Australian airlines are flying into a period of financial stability as they benefit from disciplined domestic capacity growth, structurally lower fuel prices and cost-saving measures.
That’s the view of ratings agency Standard and Poor’s which this week affirmed its stable outlook for Qantas and revised upward from negative to stable its outlook for Virgin Australia.
Qantas has outperformed a many of its full-service peers in the region in 2015-16 to post a record underlying profit before tax of $1.53 billion. It expects another bumper result in 2016-17 with underlying pre-tax profit predicted to be between $A1.35 billion and $A1.4 billion.
S&P does not expect either airline to benefit from a demand-led recovery in Australia’s weak consumer environment but it expects domestic capacity growth to remain flat over the next two years and the revenue seat factor to improve.
It said the strong Qantas balance sheet, conservative capital management, dominant domestic market position and industry-leading loyalty business would combine with a benign domestic competitive environment to underpin credit quality at a BBB- level.
“We expect Qantas' profitability to moderately improve as excess capacity washes through the domestic system, and as the airline benefits from disciplined capacity growth, structurally lower fuel prices, and past cost-saving measures,’’ S&P said in its analysis
“However, we believe it is likely that competition for high-yielding corporate and government travellers will remain intense, domestic demand will remain weak, and some excess capacity will linger across its networks.’’
Virgin has been working to boost its balance sheet after an audacious move to evolve into a full-service carrier that sparked a profit-sapping surge in Australian domestic capacity. It cut debt in the first three quarters of the 2016-17 financial year by a third.
However, it has been struggling to move into the black and in May revealed a net loss of $69m for the three months to March 31.
S&P predicts Virgin’s profitability will benefit from many of the same factors helping Qantas — disciplined capacity, lower fuel prices and restructuring.
It is the other side of the intense competition for high-yielding travellers and will also feel the effects of weak domestic demand and lingering excess capacity.
The agency said the carrier’s share of corporate and government travel had risen with the help of relatively cheaper fares and travel policies favouring cheaper fares.
“Although Virgin has repositioned its mainline brand and now mirrors Qantas' dual-brand strategy with the acquisition of Tigerair Australia, its share of the domestic profit pool remains small relative its market share,’’ it said.
“We expect this to somewhat improve, both in relative and absolute terms, as the airline improves its cost position and the domestic market becomes more profitable.
“Virgin's international business has not performed as well and struggles to achieve profitability despite structurally lower fuel prices and the airline's relatively "capital-light" operating strategy.’’
The agency noted that private equity firm Affinity Equity Partners, which has a 35 per cent stake in the Velocity frequent flyer program, has the option to exit from October this year via a trade sale or an initial public offering.
It said Virgin’s highly leveraged capital structure continued to weigh on its rating but it expected it to continue to reduce debt through fiscal 2018 and gain more “ a little more momentum” in fiscal 2019.
It also noted it had become “more comfortable’’ with Virgin’s ownership structure at the B+ rating level.
Virgin is 90 per cent owned by foreign investors Etihad Airways, Singapore Airlines, Nanshan Group, HNA Group and Virgin Group.
The owners on two occasions have stepped in to bolster Virgin either by supporting loans or through equity injection.
“Since November 2013, Virgin has raised A$1.45 billion in new equity, which is broadly equivalent to its current market capitalization,’’ S&P said. “We estimate that Virgin's most recent recapitalization was insufficient to resume capacity-based competition.
“This reinforces our expectation that Virgin will focus on cash generation to mend its balance sheet.”
Virgin shareholders have some reasons beyond Virgin’s profitability to invest in the airline but S&P noted there was no guarantee they would continue to underwrite the airline’s operating losses.
It pointed to Etihad’s recent decision to allow Alitalia to file for special administration and the possibility more difficult operating environments facing the Gulf carrier and Singapore Airlines could reduce their willingness to provide more support.
“Government stakes in Virgin's owners might also complicate these decisions,’’ it said. “Furthermore, we believe Chinese government capital controls could hinder HNA and Nanshan's outward investment. ‘’
“After five years of ownership, Air New Zealand sold the bulk of its interest in Virgin after participating in the August 2016 capital raising. The remaining owners have not indicated any change in their stance toward Virgin.’’
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