Never let a crisis go to waste: Virgin cuts deeper amid coronavirus gloom

Virgin Australia’s newish chief executive Paul Scurrah’s mantra must be something along the lines of 'never let a crisis go to waste'.

Scurrah has taken a knife to the airline – its capacity, its fleet size and staff – that is sharper than previously anticipated. But this is not only about mitigating the financial fallout from the coronavirus, it also provides Scurrah with cover to fast-track resetting its earnings base.

It’s not the first time Scurrah has found upside in what prima facie looked like a problem. Remember the troubled MAX 737 planes that had two crash disasters in 2018? Virgin was able to delay the delivery of this aircraft – a move that was financially fortuitous.

Virgin’s Paul Scurrah and Qantas’ Alan Joyce – both are cutting capacity.

And then there was Virgin’s Hong Kong route – which Virgin admitted on Wednesday had accumulated losses of $130 million since it began operation in 2017. The route had performed poorly but the political unrest again provided Virgin an excuse to abandon it.

The coronavirus will in the short term hurt Australian airlines' earnings, but it does provide additional impetus to make the cost and capacity cuts that Virgin needs to become a business that makes a reliable return.

(Virgin will cut capacity by 3 per cent in the second half of 2020 and up to 5 per cent by 2021. This includes a 40 per cent reduction in Tigerair’s fleet in response to falling leisure demand related to the coronavirus. It could be ramped up if conditions dictate.)

Virgin estimates the advent of the viral epidemic will impact earnings by between $50 million and $75 million in the June half. Qantas, a larger airline with a far bigger international network, last week warned coronavirus will cost it between $100 million and $150 million in second-half profits.

The coronavirus will in the short term hurt Australian airlines' earnings, but it does provide additional impetus to make the cost and capacity cuts that Virgin needs.

Short of a miracle, coronavirus will wipe out any earnings Virgin makes in the second half of the 2020 financial year as well as the $14.5 million underlying earnings it posted in the first half to December 2019.

The underlying result in the half was an 87 per cent decline on the previous corresponding period – a performance that Scurrah readily admits is not where it needs to be.

“We are a great airline but we need to turn ourselves into a great business’, he said.

Scurrah’s progress on his planned transformation is already being reflected in the first-half statutory results – which show Virgin moved to a loss of $88.6 million.

This includes one-off charges associated with redundancies, fleet simplification and the writedown of property, plant and equipment.

Another plank in Scurrah’s revival strategy was moving to 100 per cent ownership of frequent flyer group, Velocity. This also hit Virgin’s earnings in the December half by $26.8 million but the acquisition will allow Virgin to access Velocity’s growing cash flow.

Given Scurrah is pushing ahead full throttle with his transformation plan, we could expect to see one-off statutory losses related to the changes in the second half as well, whilst the benefits of the cost cutting will not reach full stretch until 2021.

No promises

Scurrah won’t make any promises on when returns will start to hit his targets. To be fair, the coronavirus outbreak makes the near term unpredictable.

On a more positive note, while the underlying profit was hurt in the December half by increases in fuel prices, airport charges and interest, Virgin managed to improve both passenger numbers and revenue.

It also forecast that second-half revenue would be flat on the previous corresponding period despite coronavirus-related cancellations and soft forward bookings.

This will be achieved thanks to a combination of higher load factors and a better yield (read better pricing.)

Qantas has also announced capacity cuts to deal with weaker demand. This suggests neither airline is prepared to engage in a pricing war to fill planes – an outcome that will be greeted with relief by investors.

Indeed Scurrah re-stated earlier comments that he is not particularly focused on market share, but pays attention to profits.

This explains why a disproportionate amount of attention is being paid to Tigerair and to Virgin’s International divisions – both of which have been trouble spots in the group.

Thus Virgin remains a work in progress – the timing of which should be clearer in 2021.

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