Are Virgin Australia's growing pains over?
Chanticleer Aug 10 2017 at 3:52 PM Updated Aug 10 2017 at 4:19 PM
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Virgin Australia CEO John Borghetti could not afford another bad year. Janie Barrett
It was the quarter John Borghetti badly needed.
A pick-up in corporate travel in the domestic market in the final months of the financial year and capacity cuts helped the Virgin boss contain a blowout in losses in the third quarter. Importantly, there is now evidence Virgin has its balance sheet under control as it slashes debt and turns cashflow positive for the first time in five years.
Borghetti could not afford another bad year. Despite the airline's transformation into a serious competitor against Qantas, concerns about the airline's deteriorating cash position spilled over into the board-room last year and the weak performance peaked in the third quarter when losses widened dramatically after the withdrawal of Virgin's budget carrier Tigerair from Bali, a cyclone in Queensland and unfavourable currency movements.
There is now light at the end of the tunnel. Virgin's $3.7 million underlying pre-tax loss was better than the $18 million analysts expected. The market is tipping an $80 million underlying profit this year. The pick-up in domestic trading has continued into the first quarter, Virgin's international business is now profitable (just) as it refocuses its attention on Asia and North America and the bean-counters have found an additional $50 million in costs to strip out each year.
There is no dressing up the fact Virgin still has a way to go following years of heavy investment, a crippling capacity war with Qantas and subdued demand for domestic travel. By comparison, Qantas is expected to post a $1.4 billion profit when it reports full-year results later this month.
Borghetti puts this down to growing pains. He says the airline is the fourth phase of its seven-year life. The first was the investment phase where he poured billions into turning a budget airline into a full-service carrier. This was followed by the battle phase when Qantas fought back in a bitter capacity war. The third phase was the repair job when Virgin raised more than $1 billion from shareholders to recapitalise its balance sheet. Borghetti says the fourth phase is getting the airline on the path to sustainable earnings growth.
"People forget airlines take a while to get going," Borghetti told this column. "This airline has really only been going for six years. We went through that period of heavy investment, we then had to suffer the war [with Qantas]. You dust yourself off, you get up and you say right we've earned the right to exist, it is now time to recapitalise the company and start getting our debt down."
That narrative has been a hard sell given the repositioning of Virgin has taken longer to produce results than originally expected. Before Thursday's results, there were five "sell" and two "hold" recommendations on the stock. But analysts were upbeat about the fourth quarter performance even though the leisure travel market still has not picked up.
Virgin paid down $839 million in debt last year and its $34.3 million positive free cash flow is a $126.4 million improvement on last year. It is ramping up the cost savings, with $350 million per annum now expected by the 2019 financial year compared to $350 million previously.
With the balance sheet healing, Virgin needs to show it can turn a profit without further capital injections from its big airline shareholders. This would be difficult anyway given the restrictions on Chinese capital outflow which would impact two of its shareholders and Etihad's financial difficulties.
A solid 2018 financial year also means Borghetti, 61, can think about retiring after seven years transforming the airline. The board will need to find a successor though and there are no obvious internal candidates after Borghetti's number two, John Thomas, departed after just a year in the job. Tigerair boss Robert Sharpe is a strong contender to replace Thomas but is not necessarily CEO material although there would be plenty of external candidates vying for the job.
Virgin's results also point to an improvement in the domestic airline market, which is good news for Qantas. Both Virgin and Qantas are behaving rationally in the domestic market which will mean some airfare rises for consumers. But, their investors will not be complaining.
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