Transport Airlines

Virgin Australia Is Going All Out to Battle Qantas for Domestic Market

Sep 02, 2013 6:59 am

Skift Take

Virgin Australia’s aggressive moves will either begin to pay off, or its deep-pocketed partners will take the pieces they need and move on in the region without the brand.

— Jason Clampet

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Virgin Australia Holdings Ltd. is stepping up its efforts to take on Qantas Airways Ltd.’s dominance of the country’s domestic travel market.

The Brisbane-based company has the third-highest debt ratio among global airlines as it takes on loans to fund this battle. Virgin is pledging its head office building for a new bank loan, taking out credit lines from Air New Zealand Ltd., Etihad Airways PJSC, and Singapore Airlines Ltd., all big shareholders in Virgin Australia. It also has a credit line from a joint venture with the Samoan government.

“It’s their way of saying, ‘We’re behind you and if you need some help we’re here’,” Chief Executive Officer John Borghetti said in a telephone interview on Aug. 30, referring to the three airlines. The carriers are extending the financing “because of their belief in our strategy, their belief in what we’re doing and that we’re on the right track.”

Since Borghetti took over in May 2010, Virgin has spent at least A$1.54 billion on capital projects to buy planes and airlines, renovate lounges and add business-class seats to crack Qantas’s 65 percent dominance of the domestic travel market. Virgin has about one month of operating cash-flow requirements and if economic conditions worsen, the carrier may have to raise equity or sell and lease back aircraft, Deutsche Bank AG said.

Debt

The carrier opened about A$223 million ($199 million) in secured debt, lease-back agreements and loan facilities with associates over the past year. That’s more than Brisbane-based carrier’s net income since September 2004.

“If conditions remain pretty challenging, then there will obviously be more stress on the balance sheet over time,” Mark Williams, an analyst at CIMB Group Holdings Bhd. in Sydney, said by phone. “That facility with the airlines gives them a bit of a buffer.”

Virgin shares climbed 3.9 percent to 40.5 Australian cents at the close in Sydney, while the S&P/ASX 200 index rose 1 percent. The stock has declined 3.6 percent this year against a 12 percent gain in the index.

Year-end net debt, calculated as the value of Virgin’s interest-bearing liabilities minus its cash and cash-equivalent holdings, rose 50 percent during the period to A$1.31 billion from A$872 million a year earlier, based on a calculation by Bloomberg News.

Unsecured Loans

That’s 22 times last year’s earnings before interest, tax, depreciation and amortization of A$191 million, compared with a 2.3 times multiple a year earlier, the data show. Out of 120 airlines globally, only two had a higher debt ratio, and the median was 2.0, according to data compiled by Bloomberg. Brazil’s Gol Linhas Aereas Inteligentes SA and PAL Holdings Inc. topped the list.

Air New Zealand, Singapore Air and Etihad, with a combined 53 percent share in Virgin, are setting up one-year unsecured loan facilities with a joint value of A$90 million to “supplement and diversify the company’s liquidity position”, the carrier said in a regulatory statement.

Virgin has also taken out a A$99 million bank loan secured against its head office northeast of Brisbane’s city center and sold its hangar at the city’s airport, which it’s now leasing back, the company said in its annual results. In addition, it’s taken out a A$9.3 million unsecured facility from Virgin Samoa, a joint venture between the carrier and the government of the South Pacific island state.

Annual Loss

Virgin had a narrower-than-estimated annual loss for the year ended in June as the introduction of business-class services and a new booking system across its network helped support fares. The carrier also bought rural carrier Skywest Airlines Ltd. and a 60 percent stake in Tiger Airways Holdings Ltd.’s money losing local unit to compete with Qantas.

“The last year was a costly one for them,” John O’Shea, an analyst at Bell Financial Group Ltd. in Melbourne, said by phone. “Airlines are a capital-intensive business. If you make a material loss, cash is going to be crucial.”

The investments have been an essential part of Borghetti’s strategy to take a slice of the domestic corporate air travel market, said Oliver Lamb, director of Pacific Aviation Consulting in Sydney. Qantas enjoyed an effective monopoly for a decade after the collapse of Ansett Australia in 2001, he said.

Competitive Market

“The domestic marketplace has become a lot more competitive as a result of Virgin’s actions and everyone’s wearing some pain because of that,” Lamb said. “I’ve got every confidence in Virgin being able to improve over the next 12 months, and the underlying results show they’re on that trajectory anyway.”

Virgin still has further commitments to fund in the year ahead, Chief Financial Officer Sankar Narayan said Aug. 30. It plans to invest as much as A$63 million in Singapore-based Tiger Air’s Australian unit, in which it bought the stake.

Alongside additional funding, Virgin has been looking to increase cash balances by cutting costs, and reduced expenses by more than A$60 million over the course of the year.

It trimmed about A$8 million from its fuel bill by taxiing twin-engine planes around airports using power from just one engine, and saved another A$4 million from staff expenses by adjusting crew rosters to limit the amount of time spent away from home, according to Borghetti.

Still, the increase in debt leaves less of a cushion amid a volatile aviation market, said Evan Lucas, a market strategist at IG Markets in Melbourne.

“Their balance sheet isn’t in brilliant shape,” he said. “Fuel costs and costs in general across the globe are ballooning.”

Editors: Vipin V. Nair, Anand Krishnamoorthy. To contact the reporter on this story: David Fickling in Sydney at dfickling@bloomberg.net. To contact the editor responsible for this story: Anand Krishnamoorthy at anandk@bloomberg.net. 

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