Virgin Australia says low fares will continue

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August 01, 2016
Virgins and Velocity

Low fares are set to continue  in Australia as a hoped-for improvement in consumer sentiment has failed to eventuate.

Virgin Group chief executive John Borghetti said on Friday that the aviation landscape remained challenging and categorised by soft consumer demand, the resources downturn, uncertainty about the economy and the impact of the recent federal election. Virgin reduced capacity last financial year as a result of the soft demand from conservative consumers

“Can I also say the environment continues to be challenging and we’re not seeing any changes to what we’ve experienced in the last six months or so,’’ he said.

Asked where airfares would go in the next year, Borghetti said they would remain competitive but did not believe they would sink much lower.
He said there were already low fares in the market with fares to America for $900 plus return.

“That’s pretty damn low so fares are low now,’’ he said. “But you know there comes a point where lowering fares doesn’t actually generate more traffic. If people are not wanting to spend, they don’t spend.’’

The Virgin boss said Australia had one of the most competitive markets in the world when the distance customers flew and the amount of money they paid to fly that distance was taken into account.

“The big thing is we are here to create competition and we have created competition,’’ he said. “One of the reasons airfares are so competitive is we brought that competition – just think back to five years ago and where fares were then.’’

Despite the lacklustre economic conditions, Borghetti was upbeat about Virgin’s performance, saying it was in “good shape and a good position to go forward’’.

“We now have a group which has all its business in the right trajectory, a recapitalised balance sheet and a company that has excellent growth opportunities,’’ he said.

The airline group reported an expected net loss of $224.7 million,  driven by $440.5 million in restructuring charges related mainly to a fleet simplification program.

But its $41m underlying pre-tax profit, which strips out one-off charges and is the preferred metric of management,   was up by $90.1m compared to last financial year.

Group revenue rose 5.7 per cent to $5.02 billion while unit costs, excluding fuel and foreign exchange movements, were down by 1.9 per cent. All but one of the group’s business units were profitable in 2015-16 and the laggard, its international airline, is expected to move into the black this financial year.

Australia’s second biggest airline group achieved its goal of deriving 30 per cent of its domestic revenue from higher paying business and government customers ahead of time.

It is also on track to meet its 2017 financial targets after cost and capacity controls boosted underlying pre-tax profit and saw an improvement in 2015-16 earnings across all flying businesses.

Borghetti categorised fiscal 2016 as the year the carrier completed its transformation, strengthened its balance sheet and put the business on a firm footing for the future.

Although he stuck with his usual practice of not giving a profit outlook,  the airline group is on track to boost its underlying figure and return the black on a statutory basis next year.

“We’ve recapitalised the company with the help of shareholders and welcomed new shareholders. With them come new opportunities,’’ he said “All the operating businesses are now profitable apart from international, which has already shown good improvement because of the changes that we’ve put in place and can I also say I’m happy that is on track to be profitable next year.’’

Virgin is reducing costs and restructuring its operations as it repairs its balance sheet. The fleet simplification program has already seen it decommission its Fokker 50 fleet and start to reduce numbers in its  Embraer E190 regional jet and ATR turboprop fleets. Tigerair will also move from Airbus A320s to Boeing 737s over the next three years.

Once complete, the move will simplify the number from aircraft types from eight to five, although the group will retain two Airbus A320s for charter work as Virgin Australia Regional Airlines seeks to grow its charter business through a proposed long-term partnership with Alliance Airlines.

The group’s total cash balance of $1,123.8 million was up 9.3 per cent and will be further bolstered by the recent $852 million capital raising. A share placement to Chinese group HNA and a subsequent top-up increase this to $1.1 billion, although Virgin will use some of this to retire debt.

The equity placement and the arrival of HNA have reduced the airline’s free float to about 8 per cent, prompting speculation one of its shareholders will take it private, but Mr Borghetti declined to comment. Analysts have noted that such a move would further reduce costs for the airline.

Borghetti said the group’s “Better Business” program of capital and operational efficiencies would further improve liquidity, reduce debt as well as drive further improvements in earnings and cash flow.

This would deliver annual savings of $300m by the end of the fiscal 2019  is in addition to the $1.1 billion that will have been saved from an existing cost control program..

“This is not only good business sense but it also insulates us from future shocks that so frequently occur in the aviation industry,’’ he said. A break down of the business units, saw the all-important domestic operations record a 45.8 per cent rise in underlying earnings to $162m on improvements in yield, unit revenue and underlying earnings margin.

Virgin Australia International remained in the red with a $48.8m  loss but this was an improvement of 30 per cent on 2015-16 and included the $19m impact of volcanic activity in the first half.

Unit revenues and yield were down on the prior year due to the intense competition on the routes Virgin flies.

However, the airline has been fitting its Boeing 777 aircraft with new business and premium economy seats aimed at boosting yield and Borghetti said the international operations would realise benefits from this in the current financial year.

Low-cost subsidiary Tigerair Australia recorded its first-ever profit,  $2.2 m,  as passenger numbers rose  11.6 per cent on the prior year. The Virgin boss noted Tigerair led the low cost carrier market in terms of on-time performance, had revamped its website and started operations from Melbourne’s Terminal 4. It had also joined an international low-cost alliance and started international flights to Bali.

“Tigerair Australia’s customer satisfaction scores have increased across almost every aspect of the …. travel experience,’’ he said.

The Velocity frequent flyer program, in which Virgin Australia is the majority shareholder, saw revenue rise 37.4 per cent to $327.6m and earnings increase to $58.5m.

Virgin is looking to its new Chinese investors, including a strategic alliance with HNA and its links to  Hanshan Group, to help drive growth.

“Going forward, we will continue to focus on our lower cost base and growing revenue and earnings,’’ Borghetti said. “In particular, we will develop and exploit revenue growth opportunities which will open for us due to the new, proposed strategic alliance with HNA Group.’’