw inbound tourism from Australia is one of the things in the last month and not that high. But some of those 3 factors, and I think helped by our product composition, the way we compete with both full service and low-cost carriers and expected growth we're putting in there should give us a pretty good revenue result.

Marcus Curley: My question was on yields. Have you seen if it's starting to fall or are they remaining up?

Jeff McDowall: They are not falling significantly. We focus more on RASK than yield, to be honest, because we see yield and load factors as the ingredients that the RASK [indiscernible] that we're looking to maximize. When there's capacity up in the market, which is up a little bit, 3% I think, you wouldn't expect to see -- you wouldn't be surprised to see a slight flattening in yields, but it's nothing pronounced.

Leila Peters: And Marcus, just as a reminder, we lapped for the Emirates exit from Melbourne and Brisbane right around now, March or so. So we would expect to see some variability on the month-to-month offsets on there. But overall, Jeff's comment holds completely true. It's quite resilient levels so far.

Jeff McDowall: Yes. You will see choppiness in the offsets with Chinese New Year being a bit earlier. But also we've got the period in ARPU and [indiscernible] they've fallen the same way, which will drive a really strong period for demand, and actually which will bring some demand that was previously [indiscernible]. So you'll see some volatility month to month there.

Marcus Curley: And then just on the labor costs. Could you give us a breakdown in terms of what -- wage rates are up, is the staff numbers, and what to expect going forward? Is there any initiatives to limit the growth in staff numbers?

Jeff McDowall: We'll take a look at the -- let's break out page 21 I think in the supplementary slides. The labor cost was up $36 million for the half. If that had been driven truly by price increases and volume, it would have been up $42 million. So there were some efficiencies there. That number understates the efficiencies because we do see good economies of scale, for example, we'll get with [indiscernible] and now overhead bags [indiscernible], offset by those operational disrupt costs and labor costs that we talked about before. So it does all that, we expect the efficiency picture to improve.

Marcus Curley: And what was the level of rate increases?

Leila Peters: 2-ish. 2-ish percent.

Marcus Curley: And do you have the hand -- the level of the number of people that have gone in, what the rate of increase of that is?

Christopher Luxon: Yes, we've had about a 6.3% increase in FTAs across the business. I think it makes for 690 people. A large part of it has been into cabin crew, airports, and in regional airlines as well.

Marcus Curley: Christopher, that's 6.3?

Leila Peters: Yes, around that. Exactly.

Christopher Luxon: Yes.

Marcus Curley: It seems like fairly large number, given what we've seen recently out of the business. So that was -- do you think that there's some step-ups, oneoff step-ups in that, or is that a bit of a catch up, or how would you sort of think about the 6%?

Jeff McDowall: Yes. So a lot of it is [indiscernible]. I think it's 4.3. So to the extent that [indiscernible], those two main drivers, I think the bigger one is that we have deliberately kept larger work groups to give us more flexibility as we're going through a period of schedule disruption. Yes, typically we want a very disciplined, focused, rostering cost base where we don't have a lot of [indiscernible], which is great for efficiency, but it means in a period of operational uncertainty, [indiscernible] resilience. And so we have added labor to improve resilience, knowing that there's more operational uncertainty. There are some oneoffs associated with, for example, the A321 NEO entry.

Leila Peters: And we had something similar in I believe it was 2014 or 2015 with the introduction of the Dreamliners markets where we had a little bit of a bubble that then smoothed out as we got the aircraft into service and started operating.

Marcus Curley: Okay. And then finally for me, just the timing of the 777-200 replacement, is it still 2023 and beyond, or is it possibly going to be brought forward?

Jeff McDowall: No, the plan hasn't changed at this point. We're still looking at FY 2023, so calendar late 2022. And we're looking, as we've indicated before, we're looking to make an announcement this half of the year.

Marcus Curley: Okay, thank you.

Operator: Your next question comes from Nick Mar from Macquarie Group.

Nick Mar: Most of my questions have been asked. On just a couple other ones, the Air Canada announcement today, what's your kind of thoughts around that and plans around any kind of -- or the level of JV on that route?

Christopher Luxon: Yes. So from our point of view, Nick, it's a positive thing. I think it will stimulate a lot of traffic between Canada and New Zealand. We're obviously now in Air Canada for a long period of time, but then we're -- and this intention. We've signed an MOU with aim to explore a JV. Obviously that will need regulatory blessing at both ends of the markets, and we'll work our way through that in the coming months. But I think if you think about North America and an American entry, this is a very, very different experience here. So we're very comfortable, very relaxed at that.

Nick Mar: And is the intention to take it all the way through to a similar kind of revenue share as you have with some of your other partners?

Christopher Luxon: That's what we'll try and work through in the coming months and obviously have to work with regulators as well.

Nick Mar: That's great. And then just on the domestic pricing restructure. How much of that was accelerated by the kind of slowdown you saw versus something that you've had in the works for a while? And then I guess what gives you confidence in the new pricing being the right one? Obviously you have a lot of data there. Can you talk about how you kind of formulated those levels to kind of balance in a way yield versus demand?

Christopher Luxon: Yes, sure. Look; we -- really that's kind of our response as we looked at our closing results and therefore projections at the end of January. And really what this has designed is purely about stimulating leisure travel. So it's all about luring the [indiscernible] at our lowest fares that we have in the marketplace, and we think fundamentally that will stimulate travel. If you think about it, there are other sectors or other businesses often in our face with lowering growth or lowering demand that actually take their prices up and actually end up getting into a negative cycle. And we have learned through GFC, we've learned from the past that we actually have been at the front for that go out and actually stimulate the market. What I'd say already within the first few days is that we've seen a doubling of people onto our website. So just to give you a feel for sort of how well we think it is actually working. And so it's a very simple equation -- we plan to stimulate demand for leisure travelers and get them moving and I think it's working.

Nick Mar: And those prices are -- how different is the overall kind of optimization equation from what you were doing previously, which is obviously [indiscernible] similar things, but obviously the latency is slightly lower, or is it drastically different overall?

Jeff McDowall: Well, the latency are lower, so that'll give us the ability to improve load factor performance that's lower demand slides. It's also a more -- it's all behind thing, but the most things will see the buy-ups as you go through the fee structure, which as Christopher talked about, a lot of our demand is from small/medium type enterprises. Having sort of moderate buy-ups allow us to cater to that group a bit more feasibly with small/moderate fares. So just a benefit of [indiscernible] consistency to buy-ups to mix nice performance across the overall network.

Nick Mar: Great. Thanks a lot.

Operator: Your next question is a follow-up question from Owen Birrell from Goldman Sachs.

Owen Birrell: I just wanted to I guess follow up on that domestic fare pricing a little bit further. You've obviously lowered the domestic fare for the lowest bucket of seats. I'm just wondering, is there any offsetting increase in the higher level buckets? That's what your RASK is probably --

Jeff McDowall: No.

Owen Birrell: No. Do you have any offsetting --

Jeff McDowall: Sorry. I missed the second part of the question. But sorry, just on the first part, the [indiscernible] does not have an increase. It's at the top end of the scale. As I mentioned, though, from the way we manage flights is using two price components. One is the fares and the other is the Revenue Management System. So the team will use the new set of fare structure to optimize performance while making sure we take full advantage of the ability to stimulate leisure demand.

Owen Birrell: And I was just going to --

Jeff McDowall: I missed the second part around CASK.

Owen Birrell: Yes. Is there any offsetting CASK benefits coming through such that your spreads on each of those individual routes is actually fairly stable?

Jeff McDowall: I mean the opportunity to drive our load factors up a bit, particularly on the lower demand flights, middle of the day type flight, and get to a point that the load factors are a bit more consistent across the day. So it's not so much a CASK thing, but it's a cost of passenger thing, if you know what I mean. Going forward, we do have the benefit that will be provided next year when the A321 domestic aircraft starts coming to the fleet.

Owen Birrell: I know your domestic load factor is around about sort of 93% at the moment, and that seems quite high from a network perspective. Some of these flights that you're discounting, can you give us a sense of what your load factor is on those flights are at the moment?

Jeff McDowall: It is quite variable. To get 93% load factor, you've got some hundreds in there and some 55s in there. So it's -- part of it is about consistency of load factor, yes. I couldn't give you -- some of them I know that the range of load factors is quite forward. Less forward than it has been because we've over time become better and better at managing that. But I can tell you there's opportunities from individual flights to drive load factors up.

Owen Birrell: Sure, sure. So broadly, we should see the domestic network load factors improve on the back of this, RASK aside.

Jeff McDowall: Yes. Yes, that's right.

Owen Birrell: Thank you.

Operator: Your next question is a follow-up question from Andy Bowley from Forsyth Barr.

Andrew Bowley: So just another question around the domestic leisure situation, and more broadly domestic travel. In New Zealand, we already have a very high propensity to fly. And I'm keen to hear your thoughts with regards to what kind of feeling is there to that propensity to fly in terms of the modeling that you do? And to what extent you do modeling in terms of how much more we can fly each year? Because there's a limit to how much I want to fly, and I'm sure that's the same for many people in New Zealand.

Christopher Luxon: Yes, I think, Andy, it's an interesting part of this fare restructure is also to actually attract some people who are currently driving. And so you can start to imagine that we're competing with the customers who are driving to the different regions they want to go to, and so there will be market growth off the back of that as well.

Andrew Bowley: So plenty of scope for further growth and propensity to fly?

Christopher Luxon: Yes, I think so. I think there's lots of opportunity to grow in the market, yes.

Andrew Bowley: Okay. Thank you.

Operator: There are no further questions at this time. I'll now hand it back for closing remarks.

Christopher Luxon: What can I say to everyone on the call? Thank you so much for joining us this morning, giving us your time, and thanks again for the interest and for the variety of questions. If you are an investor or an analyst and you do want to schedule a call or a meeting or any follow-up questions that you may have, can I ask that you just direct those questions through Leila in our investor relations team, and certainly Jeff and I are happy to sit with you in here as well. And if you've got a media-related question, can I ask that you just follow that through to Marie Hosking in the communications team. Thanks again and thanks for your time. Have a great day.