Strange bedfellows of the sky
Etihad's decision to restore its shareholding in Virgin quashes speculation that it might cut ties after Singapore Airlines almost doubled its stake in the country's second-largest airline to almost 20 per cent.
The share purchases could be part of a bigger plan for Etihad to further increase its shareholding in Virgin as part of a move to compete against the new Emirates and Qantas alliance.
There is little doubt that the airline's founder, Sir Richard Branson, who sold 10 per cent of his shares to Singapore Airlines in March, would sell his remaining 13 per cent stake in the airline at the right price.
That price was believed to be 55¢ to 60¢ but with the latest pummelling on the sharemarket on Thursday, he might have to take less, depending on his timing. The company's shares closed at 38¢.
The airline's shares fell more than 17 per cent in reaction to a profit downgrade for 2013.
While the market had been expecting a downgrade - median consensus estimates were $66 million compared with the airline's previous guidance of $82.5 million - when it happened, it prompted some analysts to go a step further and take the knife to the 2014 forecasts.
Virgin boss John Borghetti blamed the profit downgrade on a softening in demand in the fourth quarter and the introduction of the Sabre reservation system in the third quarter, which is believed to have cost the airline $50 million in lost revenue.
The $50 million came from a decision to reduce schedules by 15 per cent to take pressure off the new reservation system and avoid any chaos or customer disruptions as staff learned the new reservation system.
The decision to scale back services was a big price to pay because in effect it handed $50 million to Qantas on a platter. The hope was that the $50 million blip would be recovered in the fourth quarter, giving the airline a similar earnings profile as 2012.
Instead, demand softened and Borghetti had no option but to downgrade its earnings, something its rival Qantas seems to have done without making an official statement to the Australian Stock Exchange.
The 17 per cent fall in Virgin's share price seems like a massive overreaction, particularly given the company's yields are rising, which suggests its strategy to encroach on Qantas' lucrative corporate and government accounts is working.
In March and April, yields were up with April at the highest levels since late 2011 when Qantas grounded its fleet. However, its domestic load factor was a different story, at 71.5 per cent, which is the lowest monthly figure since May 2005.
Macquarie has lowered its 2013 pre-tax profit estimates to $58.9 million, while Merrill Lynch lowered its 2013 estimate from $82 million to $49 million, which means the second half slips into a $12 million loss. It has reduced its 2014 pre-tax profit estimates from $131 million to $103 million.
A softening in the market, the introduction of a new reservation system and a decision to increase capacity on the domestic airline market in the past 10 months has been a bloody affair for both airlines, particularly Qantas.
It cost Qantas more than $100 million in profits in the first half and Virgin more than $20 million as both airlines refrained from passing on the carbon tax impost to passengers, increased capacity, chased and protected corporate accounts and offered cut-price airfares.
Airlines have a long history of price wars. The most savage was in 2004 when extra capacity was dumped into the market when Qantas launched Jetstar.
Eventually things settle back down to some kind of equilibrium. The latest update from Virgin suggests those days of excess capacity are coming to an end.
Borghetti said that in the second half of 2013 the company expected capacity growth of 4 per cent, from a previous guidance of 5 per cent to 7 per cent. He said capacity growth in 2014 would also be wound back to between 4 per cent and 5 per cent.
In the meantime, its three main alliance airline partners, Singapore Airlines (which holds 19.9 per cent of the airline), Air New Zealand (which holds 19.09 per cent of the airline) and Etihad (which is understood to have increased its stake from 8.4 per cent to 9.9 per cent), make strange bedfellows and will be repositioning themselves for an eventual shoot-out.
All three want board representation, but none has been granted it - yet. Etihad's decision to restore its holding to 9.9 per cent sends a strong message to the other shareholders that it has its own plans for Virgin.
Whether that means buying out Sir Richard Branson could set the scene for some interesting times at Virgin.
Frequently Asked Questions about this Article…
According to the article, Etihad has been buying Virgin Australia shares to restore its 9.9% holding after it was diluted when new shares were issued to Singapore Airlines. Restoring that stake signals Etihad wants to remain a meaningful strategic shareholder — and it could be positioning itself to increase its holding further as it readies to compete with the Emirates–Qantas alliance. For investors, this kind of share activity from a major airline partner is a sign of strategic interest that can affect governance and long‑term strategy.
Singapore Airlines increased its stake to almost 20% (about 19.9%), which diluted Etihad’s percentage and changed the shareholder mix. That larger Singapore Airlines holding — along with stakes held by Air New Zealand and Etihad — means three alliance partners now have significant influence and are seeking board representation. For everyday investors, a near‑20% institutional stake can influence strategic direction, potential alliances and takeover dynamics.
Virgin downgraded profit guidance for 2013 after a softening in fourth‑quarter demand and disruption from the roll‑out of the Sabre reservation system. Management says the new system and reduced schedules cost the airline about $50 million in lost revenue. The downgrade, combined with lower market expectations, prompted a steep share price reaction — trading down more than 17% — as investors revised earnings expectations.
Virgin reduced schedules by roughly 15% while staff learned the new Sabre reservation system to avoid customer disruption. Management believes that decision cost the airline about $50 million in lost revenue. The company had hoped to recover that shortfall in the fourth quarter, but weakening demand meant the loss flowed through to downgraded earnings.
Macquarie lowered its 2013 pre‑tax profit estimate to US$58.9 million. Merrill Lynch lowered its 2013 estimate from US$82 million to US$49 million and trimmed its 2014 pre‑tax profit forecast from US$131 million to US$103 million — a revision that implies the second half of 2013 could slip into an estimated US$12 million loss. These cuts reflect a weaker earnings outlook and are important for investors tracking valuation and near‑term risk.
The article outlines mixed signals: yields were rising (April was reported as the highest since late 2011), which suggests Virgin’s pricing strategy is working. However, domestic load factor was only 71.5% — the lowest monthly figure since May 2005 — indicating softer passenger demand. For investors, rising yields can be positive for revenue per passenger, but low load factors can offset that benefit and increase short‑term earnings risk.
Virgin told investors it expects capacity growth in the second half of 2013 to be about 4% (revised down from previous guidance of 5–7%) and plans to wind back 2014 capacity growth to between 4% and 5%. The article suggests this reduction in excess capacity could help stabilise yields and pricing after a period of aggressive capacity expansion and price competition with Qantas, which should be watched closely by investors.
The article says Sir Richard Branson sold 10% of his Virgin stake to Singapore Airlines in March and might sell his remaining roughly 13% at the right price. Sources reportedly believed the price would be around 55¢–60¢ per share, but a recent market sell‑off pushed the shares down to 38¢ at close. Any sale by Branson or a larger strategic buy‑out would be material for shareholders and could trigger further governance or strategic changes at Virgin.
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