“The Group has delivered a solid result in a difficult operating and
economic environment, reflecting the significant progress we have made
in diversifying our revenue base and improving cost control, while
continuing to enhance the customer experience. We have continued to grow
our corporate and government revenue and maintained the new norm in
which more than 20% of our domestic revenue comes from this higher
yielding market,” Virgin Australia chief executive John Borghetti said.
Virgin Australia’s operating cash flow (OCF) dwindled to A$42.6
million for FY2012/13 first-half, down 83.2% from FY11/12 first-half’s
A$253.5 million, as the Sabre migration impacted forward bookings, while
the Brisbane-based carrier witnessed a net cash outflow of A$118.6
million, swung from a net cash inflow of A$126.4 million last fiscal
first-half. Total liabilities decreased by 2.8% to A$2.98 billion in
FY12/13 first-half from A$3.07 billion in the prior fiscal period while
total equities improved by 16.8% to A$1.09 billion from A$929.7 million
in the year-earlier period, thus resulting in a drastic improvement in
debt-to-equity ratio from 3.297 times to 2.745 times.
Virtually every part of Virgin Australia remains a work in progress
and the ‘Game On’ phase of its “Game Change” programme as well as its
cost-cutting programme must start to yield benefits to the business and
create shareholder value, however.
For its domestic business, its earnings before interest and tax
(EBIT) slumped by 43.3% to A$49.3 million in FY2012/13 first-half from
A$87 million the prior fiscal period despite a 3.96% increase in
domestic revenue to A$1.51 billion against the A$1.45 billion posted in
FY11/12 first-half and more passengers being carried at 8.7 million, up
from year earlier’s 8.6 million.
Importantly, successfully acquiring 100% of Skywest Airlines and 60%
of Tiger Airways Australia will be the pre-requisite for Virgin
Australia to compete effectively against Qantas and Jetstar in the
domestic market, of which the former acquisition was cleared by the
Australian Competition and Consumer Commission (ACCC) on 31 January.
“The ACCC’s view is that this acquisition is unlikely to lead to a
substantial lessening of competition in any relevant market, primarily
because the direct overlap between Virgin Australia and Skywest’s
services is limited to a single route between Perth and Broome,” ACCC
chairman Rod Sims said in a
“This acquisition will enable us to accelerate our expansion in the
high growth fly-in-fly-out (FIFO) and regional markets, increasing
competition in these important segments and bringing new benefits to
customers. It will also be very positive for business and tourism,
particularly for regional Australia, as we will invest to support the
growth of Skywest,” Virgin Australia chief executive John Borghetti
said.
Though the ACCC has raised competition concerns regarding Virgin
Australia’s acquisition of 60% of Tiger Airways, fearing the merger will
“remove all competition between Virgin Australia and Tiger Australia”.
Aspire Aviation believes the ACCC’s assumption of a removal
in competition between Virgin Australia and Tiger Airways Australia is
categorically incorrect and misleading, as low-cost carriers (LCCs) do
compete with their parents in the low-end segment for price-elastic or
price-sensitive passengers who would otherwise not have flown on the
domestic Australian routes and used bus or train travel instead.
For example, on where Virgin Australia and Tiger Airways Australia
have overlapping routes, i.e. virtually all Tiger Australia routes
except Melbourne-Perth, Melbourne-Alice Springs and Sydney-Alice
Springs, the ACCC could establish a baseline of capacity which
Virgin/Tiger must maintain as a condition of approval and ensure that
the lowest fare offered by Virgin Australia would be competitive with
those offered by Tiger Australia, although Virgin Australia should
remain free to manage the number of such heavily discounted seats being
sold.
Most importantly, allowing Tiger Australia to merge with Virgin
Australia is essential for the wounded Tiger’s survival, whose S$13
million third-quarter FY2012 loss was a 49.6% deterioration from FY11′s
S$9 million loss and its parent company Tiger Airways, with a weak
balance sheet and a 345% debt-to-equity ratio and a 0.297 current ratio,
has already issued S$297 million rights issue and preferential offering
in order to repay debts (“
Singapore Airlines at a crossroads“, 29th Jan, 13).
Image Courtesy of Virgin Australia
On the contrary to the notion that a Virgin Australia/Tiger Australia
merger will weaken competition, it in fact ensures a wounded Tiger
Airways to make a full financial recovery and enables Virgin/Tiger to
compete effectively with the former further differentiating its products
offering and targeting price-inelastic, lucrative last-minute business
travellers and the latter focusing on offering the lowest airfares at
which profitability could be achieved. Absent a Virgin Australia
acquisition and its A$35 million (US$36.2 million) payment and another
A$5 million one for meeting certain specified financial targets within
the next 5 years, Tiger Airways Australia is unlikely to survive in its
current form, which is unsustainable financially (“
Virgin Australia’s acquisition spree strengthens foundation for growth“, 12th Nov, 12).
Despite Virgin Australia chief executive John Borghetti’s reluctance
to make a firm commitment to growing Tiger Australia’s fleet from 11
planes to 35 by 2018, Tiger Australia’s dire financial straits render
such commitment non-sense commercially should it be unable to return to
profitability and compete head-to-head with Jetstar Australia.
“You can’t give an iron-clad guarantee on something like that because
you just don’t know what’s around the corner. No airline in the world
would give a capacity commitment for five years,” Virgin Australia chief
executive John Borghetti asserts.
But should Virgin Australia be allowed to use its insights behind the
rising costs of Virgin Blue and pre-emptively prevent repeating the
same mistake again while gaining economies of scale, the Australian
consumers would be the ultimate beneficiary for a strong and thriving
duopoly.
For instance, Qantas Domestic currently has a capacity share of 42.8%
whereas Jetstar has another 18% share while Virgin Australia, Tiger
Australia and Skywest Airlines have 29.9%, 4.2% and 0.7% shares,
respectively, according to a Centre for Aviation (CAPA)
report. Assuming
an average annual capacity growth of 5% at Virgin Australia over the
next 5 years, the combined Virgin Group will only control 47.9% capacity
share, very close to a duopoly with Qantas Group by then at the expense
of Jetstar and Qantas Domestic’s shares,
Aspire Aviation forecasts.
‘We have seen the competitor change the strategy multiple times, and
we have successfully introduced our two-brand strategy no matter what
the competitor has done. Virgin has given up the low-cost end of the
market and gone to the premium end. The performance of Tiger clearly
shows that Jetstar is significantly outperforming Tiger at the leisure
end,” Qantas chief executive Alan Joyce quips.
“We strongly believe the proposed acquisition will increase
competition in the market to the benefit of Australian consumers. By
partnering with Tiger Airways, we can use our expertise to leverage
Tiger Australia’s low cost base and build a competitive and sustainable
budget carrier. We are committed to maintaining the Tiger Australia
business model and brand, and we look forward to growing the Tiger
Airways business,” Virgin Australia chief executive John Borghetti
counters.
An example case would be the Sydney-Melbourne route where Jetstar and
Qantas have heightened capacity by 57% and 11% in FY13 first-half,
respectively, while Virgin Australia only upped capacity by 3%. Had
Tiger been a Virgin Australia subsidiary, the Brisbane-based carrier
would have been able to respond to the market more effectively.
Image Courtesy of Virgin Australia
Internationally, Virgin Australia transported 7.7% more passengers
during FY2012/13 first-half, with revenue soaring proportionately faster
at 7.9% from A$551.7 million in FY11/12 first-half to A$595.4 million
in FY12/13 first-half. Earnings before interest and tax (EBIT) at the
unit surged by 9.9% to A$35.4 million, up from A$32.2 million in the
prior fiscal period. Load factor decreased by 0.5% to 79.9% from 80.4%
in the same period last fiscal year.
This robust result stems from the strong codeshare partnership with
Singapore Airlines (SIA), which added 73 new codeshare destinations in
the first 6 months of FY2012/13, such as Virgin Australia’s codeshare to
Europe via Singapore from Adelaide, Perth and Darwin, with 24 more due
to be added in the second half, including SIA codeshare flights to
Europe from Sydney, Melbourne and Brisbane in the fiscal third-quarter.
As Virgin Australia has already set the platform for international
expansion properly with a “capital-lite” model, with a 56.1% increase in
interline and codeshare revenues which will rise further with the Sabre
implementation, the future challenge facing its international unit lies
in how to best serve Asian destinations without compromising its
strengthening balance sheet and how to fund this growth.
With Qantas International highly unlikely to grow again before 2016
on the as-yet-firmed 787-9 Dreamliners, leveraging this strategic
advantage created by its arch-rival could yield Virgin Australia
significant profits such as deploying its yet-to-be-delivered A330-200s
to Tokyo Haneda, Seoul, etc., while better serving North Asia and China
by forging a codeshare partnership with Hong Kong-based Cathay Pacific
Airways and its wholly-owned subsidiary Dragonair.
Indeed, Singapore Airlines is a 10% shareholder of Virgin Australia
and is an important partner for Asian growth. There is no denial that it
makes business sense for Virgin Australia to rely on Singapore Airlines
and SilkAir to serve the Southeast Asia and Indian subcontinent via a
strong origin and destination (O&D) hub for Indian traffic in
Singapore, such as Coinbatore, Kochi, Thiruvananthapuram
and Visakhapatnam in India; Bandung, Balikpapan, Lombok, Manado, Medan,
Palembang, Pekanbaru and Solo in Indonesia that neither Cathay Pacific
nor Dragonair serves in the medium term.
In terms of North Asian and Chinese network, though, Virgin Australia
should forge a close pact with Cathay Pacific for a comprehensive
network that features destinations such as Haikou, Sanya, Guilin,
Hangzhou, Xi’an, Nanjing, Ningbo, Fuzhou and Qingdao in China, Busan,
Taichung, Kaohsiung which SIA and SilkAir do not serve, in addition to
the 3-4 hours time advantage Hong Kong has over Singapore on flights to
Chinese destinations such as Beijing and Shanghai while having a roughly
identical flight time from Australian ports.
Furthermore, Virgin Australia could feasibly co-ordinate with its
sibling Virgin Atlantic, in which the United Kingdom-based Virgin Group
has a 26% stake in Australia’s second-largest carrier, to take over the
Hong Kong-Sydney leg of Virgin Atlantic’s flight. In doing so, not only
could Virgin Atlantic avoid cannibalising its yields to fill up its last
leg on the kangaroo route, a typical phenomenon given it is an
end-of-point carrier, Virgin Australia could also gain more feeder
traffic to its regional network and vice versa – providing more feeder
traffic to its Hong Kong flight than the existing codeshare, thereby
improving loads and yields in one fell swoop.
For Virgin Australia, this would be an attractive proposition for
business travellers who will gain instant access to more Chinese and
North Asian cities, while Cathay Pacific and Dragonair passengers could
gain similar access to more than a dozen of smaller Australian cities
with improved Dragonair feed.
Interestingly, this will bode well from a capacity perspective too as
Virgin Australia’s new A330-200s, of which 1 will be received in
FY2012/13 second-half and another 2 between June 2013 and June 2015,
will be deployed internationally instead of domestically, thereby
partially alleviating the overcapacity issue plaguing the domestic
market.
Over the longer term, Virgin Australia could order 787-9s which are
smaller than the A350s but are ideal for thin, long-haul routes to open
up new destinations in Asia, China and India in particular, whose 20%
fuel burn saving makes the previously economically unfeasible routes now
workable. A maintenance and crew training partnership with Air New
Zealand (ANZ), which owns 19.9% of Virgin Australia and is the 787-9
launch customer, or one with the 10% shareholder Abu Dhabi-based Etihad
Airways, will slash the induction costs while minimising risks and
possibly gaining early 787-9 delivery slots.
All in all, much remains to be done as Virgin Australia is still an
ongoing project. Domestically it must continue to improve its products
to differentiate itself from the competition and improve its yields,
which currently includes rolling out the business class on its regional
E190 fleet, equipping wireless in-flight entertainment on 80 aircraft
before the end of 2013, new Cairns lounge and revamped lounges at Sydney
and Melbourne, a new pier in Sydney and a new terminal in Canberra this
March. The carrier is also going to introduce coast-to-coast A330 with
24 leather business class seats at a 60-inch seat pitch on the
Brisbane-Perth route for the first time beginning 15 May 2013.
After all, continuously improving its product, as well as enhancing
its Velocity frequent flyer programme (FFP) whose membership base grew
by 500,000 to 3.5 million in addition to a better regional network which
sees the entry of Virgin Australia into existing monopoly routes
Brisbane-Moranbah and Brisbane-Bundaberg are the few means left to
improve its domestic profitability in a market where business fares have
slumped by 17.3% in February 2013 compared to a year ago and continued
to bump along the bottom set in December 2011 which have never recovered
since, according to the Bureau of Infrastructure, Transportation and
Regional Economics (BITRE) figures. Restricted economy fares are not
faring particularly well either, whose index, albeit recovering
moderately since a February 2012 bottom of 63.5 and rose to 71.7 in
February 2013, are still markedly lower than pre-May 2011 levels.
Factoring in Virgin Australia’s planned 5-7% domestic capacity growth
in the FY12/13 second-half, it is apparent that driving the growth in
high-yield traffic is paramount to mending its bottom line.
“We are very pleased with the increasing take up of Business Class,
with passenger traffic in the Business Class cabin growing by
91.6% compared to the first half of financial year 2012,” Virgin
Australia chief executive John Borghetti commented.
“Our new Sabre booking and check-in system will be key to driving
future revenue growth. As a result of the new system, travel agents
around the world now have far greater visibility of Virgin Australia,
enabling them to book our flights with more ease using a system that
aligns with global standards. In fact, we are already seeing the
benefits of the system, with our proportion of bookings through the
global distribution system (GDS) increasing five-fold since its launch
in mid-January. It is also important to note that bookings through GDS
channels typically have a 10% yield premium to average bookings.
“The Sabre system will accelerate our growth in the corporate,
government and high yield markets. With the stabilisation of load
factors following the change in our business model and further growth in
higher yield markets, we anticipate improved RASK [revenue per
available seat kilometre] performance going forward,” Borghetti said.
In conclusion, Virgin Australia has a strong foundation from which to
grow and there are plenty of international expansion opportunities
awaiting the carrier, which is the ultimate revenge for its chief
executive John Borghetti, a former Qantas chief financial officer (CFO)
when the board of directors of the flying kangaroo opted to promote then
Jetstar chief executive Alan Joyce instead. With the game having
already changed, the game is now on to deliver the benefits of the “Game
Change” repositioning programme and successfully integrate and turn
around the Tiger Airways Australia operation, while realising gains to
the bottom line with A$60 million of cost reduction for FY2012/13, A$120
million for FY14 and A$200 million for FY15 after A$25 million of cost
was
taken out in the first-half.
Image Courtesy of JUBES747
http://www.aspireaviation.com/2013/03/06/qantas-virgin-australia-face-new-industry-normal/