Stocks dive after airline’s blues

The Australian says that nervous investors have battered airline stocks following the profit downgrade by Virgin Blue, slashing share prices at Australia’s number two carrier by more than 20 per cent.

Virgin Blue’s shares plummeted to a new record low of 87.5c yesterday from the previous close of $1.11 in the wake of the airline’s after-market prediction on Friday night that its 2007-08 net profit after tax would more than halve to about $100 million.

The share price rout came as analysts continued to downgrade their price and profit targets for Virgin, with one predicting the airline’s woes would last as long as two years and that net profit before abnormals could sink as low as $25 million next financial year.

Virgin did not comment yesterday but majority owner Toll Holdings downplayed the falling share price, questioning whether it had any meaning given that less than 10 per cent of the airline was publicly traded.

Worries that the effect of higher fuel prices, increased capacity and slowing demand hammering Virgin Blue could also hurt Qantas saw the flying kangaroo’s shares fall almost 4 per cent, from $3.80 to $3.65.

This was despite assurances from chief executive Geoff Dixon that Qantas had no plans to revise its 2007-08 guidance of a record pre-tax profit at least 40 per cent higher than last year’s.

Yesterday Mr Dixon rejected suggestions that Virgin’s problems could be equated with Qantas’s performance.

He said the market was wrong if Virgin’s slide was driving the fall in Qantas prices.

“Our fundamentals are very, very good,” he said.

“Fundamentally, this is one of the strongest airlines in the world, and we continue to believe our cost base is still very, very good.”

New entrant Tiger Airways also expressed confidence that it would weather any storms, citing its low cost base.

Chief executive Tony Davis said the airline would match any moves by Virgin or Qantas to increase fares.

“History has shown that in times of economic uncertainty, true low-fare airlines like Tiger Airways are more attractive to consumers as they hunt out the lowest possible fares,” Mr Davis said.

Nonetheless, airlines are facing tougher times as competition on the domestic market rises due to an influx of new planes, while demand in the leisure end softens.

This is combining with record fuel prices in what one senior airline executive has described as a “perfect storm”.

Virgin estimates that airline capacity in the domestic market will increase by about 18.5 per cent in the second half of this financial year and one analyst has estimated it will average more than 10 per cent growth for the next five years.

The problem for Virgin is that this is happening as a move up-market from Virgin’s low-cost origins is increasing costs.

Virgin is spending about $70 million setting up an international airline — $40 million of it in the current half — and introducing a new fleet of Embraer regional jets.

And unlike Qantas, Virgin does not have extensive international operations to offset a weak domestic market.

Centre for Asia Pacific Aviation chief operating officer Derek Sadubin said yesterday that Virgin was caught in a strategic “no man’s land”.

“It is experiencing the same headwinds as the rest of the aviation industry, in higher fuel costs and a slowing economic environment, at the same time as it transforms into a business carrier,” he said.

The ramp-up in capacity in the Australian domestic market only serves to intensify the pressure on Virgin Blue.

It no longer has the cost base to compete sustainably with Tiger or Qantas offshoot Jetstar on price.

“The other carriers know this, and will be relentless in their attack on Virgin Blue in the coming weeks and months.”

ABN AMRO analysts predict significant headwinds for the airline for the next two years.

They reduced their price target for Virgin’s shares from $1.35 to 95c and warned that it could earn as little as $24.5 million next financial year before rising about $60 million in fiscal 2010.

“Given the sizeable fleet expansion to be funded by Virgin Blue over the coming years and the increasing cost pressures, we expect the dividend to be cut in FY09 and not reinstated until post FY11,” they said.

Credit Suisse was less pessimistic about the airline’s prospects.

While its analysts predicted Virgin would make a second-half loss of at least $4.9 million and lowered their price target from $2.92 a share to $1.44, they retained an outperform valuation and remained of the view that it was undervalued.

A Report by The Mole from The Australian