12-Aug-2011 2:02 PM

Virgin Atlantic swings to profit, sees tough year ahead

Analysis

Virgin Atlantic has turned a record GBP132 million loss in 2009-2010 into a pre-tax operating profit of GBP18.5 million in the 2010-2011 financial year (12 months to 28-Feb-2011), boosted by a sharp recovery in the first half of the year. The return to profit was aided by strong growth in business traffic and solid load factors across all cabins.

However the carrier, which recently reached a new agreement with pilots to avert potential and devastating strike action this summer, warned of tougher market conditions due to a challenging combination of increased capacity in the market, "faltering" consumer confidence and high fuel prices. Mr Ridgeway also noted that recent rioting in London and the downgrade of the United States' credit rating could dampen the mood of consumers further. "Over the long-term consumer confidence is very important to us and it was pleasing London had a quiet night last night in terms of riots, these things all affect sentiment," Mr Ridgeway said.

Economy cabin challenge; business traffic remains strong

Commenting on the results, Virgin Atlantic CEO Steve Ridgway stated the carrier has "demonstrated the resilience of our business by weathering the toughest economic period for aviation and have now returned the business to profit". However, he noted that the recovery seen in the first half of the year "tempered by more challenged trading in the latter period due to increased capacity in the market and high fuel prices."

Commenting on the outlook, Mr Ridgeway stated the carrier has seen "softer trading in the areas that are hit hardest by the continued rises in Air Passenger Duty, particularly the Caribbean routes and Premium Economy cabins. Whilst business traffic remains strong, demand in the economy cabin is more challenged".

Peer comparison: Lufthansa and Air France report losses; IAG reports profit

Lufthansa, last month, reported a EUR206 million net loss in the six months ended 30-Jun-2011. Air France, meanwhile, reported a net loss of EUR197 million in the three months ended 30-Jun-2011. Both carriers trimmed capacity growth plans over winter 2011 as a result. However, International Airlines Group, Virgin's main rival at London Heathrow, swung to a profit after tax of GBP71 million in the six months ended 30-Jun-2011, and predicted full-year earnings growth.

Profitable result of GBP18.5 million for Virgin Atlantic in FY2010/2011

Virgin Atlantic's GPB18.5 million profit reported in FY2010/2011 came after the carrier reported a loss of GBP132 million in FY2009/2010, and despite the winter closure of Heathrow and the Icelandic ash cloud crisis costing the business a combined GBP40 million. The carrier reported revenue growth of 13% to GBP2.7 billion in the 12 month period.

Virgin Atlantic financial results for the 12 months ended 28-Feb-2011; three months ended 31-May-2011

FY10/11:
- Revenue: GBP2.7 billion, +13% year-on-year;
- Cargo revenue: GBP224 million, +39%;
- Pre-tax operating profit: GBP18.5 million, no year-on-year comparison provided;
- Load factor: 82%, no year-on-year comparison provided;
- Cash balance: GBP562 million, no comparison figure provided
Three months ended May-2011:
Total revenue: USD1.1 billion, +7.6%.

Virgin Holidays also recorded a "strong performance" in the 12-month period driven by high demand for its core Orlando and Caribbean holidays. The company is doubling its UK retail network to 120 stores, creating 200 jobs nationwide.

From a cost side, Mr Ridgway stated the carrier's fuel bill was over GPB1 million in 2010/2011. "It's gone down in recent days due to worries in the market but I guess you'll see that go back up but we have a three year strategy and hedge somewhere between 70 and 80 percent and build the book all the time," he said.

While yield data was not provided, Virgin Atlantic has been attempting to boost demand by offering discounted fares, which means yields this year are not as strong as the previous year, although premium products are performing well. The airline has also been pushing to increase traffic from both its home market and the destinations to which it travels.

The carrier, the second largest long-haul carrier at London Heathrow, also stated revenues in 1QFY2011/2012 (three months ended 31-May-2011) increased 7.6% to GBP658 million although no profit figure was issued.

Cargo numbers soar

Despite a slow economic recovery, Virgin Atlantic Cargo reports strong demand for its freighter business.During the 12 month period, Virgin Atlantic Cargo reported a 39% increase in cargo revenues to GBP224 million. The carrier attributed much of this growth to notable gains across the world, particularly in the Europe, the Middle East and Africa (EMEA), the Americas and the Asia-Pacific regions.

Commenting on the result, Virgin Atlantic Cargo Director John Lloyd, stated the fact that the division achieved double-digit gains speaks volumes about its business model. "Even in a year when air cargo volumes across the industry were recovering, this is a fantastic result and a tribute to our team around the world for consistently providing the exceptional levels of customer service that help to set us apart from other airlines," he said.

Year-over-year cargo volumes increased in the EMEA 19%, with growth of 16% in the America. This was stronger than the 13% growth witnessed in the Asia Pacific region.The carrier's Virgin Atlantic and V Australia networks also posted significant gains, transporting 227,000 tonnes of cargo in fiscal year 2010-2011, for year-on-year growth of 17%. Mr Lloyd stated the affiliation with Virgin Australia had a key impact on the carrier's success in its cargo performance. "Once again, [this] had a strong impact on our results, and this is a model we believe we can successfully implement with other airlines to deliver positive and mutual benefits," he stated.

This was outpaced by even larger gains in cargo revenue. Revenue in FY2010-2011 in the EMEA increased by 47%, with revenue growth of 41% in the Asia Pacific. Revenue growth in the Americas was weaker, but still gained 29%.

Virgin Atlantic to invest GBP100m on product upgrades

Virgin Atlantic, meanwhile, stated it plans to invest in modernising its cabins, to enable the carrier to "retain and enhance our leadership in customer service and experience". "This year we are investing heavily in new product innovation so that we retain and enhance our leadership in customer service and experience," Mr Ridgeway said.

The airline, 49% owned by Singapore Airlines and 51% owned by Virgin Group, will invest GBP100 million in total, including GBP75 million for new aircraft and GBP25 million for updating interiors and installing in-flight technology to enable passengers to use Internet and mobile devices on board. The carrier also plans to improve its lounges, particularly in New York (JFK and Newark Liberty), which remains one of its most lucrative routes.

Virgin is also introducing more efficient A330 aircraft and aims to have eight featuring a new Upper Class cabin by the end of 2012. The carrier is also scheduled to take delivery of its first B787 in 2014. The carrier will also retrofit its fleet of London Gatwick-based B747s. The carrier, at present, operates a fleet of 37 aircraft, with three aircraft in storage. The carrier also has 26 aircraft on order, including 15 B787-9s. Deliveries will commence in 2014, based on the current schedule.

Virgin Atlantic fleet profile: Aug-2011

A look at the Virgin Atlantic network

Virgin Atlantic, the second largest operator at London Heathrow after British Airways, stated on its routes between the US and the UK, which include five times daily London Heathrow-New York services, summer services from Orlando to three UK airports, and service from eight other destinations, Virgin Atlantic reported a strong 21% increase in revenue in FY2010/2011.

London Heathrow Airport capacity (seats per week, to/from) by carrier (08-Aug-2011 to 14-Aug-2011)

"These are excellent results for the U.S. In a challenging environment for the industry, we're delighted to have grown revenue by 21 percent year over year. Stronger economic performance on both sides of the Atlantic produced healthy growth in traffic, passenger market share gains across our gateways and more rational market capacity," Senior VP in North America Chris Rossi said.

Virgin Atlantic is the second largest operator by capacity between the UK and US.

United Kingdom to United States (seats per week, one way, 4-Jul-11 to 29-Jan-12)

Revenue on the carrier's route between London and Sydney, via Hong Kong, rose 13% in the 12-month period, with a 22% increase in sales generated in Australia. Virgin Atlantic is the fourth largest of five carriers operating between the UK and Hong Kong, and the third largest of three operators between Hong Kong and Australia.

United Kingdom to Hong Kong (seats per week, one way, 4-Jul-11 to 29-Jan-12)

Australia to Hong Kong (seats per week, one way, 4-Jul-11 to 29-Jan-12)

Revenue on Virgin Atlantic routes between Kenya and London, meanwhile, rose 15% which included a 25% increase in sales generated in Kenya. On the airline's Shanghai route, revenue increased 41%, boosted by a 57% rise in leisure demand and 42% jump in business demand.

Virgin Atlantic manager for China, Jim Bai, said the airline is gaining recognition in the eastern China market and loyalty continues to grow, despite increased competition. The carrier this month also announced the expansion of its codeshare agreement with Air New Zealand to include Auckland-Shanghai Pudong-London Heathrow service.

United Kingdom to China (seats per week, one way, 4-Jul-11 to 29-Jan-12)

The carrier did not reveal numbers on its London-Tokyo route, which would normally carry a large proportion of business travelers, due to the disruptions to service it suffered after the 11-Mar-2011 earthquake and tsunami.

Meanwhile, the carrier last month stated the carrier would launch a second daily London Heathrow-Dubai service following the delivery of B787 equipment. However, CCO Julie Southern stated the airline has no plans to expand in the Middle East, with the exception of the Dubai route.

Virgin Atlantic also stated revenues on its London Heathrow-Delhi route was "driven largely by sales in India" with the demand remaining high with a positive 80% load factor. "Virgin Atlantic in India has made a positive contribution to the airline's overall 2010-11 results," Virgin Atlantic Country Manager for India Michael Burke said. "Loyalty to Virgin Atlantic continues to grow. Last year we saw a 13% growth in our Delhi to London business reflecting a rebound in confidence particularly in the business travel sector," Mr Burke added,

Virgin Atlantic pilots accept pay deal

Virgin Atlantic pilots, represented by British Airline Pilot's Association (BALPA), this week voted to accept a pay offer from the airline, which includes a profit share scheme, a programme to review pilot lifestyle and a commitment on improving the way management and pilots will work together. The acceptance of the offer ends the prospect of strike action.

In a letter to Sir Richard Branson, BALPA secretary Jim McAuslan said that although long service pilots recall Virgin being "fuelled by passion, fun, and unbounded enthusiasm", he said "that does not feel like the DNA of today." He said pilots need to hear less from their president about how things used to be and more about how they ought to be.

Virgin Atlantic sale 'attracting interest'

While no official mention was made of potential new investors in the airline upon the release of the carrier's financial results, Mr Ridgway noted that the carrier has attracted interest from potential investors after completing a study of its strategic options. "We have a pretty good understanding of what's happening in the market. We know where all the chess pieces are," he said. He however added that "there's nothing happening right now" with any takeover discussions.

Virgin Atlantic is reviewing its operations after US and European antitrust regulators approved British Airways, Iberia and American Airlines to create a joint business in its key North Atlantic market in Jul-2010. This development not only highlighted Virgin's relative small size in the market, but its vulnerability due to not belonging to any of the three major airline alliances.

Virgin Atlantic hired Deutsche Bank in 2010 to look at growth opportunities and assess its financial environment, which could lead to an equity restructuring of the airline. The carrier is considering two options - either aligning itself with an alliance or equity-ownership restructuring - as it seeks to survive in the face of "mega alliances" and the rapid pace of consolidation among competitors. The increased consolidation activity and alliance focus has been accelerated by the global downturn that Mr Ridgway has stated has changed the industry for good

Announcing the alliance plans back in Jan-2011, Sir Richard said: "We've enjoyed being independent but we think that having some kind of alliance attached to Virgin Atlantic will make us that much stronger. We're going to need a big brother to take us through the next 30 years. Most of the people we talked to are keen to have Virgin as part of their alliance, and that's the more likely outcome. Since the competition authorities in their wisdom have allowed these mega alliances, in order to protect Virgin Atlantic long term ... we're now going to have to make sure we have the firepower and the strength to survive the next 50 years."

Virgin Atlantic is the only one of the three London Heathrow-based airlines (along with British Airways and bmi) that is neither part of a larger group nor even of an alliance. This presence in London Heathrow and the ownership of the extremely valuable London Heathrow slots, is one of Virgin Atlantic's biggest drawcards. The airline holds around 3% of slots at the airport, around the same level as American Airlines but less than British Airways which controls 42% of the slots and bmi 11%.

A number of carriers have expressed interest in Virgin Atlantic although talks are complicated by Singapore Airlines' 49% ownership in the carrier, acquired for GBP600 million in 1999. Singapore Airlines CEO Goh Choon Phong in Jun-2011 however stated the carrier was open to any offers for its stake in the carrier. He added that the company is not opposed to mergers and acquisition possibilities and would look at future opportunities. "I think we have been quite open, we have stated that we are open if somebody is interested in the 49 percent stake in Virgin, they can make an over and we will evaluate it and we will make decision based on that," he said.

Meanwhile, Virgin Atlantic President Sir Richard Branson in Jun-2011 stated he was prepared to reduce his stake in Virgin Atlantic if it would aid the carrier's search for an alliance partner. Sir Richard added that he would always be a "major shareholder" and his preferred option is for Singapore Airlines to reduce its 49% holding. Sir Richard also noted that the carrier needs a partner to compete with British Airways. "It makes sense for Virgin Atlantic to have a partner as well. I will certainly still be extremely involved in the airline, whatever we decide to do, and I will still be a major shareholder. We are in discussions with various people and will see what comes out of it. We have received offers, but it's too soon to say more," he has said.

Mr Ridgway previously stated that he is confident that "even if nothing happens, we can continue to grow". He would not comment on whether Etihad Airways or Delta Air Lines, both of which have voiced an interest in the carrier, would be a better fit for Virgin Atlantic. Etihad Airways, in Jun-2011, ruled out a takeover of Virgin Atlantic, but declined to deny any interest in acquiring a stake in the carrier.

A good week for Virgin Atlantic but future remains uncertain

It has been a good week for Virgin Atlantic, with the carrier heading off a potentially devastating mid-summer strike and reported a return to the black in the 12 months to Feb-2011. However, as consolidation activity continues among airlines in different parts of the world (most recently with the MAS-AirAsia tieup), Virgin Atlantic remains alone in the increasingly competitive European market. While Virgin Atlantic is able to stand alone for now, its long-term future is dependent on some kind of alliance, whether in the form of membership in a global airline alliance or through a merger of some kind.