Grupo Aeroportuario del Centro Norte SAB de CV Q3 FY2023 earnings call

Hurricane Impact

• On October 25, 2023, Hurricane Otis struck Acapulco Airport with Category 5 intensity, causing damage to the terminal building, but the airport remains operational and is focused on humanitarian operations, with plans to restore regular operations soon.

Regulatory Landscape

• On October 4, 2023, the Civil Aviation Agency notified of immediate modification in Annex 7 of tariff regulation basis. After review and communication, modified basis was received on October 19, 2023, with no significant expected impact.
• On October 25, 2023, Senate approved new federal duties law increasing concession tax from 5% to 9% effective January 24, 2024, with the increase to be recognized in next tariff negotiation for 2026 - 2030 period through reference value.

Quarterly Results

• Adjusted EBITDA grew 33% to MXN2.5 billion in the quarter with a margin of 79.4%. Passenger traffic reached a record 7.4 million, up 19% vs Q3 2022. Aeronautical revenue grew 31% due to passenger traffic growth and higher revenue per passenger. Commercial revenue grew 24% driven by various categories. Diversification revenue grew 8%.

Capital Expenditure

• Total investment in the quarter was MXN964 million, with projects including expansion/remodeling of several airport terminal buildings, reconfiguration of Mazatlan terminal, major rehabilitation of platforms/taxiways, and construction of industrial warehouses.

In 2022, Acapulco contributed 3.6% of total passenger traffic and 3.4% of OMA's total aeronautical and non-aeronautical revenues. In the third quarter, aeronautical revenues increased 31% to MXN2.5 billion. Non-aero revenues increased 17.6%, with commercial revenues up 23.6% (driven by restaurants, parking, car rentals, and VIP lounges). Diversification activities increased 8.3%. Aeronautical and non-aeronautical revenues totaled MXN3.2 billion in the quarter, an increase of 27.9%. Construction revenues were MXN719 million, a 10% increase.

• Regarding discount rate calculation under new rules, components are clearer and no significant impact assessed.
• TUA decrease of 10% in 10 airports is unrelated to new tariff basis, due to other agreements, and deferred CapEx partially offsets it.
• Expect near 4 percentage points impact on margin from concession tax increase next year, with the increase recognized in reference value for next tariff negotiation.
• Anticipate slight growth in aero business for next year.

• Hurricane Otis caused damage to Acapulco Airport terminal, potentially impacting operations and revenue.
• Regulatory changes such as concession tax increase and tariff adjustments bring uncertainties.
• Engine recall issue from Pratt and Whitney may have negative impact on traffic, though hard to assess currently.

Q: If you have done a quick calculation of what could be your discount rate under these new rules? And how does it compare to the previous discount rate on the previous rules? And the second question is about what the media has been published on the 10% decrease of the TUA. Can you please confirm whether decrease in the TUA is in any way related to the new tariff methodology?

A: Ruffo Perez Pliego: The components for the calculation of the discount rate used in the maximum tariff are now clearly stated and less subjective to interpretation. As you know, before the discount rate was based on the yield of Mexican government bonds plus a premium that was to be defined by the ministry and now the new basis establish clearly the variables to be used to determine the discount rate. Based on our calculations, we do not assess a significant impact on the discount rate as a result of the changes that were made in the new tariff basis. Ricardo Duenas: And regarding your second part, Pablo, the discounts are totally unrelated from the new basis. They are unrelated to the aforementioned new regulatory guidelines. There are other agreements we have made with regulatory bodies. These agreements entail a general 10% extraordinary discount in real terms for our passenger charges on TUA starting November and December of '23, applicable to 10 of our airports. After application of discount this discount in '23, we expect to apply annual inflation adjustments on TUA. Other aeronautical tariffs in addition to TUA are not subject to the discounts. It is also important to mention that as a result of the discount package previously mentioned and unrelated to the changes in the Annex, we will have an MDP CapEx referral for 24 months. This MDP CapEx deferral amounts to 1.2 billion in the aggregate. And as a percentage of the original CapEx commitment represents about 25% in '24 and 13% in '25. These deferments do not compromise the operations, quality and safety standards of our airports.

Q: How should we think about margins going forward, especially thinking in terms of the increase in the concession fees? And if it's that will be fully compensated on the aeronautical part of the business and the second question is regarding to the impact brought by the hurricane. If you can provide a little bit more color in terms of what should be the actual impact thinking on fourth quarter numbers and potentially early 2024 numbers as well maybe in terms of traffic or in terms of revenues impact?

A: Ricardo Duenas: Sure. For the hurricane, it's too early to assess the amount of the impact. What we can say is that the runway, the platform, the taxiways are in perfect state. The terminal has suffered some damages. However, it is operational. It's important to remind you that Acapulco represents only 3.4% of the total revenues of the company. We still have intermittent communication with Acapulco and we will know the impact of the damages in the next coming days. And regarding to margins, we expect the next year some -- around 4% impact as a result of the concession tax increase. However, this concession tax increase, the amount for '24 and '25 will be recognized as reference value for the next MDP negotiation in '26.

Q: Just a clarification on the previous one before I go into a couple of questions I have. So the hit you're expecting on the concession fee, you're expecting it to be reflected now in an upcoming MDP, but will it be a kind of a backward-looking adjustment or is it just going forward you'll be able to compensate that to the tariff?

A: Ricardo Duenas: Just for the next two years, for the next two years, that amount will be recognized in the reference value for the next negotiation. And going forward, that will be reflected as an OpEx expense as it has been in the past.

Q: I mean, we're still finalizing our budgets for next year. We'll have to, obviously, we're incorporating the increase in the concession tax, which will trim close to four percentage points of margin. And with respect to other inflationary pressures, I think, that they could be compensated with inflationary increases in our tariffs?

A: Ruffo Perez Pliego: I mean, we're still finalizing our budgets for next year. We'll have to, obviously, we're incorporating the increase in the concession tax, which will trim close to four percentage points of margin. And with respect to other inflationary pressures, I think, that they could be compensated with inflationary increases in our tariffs.

Q: Just a clarification on the reduction of TUA. I understood that you mentioned that you're going to lower TUA in 10 airports. And that would be offset by CapEx postponement. Is it fair to say that from an NPV perspective, you're looking to recover 100% of the reduction in TUA through this postponement in CapEx so that the value of the company will not be impaired and also in that same topic, if you lower the TUA, which, I guess, accounts for the majority of your revenue, and if you expect no changes to your tariffs in the MDP as a result of the ongoing discussions. This means that you are going to going forward run below the maximum tariff?

A: Ricardo Duenas: Just to clarify, there's no extension of the concession has been discussed during this conversation. It's too early to say what will happen on the next negotiation. We're still two years away. Obviously, the concession tax will get factored into the reference value. There will be many variables that will be moving from now to the '26 negotiation and this concession tax will be just one of them as many variables are moving. For the next year, maximum tariff compliance, we're looking to -- it's still difficult to assess what will be the percentage compliance given that these TUA discounts could have some impact on traffic as well. Ruffo, do you want to add something? Ruffo Perez Pliego: Well, in preparation for the next MDP cycle, obviously, we'll have to look into how to be more efficient and how to make our investments and to extract the most value out of the infrastructure that currently is in place to maximize its utilization before increasing the size of the terminals for investing in additional infrastructure. So that's something that we'll be working closely in the next couple of years as well.

Q: And if I may, just one follow-up question on the potential impact from the grounding of aircraft as a result of the issue with the engines from Pratt and Whitney even though you mentioned you are not ready to provide a forecast for traffic next year. Are we talking about negative traffic variation or can traffic still grow next year or directionally, what do you think can happen given the extent of the exposure of the two main low-cost carriers in the country? Any guidelines you could provide at this point in time?

A: Ricardo Duenas: It's -- as you said, it's difficult to assess right now what will be the impact with the Pratt and Whitney engine issue. But what I can tell you is we are expecting some small growth in the aero side of the business for next year.

Q: My question is regarding the change in the MDP rate of return calculation from focus on equity returns towards WACC kind of calculation. Do you expect to change your capital structure given this change -- are you evaluating this or are you comfortable with the current structure?

A: Ricardo Duenas: We're still evaluating. We believe in the case of OMA, the impact of changing from return on equity to the WACC, it will be relatively small. Given that our amount of leverage at the moment is currently low -- it's currently low. So I believe we would expect to remain most in line with what we do have seen in the last couple of years.

Q: Would OMA ever consider investing in airports outside of Mexico?

A: Ricardo Duenas: We're always open to understanding -- to looking at opportunities. We don't have, at the moment, any concrete transaction in the pipeline, but we're always opening to -- for opportunities outside.

Q: Besides the concession fee hike, until the end of 2025, do you guys see any other regulatory changes coming in?

A: Ricardo Duenas: We don't expect -- it was hard to say, but we don't expect any more changes from our conversations with the government, both from the treasury and the communication and transportation. They have mentioned that this has been the end of this modifications in the regulatory process.

Q: I have only one related to cost of services this quarter increased 22%. So could you give us a little bit more color that what happened specifically?

A: Ruffo Perez Pliego: So most of the increase is related to maintenance and utilities expense as we have increased areas in and expanded the terminals in the last year or so. And with the increase of volume of passengers, we have seen a greater growth in maintenance. Sometimes, there is some timing issues, but I mean, the accumulated expense for the nine months is reflective of the full -- I mean, if you annualize it would be reflective of the full year cost of maintenance.

Q: Considering that the 10% decrease on TUA, the increase on the concession fee and the change in the methodology for the discount rate will be somehow offset or considered for the next MDP? And also the concession fee to my understanding, it also considers the non-regulated portion of the business. How will this portion or this impact will be offset by tariffs. Thank you. And also if you can clarify again the CapEx -- the CapEx movement for the next two years that will be resulting from this amendment, I mean, these regulatory changes?

A: Ruffo Perez Pliego: Sure. So in the next review, certainly the increase in the concession tax and the rate of 9% will be incorporated into the calculation. Now the discount of the 10% TUA is something that only affects this period. So it will not be part of the variables to be used in the negotiation of the next tariff -- maximum tariff in 2026. Now with respect to the CapEx referral in the aggregate is MXN1.2 billion. So September 2023 purchasing power. And that's around MXN 890 million for 2024 and the remainder around MXN400 million for 2025 which represents roughly 25% of the regional CapEx commitment in 2024 and 13% in 2025.

Q: I just wanted to understand the rationale of the government to apply this 10% of extraordinary discount. Was it just because if you don't apply it, you would probably surpass the maximum rate or it is a measure to incentivize to lower air tariffs? This is the first one. And then I make my second one.

A: Ricardo Duenas: I think it was hard to speak on the rehab, but I think that the rationale is trying to incentivize.

Q: Still on this topic. We know that this is a nearly discount. Could you give us a sense of how much discount did you apply last year just for a reference for us to see if this 10% is in line with historical average?

A: Ruffo Perez Pliego: We, from time to time, enter into agreements for new route openings and other strategies with airlines. But we haven't had general discounts such as these for many years.

Q: The TUA represents what percentage of aeronautical revenue? And the second question would be on the expected higher CapEx for the Acapulco Airport and would that be incorporated into the new Master Development Program or before?

A: Ricardo Duenas: On the second part, we've been in very close coordination with the government for Acapulco. We still don't know the size of the damage. We know that the core part for operating the airport is okay. Obviously, terminal has suffered some damages. On our last conversation with the government, they are very open to work closely to how can we offset the impact from the hurricane in our CapEx. And for the TUA, it represents 89% of our aeronautical revenues.

Q: On the engine recall impact, any impact you have seen as of October during October? Thank you.

A: Ruffo Perez Pliego: Yes. We have seen that the scale sheets in databases such as OAT have been trending down over the last month or so. So, yes, we do believe that what is reflected right now in the system is already incorporating what's known of the recall of brand Whitney engines at least for the winter season. Ricardo Duenas: We also -- we know that the airlines are taking a lot of measures to try to offset this impact. We know they are trying to extend leases, trying to extend the life of some of their other aircraft. So let's -- in the next couple -- in the next two months, we will have more clarity what will be the real impact next year.

Q: I just wanted to clarify one specific point. What leverage or what that specifically will be considered for the calculation of the cost of capital is the debt at the moment of the MDP discussion, is it a five-year average? And also to the extent that you might have corporate that or in the event that you invest abroad and you have that attached to it. Will they look just at the debt at the asset level in Mexico or will they look at OMA as a whole?

A: Ruffo Perez Pliego: I think in the basis that we published there are some debt to capital ratios that are averages that includes other airport groups as well. And it's only that related to assets in Mexico and it excludes that is not funding operations in Mexico.