Virgin feels the price of its ambition

Back in May Virgin Australia shocked the market with an earnings downgrade, but still held hopes of generating an underlying profit in the final quarter of the financial year. Today those hopes were well and truly dashed.

Virgin Australia’s updated guidance today showed it expects to post an after-tax loss of between $95 million and $110 million for the year to June, with a pre-tax loss excluding significant items of between $30 million and $50 million. Given that it generated an underlying pre-tax profit of $61 million in the first half, that says it experienced some severe turbulence in the second half.

In some respects the severe downturn isn’t unexpected. It has been a busy – and messy – year for John Borghetti and his team given the acquisition of a majority interest in the troubled Tiger Airways Australia business and the simultaneous acquisition of Skywest. The introduction of the Sabre reservations platform was also disruptive.

Beyond its control were the patchy and weakening economy and the impact of the carbon tax, which Virgin Australia said today cost between $45 million and $50 million – costs which couldn’t be recovered in the soft economic conditions and the competitive market.

Within its control, however, was the capacity war it ignited last year, to which Qantas responded aggressively and which has hurt both airline groups.

While the rate of growth in capacity has slowed in recent months, resulting in improving yields and load factors, and Virgin said today that forward domestic books were up about 6 per cent on last year, the damage had already been done.

This was, perhaps, always going to be a challenging period for Virgin Australia, given the speed and scale of the transformation Borghetti has been undertaking.

The acquisitions and restructuring of Virgin Australia and its new brands have resulted in significant transaction and restructuring costs, which the group estimates at around $100 million. It described these as the “final component of the company’s transformation”.

In the past, losses of the magnitude foreshadowed today might have been quite destabilising for Virgin Australia. But its register – its allies Singapore Airlines, Air New Zealand and Etihad are all substantial shareholders and all appear to want to continue to build their shareholdings – gives Borghetti access, if he needs it, to some deep pockets with strategic interests to protect and pursue.

While his shareholders might prefer Borghetti to be making profits rather than losses, if Virgin Australia’s increased presence across the market segments and its increased capacity has a leveraged impact on Qantas, one assumes they’d be reasonably satisfied. They have sharply increased their own assault on Qantas’ international business in response to the Qantas alliance with Emirates.

Borghetti has largely completed his repositioning of the main brand to try to tackle Qantas’ dominance of business travel but it will take time to restructure and re-orient Tiger and Skywest to attack the Jetstar and QantasLink brands. Skywest contributed between $5 million and $10 million to Virgin Australia’s loss.

In a more rational market, with capacity growth wound back and the pressure on yields reduced and, perhaps, some post-election improvement in business and consumer confidence, both the domestic carriers might be able to produce more sustainable performances.

The aviation industry, of course, routinely throws up unpleasant surprises. Rising oil prices and a falling Australian dollar have forced Virgin Australia to emulate Qantas and increase its fares and fuel surcharges, which isn’t going to help their passenger volumes.