Moody’s has placed Virgin Australia in line for a potential credit rating downgrade due to its balance sheet profile and major shareholder Air New Zealand’s move to potentially offload all or part of its 26 per cent stake in the Australian carrier.
“The review for downgrade reflects Moody’s view of the uncertainty which has emerged over the outcome of Virgin Australia’s capital structure review and the level of shareholder support,” Moody’s vice president and senior analyst Ian Chitterer said in a statement on Monday.
“The review also reflects the slower-than-expected momentum now evident in the deleveraging of the business and the deterioration in its liquidity profile, as reported for July-December 2015.”
On March 30, Air NZ said it was “exploring options with respect to its shareholding” in Virgin, with First NZ Capital and Credit Suisse advising the company in this matter.
Air NZ chairman Tony Carter said his airline’s review of its financial investment in Virgin would look at “possible alternate uses of capital currently deployed in Virgin Australia”, adding the carrier did not want a large minority equity position in Virgin as it focused on its own growth opportunities.
The move came a week after Air NZ and Virgin’s three other major shareholders – Etihad Airways, Singapore Airlines (SIA) and Sir Richard Branson’s UK-based Virgin Group – agreed to provide Virgin a $A425 million 12-month loan to boost its balance sheet while the airline group conducted a capital review.
Moody’s said it believed the Air NZ decision to potentially sell its investment in Virgin “creates uncertainty around the future ownership structure”.
“This may impact shareholder support,” Moody’s said.
“Virgin Australia’s strong shareholder base and its willingness to offer financial support in challenging times have historically provided additional support to the airline’s ratings and increased Moody’s rating tolerance for its current weak credit metrics.
“During the review, Moody’s will look for more clarity around the future of the shareholder base and support.”
Moody’s noted Virgin’s adjusted debt to earnings before interest, tax, depreciation and amortisation (EBITDA) for the 12 months ended December31 2015 was 7.2 times, which exceeded Moody’s tolerance of 6.5 times for its B2 corporate family rating.
Virgin has a B2 corporate rating from Moody’s, which is below investment grade. The airline group’s senior unsecured debt is rated at B3, which is also below investment grade.
The Moody’s review of Virgin’s credit ratings comes on top of Standard & Poor’s (S&P) announcement on March 31 it had revised its outlook for the airline to negative, from stable, citing similar reasons to Moody’s.
“The outlook revision to negative reflects a degree of uncertainty over Virgin Australia’s near-term funding requirements and future ownership structure,” S&P analyst Graeme Ferguson said in a statement.
“We could lower the rating if we assess shareholder support to have diminished, or if the group fails to strengthen its liquidity position over the next three-to-six months.”
S&P described Virgin’s operating performance as “fundamentally sound”.
However, it said adverse currency and working capital movements, as well as increased capital expenditure relative to what it had previously forecast, to affect the airline’s current debt and liquidity levels.
“This may require a sizable new funding commitment over the next 12 months. We view shareholder support as the most reliable source of funding as prevailing credit market conditions may render bank or debt capital markets issuance unfeasible,” S&P said.
“In our opinion, without ongoing and timely shareholder support, Virgin Australia would not be able to absorb low-probability adverse events, even after factoring in capital-spending cuts, asset sales, and cuts in shareholder distributions.”
S&P also has Virgin at below investment grade with a B+ corporate credit rating.
Virgin Australia chief executive John Borghetti said the company had undertaken the “biggest airline transformation anyone has ever done in a short period of time” as it moved away from its Virgin Blue roots to a diversified airline group that included full-service, low-cost, regional, cargo and fly-in, fly-out businesses.
“Couple that with an enormous capacity war you have to fight there comes a time when you get over those two things and you have to strengthen the business and go forward,” Borghetti told the Australian Financial Review on April 2.
“It’s really now focusing on the capital structure and the efficiency of the business through reductions in sustainable costs such as simplification of the fleet and other business.”
Borghetti, who took over as Virgin chief executive nearly six years ago in May 2010, also expressed some frustration with the recent criticism of the airline at a time when it was back in profit.
“When we were losing $300 million no one said so much as Boo. And now we have posted the biggest profit in the front half since 2010 and everyone is coming out of the woodwork. You kind of scratch your head a bit,” Borghetti told the newspaper.
“Ever since Day One there have been people that have not believed we could achieve things. Analysts in particular because of their short-term thinking are focused on the next reporting period and we always said from the first day I walked in this is a long-term game.”