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Virgin America will be well pleased with its timing in accessing the public markets as airline stocks are currying favour with investors after consistent capacity discipline and lower fuel prices have drawn attention to airline stocks, driving up the sector’s performance during CY2014.
The airline is enjoying a trading price well above expectations after recording a profit for 3Q2014 and the 9M ending Sep-2014, setting the stage for its second consecutive year of profitability. Much of Virgin America’s recent financial success rests on capacity reductions and debt restructuring, so arguably the real test of its ability to generate profits is yet to unfold.
Virgin America becomes a newly traded public company at an interesting time in the US airline business as the completion of consolidation among the major airlines creates space for smaller airlines to fill gaps created by those mergers. It is not totally clear how Virgin America intends to position itself in the new environment, but it could scarcely have chosen a better time to be exploring new territory, much of it newly vacated.
Previous warnings by LATAM Airlines Group that reduced corporate demand during the FIFA World Cup soccer tournament would pressure 3Q2014 results came to fruition as the company posted net loss for the quarter.
Other more familiar factors also dragged down the company’s results including an overall weak macroeconomic environment and currency devaluations that are eroding LATAM’s pricing traction.
Even as the macroeconomic weakness seems likely to persist into 2015, LATAM for now plans a system wide capacity growth of 2%-4%, which is an increase over its overall capacity projections for CY2014. LATAM’s planned expansion of supply next year is raising some eyebrows given the sluggish conditions it continues to face.
Two upstart ULCCs aiming to execute the model within Canada – Canada Jetlines and Jet Naked – have gone somewhat quiet since making a splash earlier in 2014 with their plans to interject a new level of competition within the Canadian market place.
Many airlines with similar plans have come and gone, leaving Air Canada and WestJet in a comfortable duopoly, that on paper, seems ripe for breaking.
But many of the market dynamics that have driven other Canadian start-ups out of business still exist, and the country’s tenuous economy could make it difficult for the new airlines to attract investors for what is still a risky business venture.
IAG and its CEO Willie Walsh are becoming increasingly confident. The group's new plan for 2016 to 2020 aims to achieve operating profit margins in the range 10% to 14%, with each of the operating airlines also reaching this level. To illustrate how ambitious this target is, IAG's 2013 margin was 4.1% and British Airways' cyclical peak margin was 10.0% in 2007/08, before the merger with Iberia. The latter did not record a margin in excess of 8% in the decade before the merger and has been in loss since, although it should be back in profit in 2014. Vueling, the most profitable of IAG's airlines, recorded a margin of 9.7% in 2013.
The achievement of this margin range would allow IAG to beat its cost of capital. This would be rare in an industry that typically destroys value, an unfortunate fact that Mr Walsh recognises. Nevertheless, he says, "we are in this business to exceed our cost of capital and to remunerate shareholders". He identifies the keys to IAG's future success as capacity discipline and cost discipline.
IAG's recent capital markets day set out what it sees as the key drivers of profit improvement.
Air Canada is planning to grow its CY2015 capacity at higher levels than most of its North American global airline peers as its new low-cost airline rouge has exceeded expectations, which is giving the airline confidence that the lower cost capacity it plans to introduce should help the company reach its medium term cost reduction targets.
The airline is not yet offering unit revenue or yield guidance for CY2015, but given that its focus during the past couple of years has been adding capacity into leisure markets, the decline in yields Air Canada has recorded throughout CY2014 are likely to carry over into CY2015.
As Air Canada prepares for a capacity push in CY2015, it continues to record a solid financial performance in CY2014, posting strong results in 3Q2014 despite falling yields and unit revenues.
Management at ULCC Spirit Airlines continues to push forward with ambitious plans to grow capacity by approximately 30% in CY2015 even as overall industry supply in the US domestic market appears to be creeping up.
Underlying Spirit’s bullishness is a 4% decline in unit costs excluding fuel for 1Q2015, and the airline believes a decrease in that range is possible for CY2015. The company concludes even if the capacity increases puts some pressure on unit revenues, its cost performance will help lift margins, which is a major focus for the airline.
Alongside its aggressive capacity growth, presently Spirit estimates recording an operating margin of roughly 20% in CY2015, which ultimately could prove to be a conservative target.