Virgin America closes 3Q facing stiff headwinds for 2012, but still breaking even
As most of the US airline industry was collectively earning over USD1 billion in the third quarter, Virgin America joined Southwest and American in posting losses. The San Francisco-based carrier posted USD3.3 million in losses – a paltry sum compared to the USD140 million loss at Southwest, and relatively positive news considering the airline's overall financial performance.
The story for Virgin America was much the same as for the rest of the US industry and is likely to be repeated in the fourth quarter and the new year. That story is a frustrating one of rising revenue on falling profits, meaning costs often outstripped revenues.
For its part, Virgin posted an operating profit of USD16.2 million for the third quarter resulting in a 5.6% operating margin, the carrier said, which was down 4.8 points from 3Q2010, when Virgin posted its first net profit, indicating the carrier is still working towards sustainable profitability.
Revenue was up 43.8% to USD290.6 million. But the increase in costs, up 51.5% to USD274.4 million, outpaced the revenue increase by a wide margin.
Virgin America does not meet the threshold for reporting to the Department of Transportation (DoT) but has voluntarily released its quarterly results for some years. However in 2012, it will qualify for major-carrier status, with the carrier required to report to the DoT.
The carrier’s available seat miles (ASMs) rose 32.2% to 2.5 billion in the third quarter as the number of passengers grew 39.1% to 1.3 million. Load factor was down 0.1 points to 84.2% as its average fare rose 5.1% to USD194.68. Total revenue per available seat mile (TRASM) rose 8.8% to USD 11.28 cents as passenger revenue per available seat mile (PRASM) rose 9.7% to USD 10.36 cents. Yield jumped 9.8% to USD 12.30 cents. The airline reported established markets rose 17% year-on-year.
However, cost per available seat mile (CASM) increased 14.6% to USD 10.65 cents while CASM ex fuel rose only 2.1% to USD 6.38 cents, one of the lowest in the industry on expansion costs on training, aircraft and hiring.
The culprit on costs, of course, was fuel which rose 43% year-on-year resulting in a USD4.8 million decline in operating income compared to 3Q2010. Had fuel remained at 2010 levels, the carrier would have posted a USD33 million higher operating profit.
Aircraft numbers were up 39%, or 11 aircraft year-on-year for a total of 46 scheduled by the end of 2011 and 58 by year-end 2012. Virgin America wants to triple its fleet by 2019 by which time it will have become the launch customer for the A320neo.
The carrier hopes to garner USD1.9 million annually in fuel savings with its neo fleet but that will not be until at least 2015.
It is investing in NextGen technologies, choosing the Leap X for its neos and developing Required Navigation Performance routes to save tens of millions annually.
The addition of these aircraft will strain the financial outlook since lease payments begin approximately 45 days before revenue is earned on the aircraft given modifications necessary. That means its crew, training and aircraft costs will continue to rise in 2012 as they have in 2011.
Virgin ended the quarter with USD24 million in unrestricted cash and USD42 million in total liquidity not including its latest cash infusion.
As it announced its results, Virgin American also announced a USD150 million debt offering to be used for long-term growth. The financing facility covered the majority of pre-delivery payments on the first 20 aircraft in its 60 Airbus A320 order that begins delivery in 2013. It also is scheduled to begin delivery of a A320neo order in the latter part of the decade.
It is clear the carrier will have to go public to reach its goal of operating one of the best small airlines. It sees a fleet of 100-150 aircraft. It is targeting 2013 for its initial public offering (IPO) depending on market conditions. Even so, it could duplicate the questionable success of Spirit in its IPO, which did not reach the revenues expected from the move.
Despite its minimal performance in profitability, it plans to continue its ambitious growth programme with a 35% capacity growth rate in 2012 and 10% in 2013. Even so, it cautiously shelved plans last year to achieve higher rates by leasing more Airbus aircraft with the economic downturn.
Virgin America may be a vision of customer service success but it has lost USD661.4 million through the second quarter and increased this another USD3.3 million in the third.
Even so, CEO David Cush expects the company to become profitable again in 2012, despite some headwinds coming his way.
High on his agenda is converting its frequent flyer programme from domestic 48-states only to earning and redemption for Hawaii and other long-haul destinations through deals with sister companies Virgin Australia and Virgin Atlantic. Its current interline agreements include Singapore Airlines, Cathay Pacific and Emirates and they are being expanded to include frequent flyer reciprocity as well.
This is critical for the carrier given its desire to compete with United and American on their home turfs and JetBlue in the trans-continental markets. Its current programme is seen as a problem for achieving its goal of becoming a viable alternative to legacy carriers. Southwest and JetBlue not only made that transition some time ago, but changes in their frequent flyer programmes have boosted their success.
The carrier's current, and biggest, problem, which not only affects these burgeoning partnerships but customer service as well is the conversion of its computer reservation system (CRS).
Virgin America converted to the Sabre system in October and the fourth quarter results are expected to take significant hits on problems with the conversion. When JetBlue converted in Jan-2010, it shut down booking for a weekend and hired Verizon to handle call centre operations. It also cut capacity, which resulted in a near-seamless transition.
While Virgin America followed suit, cutting 40% of its schedule, its transition has not been so seamless and follows many of the same problems experienced by WestJet. Complaints range from the inability to check in or change seats online to exorbitant call centre waits resulting from the online troubles. Complaints also included scrambled itineraries and frequent flyer records.
The problem began with the company’s founding when it used aiRES, which has since been rejected by WestJet in favour of Sabre, just as Virgin America is now doing.
Virgin’s move to Sabre was based on its strategy to follow JetBlue and Alaska in becoming interline partners to all comers since the old reservations system could not support that functionality. Now, two months after the conversion, a complete resolution of problems is still far out.
Seasonality a problem
Virgin is also trying to smooth out its seasonality as illustrated by its San Francisco-Palm Springs move as well as its previous moves into Cancun, Cabo San Lucas and Puerto Vallarta. And it is following other low-cost carriers in transforming itself into an option for business travellers.
This move is behind its entrance into Dallas/Fort Worth against American, which immediately dropped fares to make the route a loss for both. A thirst for business travellers was also behind the Toronto service, which the airline exited in short order after it miscalculated the demand.
Mr Cush expects to breakeven in 2012 and hopes to benefit from American’s bankruptcy especially if AA shrinks in San Francisco where the two share the cramped T2 facilities.
Key to its success is gaining access to the long-desired, but slot-constrained Newark, if it can get slots and gates, now monopolised by competitors. The airline hopes that the push for profitability at legacies will ease the lockout as fuel makes the regional jets, used to fill slots, more and more unprofitable. It is also eyeing Washington National service, which is also slot constrained.
Even so, United Continental Holdings may continue the losses as a cost of doing business since Virgin America usually means a 30-40% drop in fares when it gains a foothold.
The carrier is facing a multi-year construction programme at San Francisco, an already congestion-delayed airport at a time when Virgin is on a growth path.
Low costs help bottom line
Virgin America has a USD 6.38-cent CASM excluding fuel but its CASM rose more than 14% to USD 10.65 cents, comfortably lower than either Southwest at USD 12.26 cents (up 10.5%) and JetBlue at USD 11.03 cents (up 12.8%).
Delta’s CASM rose 13.9% to USD 14.16 cents in the third quarter while United posted lower CASM at USD 13.05 cents (up 12.4%). US Airways' CASM is still too high at USD 14.41 cents (up 15.1%) in the third quarter.
American’s CASM was down 12.1% to USD 12.29 cents but that excludes its regional operations whereas its competitors’ figures are consolidated numbers.
Yield for Virgin was USD 12.30 cents, up 9.8% while Delta’s rose 10.5% to USD 15.72 cents and United’s grew 10.8% to USD 14.56 cents. Southwest’s yield was flat at USD 14.69 cents while JetBlue’s grew 7.7% to USD 13.04 cents. Finally, US Airways’ yield jumped 7.8% to USD 15.94 cents. Virgin American has some way to go to attain the level of Southwest.
Mr Cush had hoped to become profitable in the fourth quarter but it remains to be seen whether or not the airline can pull it off. Even so, its headwinds in the new year means it will have to stay on top of costs which will be increasingly difficult with the expected aircraft deliveries.