Virgin Blue's better-than-expected profitability in 1HFY2010; Expects tougher second half

24th February, 2010

Key Points:

Better-than-expected profitability in 1HFY2010; Expects tougher second half, but profitability in FY2010;
Revenue growth outpaces cost increases;
Improvements in unit cost base;
Group yields down by double-digits;
Short-haul yields up, profitability jumps;
To “vigorously defend” core domestic markets; to secure additional 50 aircraft for domestic operations;
Outlook for V Australia improves, but still delivering losses;
V Australia managing exposure to US-centric market trends;
Polynesian Blue contributes USD1.3 million to net profit;
Cash balance boosted through equity raising exercise.

Virgin Blue's better-than-expected profitability in 1HFY2010; Expects tougher second half

Virgin Blue CEO, Brett Godfrey

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Virgin Blue delivered a better-than-expected result in the six months to Dec-2009 (1HFY2010), returning to profitability in a challenging operating environment, aided by strict cost control efforts and improved domestic yields. The carrier reported a net profit after tax of AUD62.5 million (USD55.8 million) in the six months ended Dec-2009 (1HFY2010), for a net margin of 4.1% (compared to a net margin of -7.5% in the previous corresponding period).

This result means that Virgin Blue outperformed its larger rival, Qantas (which reported a net profit of USD52.1 million in the period), for the first time in the carrier’s history.

Virgin Blue net profit margin (%): FY2006 to 1HFY2010

The carrier also confirmed its recently-updated outlook for the 12 months ended Jun-2010, of a profit before tax (excluding ineffective cash flow hedges and non-designated derivates) in the range of AUD80-110 million (USD71-98 million), indicated a tougher second half (traditionally the weakest half for Australian carriers), with expected net profit in the USD15-42 million range. However, this would represent a significant turnaround from a loss of AUD93 million in FY2009.

The recently-improved forecast reflects an improvement in operating conditions in 1H2010 in respect of two key drivers - a decrease in the average fuel price paid by the Group to USD92/bbl compared to USD127/bbl for the previous corresponding period, and some recovery in yields for the domestic business from the market lows seen in early 2009, to be broadly in line with the same period in 2008. The company noted that concerns remain around the pace of the global economic recovery and the continuing volatility in domestic and international markets.

Virgin Blue financial highlights for six months ended 31-Dec-2009

Currency: USD^	1HFY2010	% Change
Revenue (mill)	1,353.5	+12.2%
Short-haul business (bill)	1,125.3	+3.5%
Long-haul business (mill)	104.5	n/a
Operating costs (mill)	1,259.6	+4.5%
Underlying profit before tax (mill)*	67.5	+33.5%
Profit before tax (loss) (mill)	88.3	/
Short-haul business (mill)	96.5	+126%
V Australia	(34.8)	n/a
Net profit after tax (loss) (mill)	55.8	>
Group yield per RPK (cents)	9.28	-11.4%
Domestic yield (cents)	n/a	+2.7%
Revenue per ASK (cents)	8.25	-10.1%
Unit costs per ASK (exc fuel) (cents)	5.58	-4.5%
Unit cost per ASK	n/a	-16.2%
Passengers (mill)	9.27	-
Short-haul (mill)	9.1	-1.1%
Long-haul (mill)	0.2	n/a
Traffic RPKs (bill)
Short-haul (bill)	11.2	+5.7%
Long-haul (bill)	2.0	n/a
Capacity ASKs (bill)	16.4	+24.7%
Short-haul	14.0	+6.1%
Long-haul	2.4	n/a
Load factor (%)
Short-haul (%)	80.1%	-0.1 ppts
Long-haul (%)	81.1%	n/a

Virgin Blue shares soar in 2009

Despite the better than expected result, Virgin Blue shares were slightly down following the release of the financial results, having risen 9% so far in 2010 to yesterday’s close, after gaining 90% last year. The carrier, like Qantas, stated no interim dividends will be issued. The overall market's subdued state amd Virgin Blue's cautious outlook restrained buying activity.

Virgin Blue share price growth: Jan-2009 to Feb-2009

Revenue growth outpaces cost increases

During the six month period to 31-Dec-2009, Virgin Blue’s revenue increased 12.2% to USD1.4 billion, with operating costs growing at a slower rate, of 4.5% to USD1.3 billion, with increases in all areas except for and fuel costs, due largely to a 25% increase in production (ASKs).

Virgin Blue revenue growth: FY2006 to 1HFY2010

Virgin Blue operating costs (% change year-on-year): 1HFY10 vs 1HFY09

Improvements in unit cost base

Overall, unit cost per ASK (CASK) was down 16.2%, with a 4.5% year-on-year reduction CASK excluding fuel costs. Short-haul CASK was down 6.8%, with the carrier expecting controllable costs to be further reduced in 2HFY2010. The carrier’s labour cost (per ASK) remained in line with the previous years’ levels, and below Qantas Group levels (which managed a slight year-on-year decrease).

Selected airlines labour cost per ASK and year-on-year labour cost change: Three months ended 31-Dec-2009

Virgin Blue Group CEO, Brett Godfrey, commented that while favourable fuel movements had aided the carrier, he was “proud” of the carrier’s efforts to reduce CASK exc fuel, through cost saving initiatives and enhanced productivity across the network, in what Mr Godfrey described as the “toughest operating environment in the industry’s history”. The improved unit cost results also reflect a shift to longer-haul operations.

Mr Godfrey added, “any way you cut it, to continue to achieve cost reductions while we continue to grow our business and fully exploit any improvement in economic conditions demonstrates the remarkable commitment of each and everyone of our team member and the resilience of our model”.

Meanwhile, unit revenue per ASK (RASK) declined 10.1%, reflecting the growth in capacity, together with the impact of V Australia (reporting for the first time in this reporting period), reflecting the lower RASK for international markets.

Group yields down by double-digits

During 1HFY2010, Virgin Blue experienced an 11.4% yield reduction, reflecting ongoing strong price competition together with the naturally lower yields of the long haul business following the introduction of V Australia in Feb-2009. The carrier expects this pressure to be maintained for the remainder of the year.

Short-haul yields up, profitability jumps

Short haul yields were, however, up, by 2.7%, reflecting the carrier’s increasing corporate business focus, reporting a 126% year-on-year increase in profit before tax for the short-haul business (to USD96.5 million). Overall short haul passenger revenues increased 3.5% to USD1.1 billion.

Virgin Blue Group short-haul network: B737/E-Jet fleet

The domestic result is impressive, considering the intense competition in the Australian domestic market. The results reflects “decisive” capacity management, which saw 4.9% of capacity redeployed from the domestic market to other new short-haul markets (non-domestic short haul markets - ie Pacific/Asian markets - experienced capacity growth of 64.6% in the quarter, which, on a stage length adjusted basis, led to yields for the total short haul operation reduced by 4.3%). Overall capacity was up 6.3% in the period, reflecting the launch of 28 new short haul routes in the last 18 months

To “vigorously defend” core domestic markets; to secure additional 50 aircraft for domestic operations

However, Mr Godfrey emphasised that the carrier does “not intend to shy away from remaining competitive, and we plan to vigorously defend our core domestic markets”, indicating that yield pressures will remain during 2010, especially as Tiger expands and Jetstar retaliates.

As part of this strategy to maintain domestic market presence, Virgin Blue stated it is intending to secure additional short-term domestic capacity, with the carrier reaching an in principle agreement with Boeing for an order of up to 50 aircraft. The carrier, in late Jan-2010, stated it was in talks with a number of suppliers, including Embraer and Boeing, to replace some of its 30-50 aircraft that will be coming off leases in the next two to three years.

During the six-month period, Virgin Blue Group capacity (ASKs) increased 24.7% year-on-year, reflecting the carrier’s continued international expansion, with passenger numbers remaining stable at 9.3 million. Load factors for the domestic market increased 1.3 ppts to 82.9%, while short haul passenger load factors decreased marginally (by 0.1 ppts) to 80.1%.

Virgin Blue passenger numbers (mill): FY2006 to 1HFY2010

Virgin Blue RPK and ASK growth: Nov-2008 to Nov-2009

Outlook for V Australia improves, but still delivering losses

V Australia continues to suffer, reporting a loss before tax of USD34.8 million, reflecting "the difficult long-haul environment compounded by the US centric focus of the launch routes" and the one off costs attributed to the original delays to the launch of services due to the Boeing strike. Total long-haul revenues for the six-month period were USD104.5 million, with a load factor averaging 80.8%.

V Australia load factor development: Feb-2009 to Dec-2009

However, Virgin Blue Group stated its long-haul subsidiary is “meeting expectations” and is showing sustained improvements, with the carrier expecting to see a “noticeable improvement” in the second six month period, despite the fact it is seasonally the weaker half of the year. Yields and profitability are both expected to improve moving forward, albeit off a low base, with the carrier still on track to be profitable within 18 months of launch (the carrier added that the 2HFY2010 forecast is moving towards breakeven).

Mr Godfrey has previously stated he believes V Australia will eventually be more profitable than Virgin Blue.

V Australia managing exposure to US-centric market trends

The carrier is also expecting a boost from the launch of services to South Africa in Mar-2010 (the carrier launched Melbourne-Los Angeles service in Nov-2009 and Brisbane-Phuket, Melbourne-Phuket and Sydney-Nadi in late 2009 to reduce the exposure to the US-centric market trends and to absorb the additional capacity as new B777s were delivered).

Virgin Blue Group long-haul operations

V Australia will also benefit from its proposed JV alliance with Delta Air Lines, enhancing V Australia's network and improving its competitive position against the incumbents in the US-Australia market – ie Qantas and United Airlines (Australia’s ACCC granted draft authorisation to the JV in Dec-2009, and the carrier is currently awaiting approval from the US Department of Transportation).

Under the proposed agreement, V Australia will codeshare on Delta-operated services between Los Angeles and New York JFK, Salt Lake City, Orlando and Cincinnati, to connect with V Australia services to/from Los Angeles and to/from Sydney, Brisbane and Melbourne. Meanwhile, Delta will codeshare on Virgin Blue operated flights between Sydney and Melbourne and Brisbane, to connect with Delta flights to/from Sydney. The carriers also announced members of each carrier’s frequent flyer programmes will now be able to earn reciprocal points and have reciprocal lounge access within Australia and the US.

Polynesian Blue contributes USD1.3 million to net profit

Meanwhile, Polynesian Blue, which is 49% owned by Virgin Blue Holdings, contributed USD1.3 million to the carrier’s net profit results, compared to only USD90,000 in the previous corresponding period.

In other Polynesian Blue news, Australia’s International Air Services Commission this month received an application from V Australia seeking a variation of a determination to transfer 360 seats per week to Pacific Blue Australia previously allocated from Pacific Blue to V Australia, for use in the Australia-Fiji market. V Australia seeks the proposed variation "following its experience in this market and in response to market circumstances, including the anticipated entry to the market of a new competitor, and to ensure more efficient use of the Group's network and operational capacity". Under the revised network structure, V Australia will decrease Fiji frequency to six times weekly B777-300ER service. Using the re-allocated capacity, Pacific Blue will operate once weekly Sydney-Nadi B737-800 service, thus maintaining daily services by the Group in that market. Pacific Blue will also introduce a third weekly Melbourne-Nadi service, subject to approval. Submissions about the application are invited by 08-Mar-2010.

Cash balance boosted through equity raising exercise

Cash and cash equivalents increased 77% during the half to USD752 million (AUD842 million) from Jun-2009 levels, with operating cash inflow for the six-month period of USD181 million (+64%). Net proceeds from funding were USD226 million, including USD199 million from the successful equity raised in the period.

Capital expenditure in the period was USD255 million, including one B777-300ER, two E-190s and three B737-800s, and deposits for future aircraft. The carrier currently has 27 future aircraft deliveries scheduled, with aircraft financing mandated for all deliveries up to Nov-2011.

Virgin Blue fleet summary: Dec-2009

Aircraft type	30-Jun-2009	Additions	31-Dec-2009	Future deliveries
B737-700/800	59	3	62	21
E-170/190	19	2	21	3
B777-300ER	3	1	4	3
Total	81	6	87	-
Leased	35	-	38	-
Owned	46	-	49	-

The carrier has also forwarded hedged forex and fuel requirements.

Virgin Blue hedging: fuel and forex

	2HFY2010	FY2011
Forex hedging	Approximately 77% hedged at an average rate of 0.84	Approximately 56% hedged at average price of USD97/barrel
Fuel hedging	Approximately 17% hedged at an average rate of 0.87	Approximately 38% hedged at average price of USD96/barrel

Speculation of new CEO intensifies

Virgin Blue, in its financial release, stated it has drawn up a short-list of candidates to replace Mr Godfrey, who plans to retire this year. Separately, it has been reported that the carrier has selected a preferred candidate, David Baxby, the current head of Virgin Group’s aviation division, although the carrier is reportedly yet to disclose the selection to applicants.

Outlook: Challenging and volatile, but yield and profit improvements expected

During the current financial year, Virgin Blue will benefit from further strategic initiatives, including the proposed Virgin Blue/Delta JV, new routes for V Australia and a continuing focus on productivity across the business.

Short-haul yields are expected to improve, with 5% yield growth expected on a year-on-year basis, although these yields are expected to decline in 2H2010 (to Jun-2010) from 1H2010 levels, due to the competitive pressure and seasonality (domestic seasonality is traditionally split 55:45% between the first and second halves). Meanwhile, long-haul operation results are expected to improvement in 2H2010, as the business continues to mature.

However, the carrier has cautioned that the operating environment remains "uncertain", and that concerns remain around the pace of the global economic recovery and the continuing uncertainty in domestic and international markets.

But there will be an air of satisfaction at Brisbane headquarters, with a respectable result as the new profile as a widebody operator was bedded down following the focus on international establishment in 2009. 2010 will see a greater concentration again on domestic, as new capacity enters the market - and, meanwhile, the Australian Government's decision on allocating its corporate business is still eagerly awaited.

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