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Virgin Australia: “an important crossroad in our industry’s history” and 1H2014 loss as expected

Amid the smoke and noise of Qantas’ reporting of its 1H2014 results, Virgin Australia’s announcement of a pre-tax loss of AUD50 million for the period went almost unnoticed. Most media columns covering Virgin came from Qantas, in the context of their contrasting models, foreign ownership and the utter silliness of the Qantas Sale Act.

As it was, Virgin Australia’s loss was pretty much as anticipated, although involving several dimensions in the year-on-year comparisons, given the carrier’s apples and oranges situation, with AUD18.4 million (USD16.4 million) loss-making Tigerair Australia (now 60% owned) joining the group in Jul-2013 and as “business transformation and other expenses” accounted for another AUD69 million (USD61.6 million). During the first half of the FY2013, Virgin had also acquired Skywest, further clouding financial performance comparisons.

As CEO John Borghetti implied in his presentation, these first half results for Australia’s industry were however about more than merely dollar figures, given the strategic upheavals prefaced in the political debate currently raging: “I believe this is an important crossroad in our industry's history”.

It is certainly one of them – but it won’t be the last in what promises to be a turbulent decade for Australia’s airlines.

See related report: Qantas responds to deterioration: cuts 5,000 jobs & 50 aircraft - but changes are overdue

Virgin Australia is still very much an airline in transition, but getting there

The need for several clarifications of comparisons between the respective first halves of FYs 2013 and 2014 is a clear indication of the massive metamorphosis which the once-LCC is undergoing.

While upgrading fleet, airport facilities and expanding regional service organically, Virgin Australia has, in the course of the 12 months:

With all these changes, there is still more to come; Mr Borghetti is “confident that we are on track with our five-year Game Change Program strategy to create a business that can deliver sustainable performance for the long-term, through its positioning as an effective competitor in all key market segments”.

Business/premium travel remains the focus of much of the competition

Attacking the corporate and business travel market has become a core target for Virgin – and Qantas has been just as vigorous in defending it. The result has been severe decay in corporate yields. Everyone is coy when it comes to actual numbers, but Qantas CEO Alan Joyce noted during the Qantas announcements that his airline retained “over 80% by value of the corporate market”, indicating that Virgin is still making inroads.

Today, according to figures released by Virgin, the breakdown of domestic market shares is (1) “premium”, where the Qantas branded share is 58% and Virgin’s branded share 42%; and (2) “budget”, where the respective shares are 81% for Jetstar and 19% for Tigerair.

Since taking over at Virgin, Mr Borghetti has overseen a shift in these tightly defined premium market shares from 61:39% to the current 58:42%, a small but significant change reflecting the inroads the smaller airline has made in its push up market.

Meanwhile, a rebranded Tigerair Australia clearly has a lot of work to do to eat into the Jetstar hold on the leisure market. As demand in that sector appears to be softening and, according to Virgin, Tigerair lost AUD18.5 million (USD16.5 million) in the half, so clawing further share will be expensive – suggesting the budget end may simply see a holding pattern, while the main game remains in the wider business class seat region.

See related report: Virgin Australia and Tigerair dual-brand strategy commences as they start to coordinate routes

The core figures in a nutshell

Virgin Australia Holdings financial highlights for six months ended 31-Dec-2013:

  • Revenue: AUD2,242 million (USD2,065 million), +6.4% year-on-year;
    • Domestic: AUD1,694 million (USD1,560 million), +10.6%;
    • International: AUD589.7 million (USD543.2 million), -1.0%;
  • Operating costs: AUD2,284 million (USD2,103 million), +10.9%;
    • Fuel: AUD608 million (USD560 million), +5.6%;
    • Labour: AUD517 million (USD476 million), +15.0%;
  • Profit (loss) before tax and finance costs: (AUD60.7 million) (USD55.9 million), compared to a profit of AUD48.7 million (USD44.9 million) in p-c-p;
  • Segment EBIT (loss): (AUD3.8 million) (USD3.5 million), compared to a profit of AUD84.0 million (USD77.4 million) in p-c-p;
    • Domestic: AUD25.7 million (USD23.7 million), -55.2%;
    • International: (AUD29.5 million) (USD27.2 million), compared to a profit of AUD26.6 million (USD24.5 million) in p-c-p;
  • Net profit (loss): (AUD83.7 million) (USD77.1 million), compared to a profit of AUD23 million (USD21.2 million) in p-c-p;
  • Total assets: AUD4,878 million (USD4,493 million);
  • Cash and cash equivalents: AUD896.4 million (USD825.7 million);
  • Total liabilities: AUD3,624 million (USD3,338 million).

Balance sheet strengthening is fundamental – and the focus of the political battle

Mr Borghetti reported that Virgin Australia had substantially restructured its balance sheet during the first half through a number of successful initiatives including an enhanced equipment note offer and share entitlement offer. Consequently the business now has an improved balance sheet, providing additional flexibility and resilience.

The carrier made a debt issue of Enhanced Equipment Notes in Oct-2013 and then a Share issue the subsequent two months. The result was to increase the group’s total cash position to AUD896.4 million (USD825.7 million), up from AUD580.5 million at 30-Jun-2013; unrestricted cash increased by AUD338.9 million to AUD665.4 million (USD594.2 million). It was this "government owned foreign airline" support that ignited the fierce political debate.

In the process of the equity offering, shareholdings changed a little; Singapore Airlines and Etihad now hold around 20% and Air New Zealand, around 25%; Virgin Group/Richard Branson’s holding is now down to 10%. Under the investment ‘creep provisions’ of the Corporations Act designed to control potential takeovers, Etihad has also applied to increase its shareholding by a further 3%; it is allowed to seek an additional 3% every six months, subject to Foreign Investment Review Board approval.

The airline partnerships will inevitably be central to Virgin’s strategy, internationally and domestically

As Virgin puts it, the airline “will focus on optimising the business for consistent and sustainable performance. This will be achieved through accelerating efficiency and productivity initiatives, both internally and through leveraging the scale of our alliance partners, fast-tracking penetration into higher-yielding market segments in order to grow yield, continuing to lead the Australian industry in customer experience and creating value through our customer loyalty programme.”

Although Virgin too made a loss in the international segment (largely due to currency shifts), the airline arguably has the most ideally adapted model to compete in the strange new environment – a near-virtual operation, relying on premium brand airlines to gain it access to dozens of new destinations that it could never reach with its own metal.

It is surely only a matter of time too before Qantas, assuming it is eventually freed from the silly Sale Act, moves closer to this model with its premium brand.  It has been clearly demonstrated that Qantas at least is unable – even if it had a much lower cost base – to compete on equal terms with intermediate airlines on long haul; the Emirates deal was one example of this recognition.

But it has to be said that neither airline yet has evolved the appropriate vehicle to address the upside potential to the north.

Qantas has established several Jetstar cross border Asian joint ventures, which give it the platform to expand effectively to service the hybrid market segment. Whether this will become the de facto redtail in due course is something that will have to wait and see, as market conditions change.

Virgin has its equity partner, Singapore Airlines, to provide it codeshare/virtual access. But friendships only go so far when there is potentially head to head competition and buying Virgin coded seats on Singapore Airlines metal is still an expensive proposition for consumers – presumably implying that there is a lot of negotiating still to be done before Virgin has the full solution into servicing Asia through Singapore.

Both airlines need a solid partner in northern Asia; Qantas has two – China Eastern and China Southern (as well as JAL) – although the Chinese carriers are each still equivocal about greater intimacy. But Virgin still has that on its long list of needs to satisfy.

See related reports:

The budget airline in the group: Tigerair Australia’s “improving metrics”

In the first six months of the joint venture with Tigerair Australia, its operating performance has improved across a range of metrics when compared to performance during the first half of the 2013 financial year, according to Mr Borghetti. This will be the second full financial year of operations since Tiger Airways Australia (as it was previously known) returned to operations after being grounded by the Civil Aviation Safety Authority, CASA.

Aircraft utilisation increased 12.7%, load factors improved 4.7ppts to 88% and revenue per available seat kilometre also increased. Mr Borghetti said: “The goal is to ensure Tigerair Australia remains an effective and sustainable competitor in Australia’s budget travel market segment”. With the overall unwillingness to discuss future capacity expansion plans, this might have suggested little keenness to grow Tigerair.

However, schedules filed with OAG show Tigerair Australia on 2-Mar-2014 at a weekly 60,480 seats, rising more or less steadily to 90,000 in the last week of Jul-2014. This would take Tigerair from 4% overall domestic market share to around 5.7%. Over the same period, Jetstar, whose capacity fluctuates more, will go from 272,000 to 290,000, maintaining its share of around 18.7%.

Meanwhile, Virgin branded seats over this period are projected to go from 439,000 weekly seats to 469,000, keeping it steady at a total market share of just on 30%; on the OAG schedules, Qantas is showing a smaller proportional increase, from 631,000 to 643,000, reducing its share of the total domestic market by around 1%, to 41.4%.

Regional services are another battlefront, as Virgin expands into Qantas monopoly territory

Mr Borghetti made clear that Virgin intends to continue to grow regional services strongly on the east and west coasts, with a minimum of six additional ATR-72 turboprop aircraft scheduled for delivery by the end of the 2015 calendar year.

Yes it is (another) crossroad…

To finish with Mr Borghetti’s words at the results presentation, “as aviation history shows, there is never a shortage of new airlines willing to start up and take their place. I have been in the Australian aviation industry for more than 40 years and I believe this is an important crossroad in our industry's history.”

There will be many more airlines crossing Australia’s borders in coming years – four have expressed interest or actual plans in Feb-2014 alone.

There will consequently be a lot more crossroads, twists and turns and even a few large potholes before we proceed too much further.

See related report: Is Qantas and Australia's aviation system in meltdown? No, but challenges are all around

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