Positive Trajectory?

In spite of all those achievements – and the awards recognising Virgin’s product offerings attest to how successfully the airline has reinvented itself – profitability has remained elusive for Borghetti and his team apart from that one year in 2011/12 when Tiger Airways Australia (as it was then known) was grounded for safety reasons.

Over the years, high fuel prices, excess capacity in its key domesticmarket and difficult economic conditions, not to mention the cost of moving the airline upmarket, and Qantas’s competitive response have all dented Virgin’s bid for profitability. In 2014/15 it was a struggling international network that pushed Virgin into the red.

Virgin Australia posted a $93. 8 million statutory net loss for the 12 months to June 30 2015, an improvement of $210 million from the $355. 6 million net loss in the prior corresponding period.

However, a more “rational” domestic capacity environment, the improvement in Virgin’s wholly-owned low-cost subsidiary Tigerair Australia and ongoing focus on lowering costs mean the company is well placed to return to profitability in 2015/16.

“As a result of the progress on our strategy to date, we are now on a positive trajectory and on track to significantly improve financial performance again for the 2016 financial year,” Borghetti said during Virgin’s full year results presentation on August 7.

“Based on current market conditions, all fundamental business metrics are on track for the Group to return to profitability and report a return on invested capital in line with its cost of capital for the 2016 financial year.

“There is no question that there are some signs of improvement out there, albeit small. I am talking about general consumer sentiment.

“The corporate market and the government market for us has really not missed a beat. In fact it has been quite good but that is understandable because we have been winning share so that perhaps masks a little bit of the underlying trend. ” Underlying profit before tax, which the airline regarded as the best indicator of financial performance, came in at $49 million, up from a $211. 7 million loss in the prior year.

Total revenue across the airline group rose 10. 3 per cent to $4. 75 billion, Virgin said in a statement to the Australian Securities Exchange.

The significant improvement was led by Virgin’s domestic operations,which reported underlying earnings before interest and tax (EBIT) of $111. 1 million, compared with an underlying EBIT loss of $99 million in 2013/14.

On a negative note, Virgin’s international network continued to struggle in 2014/15. Its overseas flying suffered an underlying EBITloss of $68. 9 million in the 12 months to June 30 2015, some $22. 8 million worse than the prior year.

Virgin also announced at its results presentation the deferral of 17 Boeing 737-800 deliveries that were due in the 2015, 2016 and 2017 financial years. These have been converted to 17 MAX orders, whichlifts Virgin’s total order book for the type to 40, from 23 MAX aircraft previously, due from 2018.

While the airline group did not give detail fleet guidance for the period ahead, the airline did say it expected to take delivery of four new 737-800s in the current financial year. However, these will be offset by the return of three 737s to lessors. Also, improved asset utilisation was expected to “free up two aircraft for disposal”.

Moreover, three 737s will be used by its low-cost carrier subsidiary Tigerair to operate international services to Bali from March 2016 (see separate Tigerair Australia story).

“We also have a strong focus on utilisation and actually getting more out of the planes we have,” Virgin chief financial officer Sankar Narayan said.

“So what we have is a strong focus in terms of a cost program to generate more capacity with the assets we have. ” The revised fleet order for the 737s, which fly domestically within Australia and on short-haul international destinations to New Zealand, the Pacific and Asia, as well as Virgin’s 2014/15 operating statistics, suggests the flat capacity levels seen in the domestic market in recent times look set to continue for the period ahead.

In 2014/15, Virgin carried 1. 3 per cent fewer passengers on its domestic network compared with the prior year, while capacity measured by available seats rose 0. 3 per cent.

As a result load factors dipped 1. 3 percentage points to 75. 6 points.

The airline was, however, able to improve its domestic yields, oraverage airfare per passenger, by 5. 2 per cent in the year, while revenue per available seat kilometre was increased by 3. 5 per cent.

Analysts expected Virgin to keep a tight rein on capacity in the period ahead, given its focus on capturing 30 per cent of the lucrative corporate and government travel market by 2017 as part of improving yields.

Virgin is also targeting a return on invested capital of 10 per cent in 2015/16, as well as ongoing efforts to reduce debt levels.

Deutsche Bank research analyst Cameron McDonald said in a research note dated August 7 the total decline in passenger numbers underlined the fragile demand environment, and was potentially also the result of Virgin’s strategy shift to target more higher-yielding passengers.

McDonald’s research note estimated Virgin domestic was likely to increase by 2. 5 per cent in the first half of 2015/16, compared with 1. 2 per cent at Qantas and almost eight per cent at Jetstar.

Virgin said it had the flexibility to increase or decrease capacity in line with demand and the competitive environment.

“We see the Virgin result as providing a solid framework for a sustained recovery in the domestic market over the next two years,” UBS analysts Simon Mitchell and Caitlin Heffernan said in a research note dated August 7.

“We also view Virgin’s targeted reduction in leverage and improvement in return as constraints on capacity expansion.

“A restrained capacity outlook is also evidenced by the deferral of 17 deliveries until post-2018.

“We expect a flat outcome in Virgin and Tiger’s aggregate fleet of 90 narrowbody jets, although some utilisation improvements are likely to drive one to two per cent capacity growth for the international business. ” Macquarie Securities analysts Sam Dobson and Avinash Srinivasan saidVirgin’s domestic results reflected the relatively benign domestic capacity environment.

“Furthermore, this highlights the rational behaviour we are seeing across the domestic market,” the pair said in a research note dated August 7.

“In this environment, we expect VAH’s focus to remain on yield growth to drive profitability. ” In addition to the recovery in the domestic market, Virgin is also ramping up its cost reduction efforts, increasing its cost savings target to $1. 2 billion, from $1 billion previously, by the end of the 2017 financial year excluding fuel pricing and hedging benefits.

Virgin said it had achieved $514 million in cost savings in the three years to June 30 2015.

And unit costs, measured by cost per available seat kilometre, across the airline group fell 6. 4 per cent in 2014/15.

Borghetti said Virgin’s costs were 25 per cent lower than rival Qantas and rejected suggestions the gap between the two rival carriers was closer to five per cent.

“I keep reading the gap has reduced significantly and it is heading towards five per cent or something ludicrous such as that,” Borghetti said.

“The facts are what they are. The important thing is looking at the facts. ” Virgin for the first time published financial figures for its Velocity frequent flyer program, which reported revenue of $238 million in 2014/15, compared with $201 million in the prior corresponding period.

Borghetti said the recent partnership with BP, where Velocity members can earn points for fuel and other purchases at selected BP outlets, had helped drive a significant increase in membership, which stood at 5. 3 million on June 30.

And the picture at wholly-owned Tigerair Australia continues to improve, with the low-cost carrier expected to be in the black in 2015/16.

Tigerair reported an earnings before interest and tax loss of $9 million in the second half of 2014/15, compared with a $51 million EBIT loss in the prior corresponding period.

The low-cost carrier carried 3. 6 million passengers in 2014/15, up 10. 7 per cent from the prior year. And with revenue passenger kilometres rising faster than capacity, the airline was able to lift load factors 1. 8 percentage points to 86. 1 per cent.

In a similar vein to previous commentary on its international operations, Virgin again cited increased competitive pressure in the South-East Asian and long-haul markets as the main factors for the worsening full year result.

However, Virgin said some of the previously announced changes such as the introduction of business class across the Tasman and cutting the Melbourne-Los Angeles route had started to turn the ship around.

The airline was ending its Perth-Phuket service, and handing over some Bali flying to Tigerair as part of further initiatives to return the international network to profitability by 2016/17. Virgin is also adding extra flights to New Zealand, Fiji and the Solomon Islands from October.

“On the international front we have some issues but we are confident with our improvement plan,” Borghetti said.

While lower oil prices helped reduce Virgin’s fuel bill by about $60 million in 2014/15, Virgin also suffered a $35 million hit due to higher operating costs from the the lower Australian dollar.

The airline said it expected to gain a $162 million benefit from the lower oil price in the current year, while the depreciating local currency was expected to deliver a $99 million hit. ”

We see the Virgin result as providing a solid framework for a sustained recovery.