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The war is over – now the fight begins for Virgin Australia

June 27, 2016 Headline News 1 Comment Email Email

egtmedia59Australians who have hung on to Virgin Australia shares (currently 22c) hoping perhaps to eventually bask in the sort of meteoric rise experienced by Qantas (as high as $4.20 in October 2015) have crash landed.

The optimism started back in May 2010 when former Qantas whiz kid, John Borghetti, joined the Virgin board. Here was by all accounts a brilliant executive with 36 years experience with the national carrier. Borghetti was seen by many observers as the logical choice to take over the running of Australia’s iconic national carrier but it was not to be.

Alan Joyce, CEO of the flying Kangaroos  budget carrier Jetstar, was appointed Chief Executive Officer and Managing Director in November 2008. Before that, Mr. Joyce spent over 15 years in leadership positions with Qantas, Ansett and Aer Lingus. So now the two were face to face again (we can assume there was no warm handshake involved) and the fight for an improved bottom line plus market share, particularly in the corporate sector, began in earnest.

Joyce had a fairly clear but unpopular task ahead. International fights were losing money and he needed to slash staff overheads and unload debt.  In May 2014 he said Qantas was on track to complete 4000 of its planned 5000 job cuts by June 2015. He added that the airline was aiming to achieve $800 million of cost savings and reduce its debt by $1 billion by June 2015 as part of its three-year plan.

In August 2014 he shocked the public when he unveiled a $2.8 billion bottom-line loss, the largest in Qantas’s history. The net loss looked worse than it was however because he decided to clear the decks by writing down the value of the airline’s international fleet by $2.6 billion. A Qantas/Emirates alliance was the answer to the international dilemma – Dubai became the new hub for Australians heading to Europe.

With a fleet of more than 230 aircraft, Emirates offers more than 150 destinations in 80 countries around the world, and the network is expanding constantly. Over 1,500 Emirates flights depart Dubai each week on their way to destinations on six continents. By December 2014 the number of individual flights to and from Europe sold by Qantas had already tripled under its alliance with Emirates compared with its previous partnership with British Airways.

Borghetti meanwhile was planning Virgin’s “game change’’ strategy unveiled in May 2011, when he joined part-owner Richard Branson to unveil the carrier’s new livery on a two-class Boeing 737 and vowed to lift the airline’s proportion of revenue from corporate and government business from 12 to 20 per cent. The strategy included Airbus A330 wide body aircraft on transcontinental routes and new lounges. Over the next three years, the airline would significantly boost its fleet and establish a global virtual network through alliances with major partners Etihad, Singapore Airlines, Delta Air Lines and Air New Zealand.

The plan included the acquisition of Perth-based Skywest and budget carrier Tigerair Australia. Could he take Virgin all the way to Qantas levels?  In October 2014 the carrier completed the purchase of Tiger Airways allowing Virgin to move more up market and Tiger to take care of the Jetstar end. Times were tough however – fuel prices were destroying profit projections and a capacity and fare war raged. The airline was still in the air – but running out of money.

Not even its most recent profit result, due mostly to cheaper fuel, could stem the tide. The share market ruthlessly deals with problem stocks and Virgin shares that had been as high as 48 cents are today worth more like 22 cents as the carrier unveiled plans to cut jobs, streamline its aircraft fleet and slash debt. Help is on the way though – ironically following the decision by Air New Zealand to sell its 25.9 stake in Virgin Australia.

Another young turk, Air New Zealand’s chief executive Officer and Virgin board member Christopher Luxon, was increasingly critical of the way the carrier kept climbing towards bigger losses. By comparison, Air NZ pre-tax earnings for the first six months of the year are $457 million – up $260 million on last year. In the end Luxon pulled the plug. Virgin’s speedy answer was to raise $852 million to help pay down its debt on top of a $159 million share placement to China’s biggest private airline operator HNA Group.

A second Chinese shareholder – the Nanshan Group, which operates Qingdao Airlines, will buy a 19.98 per cent stake in Virgin from Air New Zealand. HNA will partner the carrier to establish direct flights on the increasingly busy China-Australia route from next year.  “This is very big. Securing a relationship with a company of this type and with this credibility in China is massive,”  Borghetti told The Australian Financial Review.

HNA, which has holdings in more than 10 airlines including Hainan Airlines and Hong Kong Airlines, is a private Chinese company. It manages16 airports and owns ground services, travel agencies and aircraft leasing operations. “I think China is the future for inbound travel and this secures our future.” an ever optimistic Borghetti said. HNA will be the fifth big airline stakeholder on the Virgin board, including Air New Zealand. Its equity injection into the airline gives Borghetti additional capital at a time when he needs it most, but Citi analysts have estimated Virgin needs as much as $853 million in additional capital.

Virgin warned earlier this month it would post a loss in the second half and forecast a full-year profit of $30 million to $60 million, well below consensus forecasts at the time of $84 million. Rod Eddington, a former chief executive of British Airways and Cathay Pacific, says it’s not a simple case of either man winning or losing the contest for supremacy of Australia’s skies.

“The fact that there has been an outbreak of peace in the domestic capacity war has helped because it means the domestic market returns to reasonable levels of profitability and Qantas is the major benefactor of that,” Eddington told the Sydney Morning Herald in August 2015. “[Joyce has] also been prepared to make painful adjustments to the international network.

The international business is a bit like a rose bush – you have to prune the dead bits and grow the good bits.” At Virgin, the champagne corks remain firmly fixed as it lags its bigger rival in returning to profitability. Its next challenge is to match the Flying Kangaroo’s offer of free, high-speed Wi-Fi, even in economy class, from 2017.

Corporate clients in particular are demanding this service. On a cash level there is little doubt that Qantas has a huge edge. It was reported in the Sydney Morning Herald in February this year that the Qantas positive free cash flow was $770 million in the first half, while Virgin’s was negative $253 million despite the improved operating environment.

However a rising tide lifts all ships and Borghetti’s domestic business will benefit from the outbreak of peace,” Eddington says. “Virgin’s return to profitability is occurring and will occur.”

Written by Ian McIntosh

Currently there is "1 comment" on this Article:

  1. AgentGerko says:

    VA is making the same mistake that Ansett did in trying to grow an international network, even to the point where its copying the same destinations as Ansett. Australia is not big enough for two international carriers and Qantas has the name and network already. VA should stick to its shorthaul int’l routes into the Pacific and leave the rest to QF. It’s partnership with Etihad is weak because no VA aircraft goes west beyond Abu Dhabi. Its partnership with SQ is particularly weak because VA has no routes where their own metal is used, and far more people are Star Alliance than Velocity. Delta is the least known of US carriers by most Australians and whilst having a big network, is weak out of LAX which is VA’s gateway, forcing many passengers a second transit at Atlanta. Domestically, I prefer to fly VA than QF, but to make VA profitable internationally is a very big ask for Mr Borghetti.

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