Strange bedfellows of the sky

It is believed that Etihad Airways has been buying up shares in Virgin Australia in the past few weeks as part of a plan to restore its 9.9 per cent stake in the airline, diluted following the issue of new shares to Singapore Airlines.

It is believed that Etihad Airways has been buying up shares in Virgin Australia in the past few weeks as part of a plan to restore its 9.9 per cent stake in the airline, diluted following the issue of new shares to Singapore Airlines.

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 fallout from the introduction of the Sabre reservation system in the third quarter - believed to have cost the airline $50 million in lost revenue.

The $50 million was accounted for in the decision to reduce schedules by 15 per cent to take pressure off the new reservation system and avoid chaos or customer disruption as staff learned how to use it.

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 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 that 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.

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