The earnings downgrade that Virgin Australia slipped out after the market had closed on Wednesday came as a shock to the market and would probably have left at least one of its bevy of strategic shareholders miffed – and another rather self-satisfied.
At its half-year results presentation in February Virgin had forecast that it would make a profit in the second half for the first time in five years and improve on its last full-year result.
On Wednesday evening, well after the market had closed, it said that while it continued to expect to record a positive underlying profit before tax for the fourth quarter, it expected full-year earnings would be below those of last year. The market took that to imply the group would again lose money in the second half.
The Virgin Australia share price fell eight cents to 38 cents on the news, wiping more than 17 per cent, or more than $200 million from its market capitalisation.
The Virgin Australia register is crowded, with Singapore Airlines holding almost 20 per cent, Air New Zealand with a similar shareholding, Richard Branson’s Virgin Group about 12.4 per cent and Etihad Airways just under 9 per cent. Of those shareholders only Virgin Group, the original financier of the local carrier, has board representation.
That means the news of the downgrade should have come out of the blue to the other Virgin Australia allies and would have been a particularly unpleasant surprise for Singapore Airlines, which doubled its stake in the carrier only three weeks ago at a cost of about $128 million. The shares it acquired are now worth about $26 million less than it paid and it is closer to $40 million down on its entire shareholding.
The shareholder with the smile on his face would be Branson, given that it was his Virgin Group that offloaded 10 per cent of Virgin Australia to Singapore Airlines to enable it to double its stake last month. His only regret might be that he didn’t sell, or perhaps wasn’t approached to sell, the remaining shareholding. Etihad’s James Hogan, on the other hand, will be glad that he didn’t respond to Singapore Airlines' move by buying those remaining Virgin Group shares.
The downgrade was based on Virgin Australia’s operating experience in April, where revenue passenger kilometres and load factors crashed despite Virgin Australia saying it had experienced its highest yield since December 2011.
There has been something of a price and capacity war being waged in the domestic market as Qantas has responded to Virgin Australia’s increased capacity and shift upmarket by adding even more capacity of its own and using its Jetstar brand to mount an attack on the leisure end of the market – still the dominant source of Virgin Australia’s passenger volumes despite its repositioning to try to attract more higher-yield passengers from Qantas.
A fortnight or so ago Qantas’ Alan Joyce caused his share price to drop sharply when he warned that his group’s second half earnings, traditionally weaker than the first half, would also be impacted by $25 million of back-pay for its pilots and the $50 million cost of shifting its international hub from Singapore to Dubai as part of its alliance with Emirates.
Virgin Australia has lowered its expectation of second-half capacity growth in the domestic market from its previous range of 5-7 per cent to about 4 per cent and says it expects capacity growth to moderate further in 2013-2014.
It would appear that either the domestic carriers pumped too much capacity into the market in the first half or Virgin Australia got its yield management wrong, with too many empty seats at the back of its planes, although it also cited the introduction of its Sabre reservations system as a factor in lowering revenue in the third quarter.
It is also obvious that the mixture of excess capacity, intense competition and a weakening economy would have a leveraged impact on airlines, although, given that airlines do get a strong signal of future demand through their forward bookings, it is perhaps a surprise that the deterioration in its performance came as a surprise to Virgin Australia.