Virgin faces gruesome second half

The Australian reports that analysts are predicting a gruesome second half for Australia’s second biggest airline when it becomes the first local carrier to report its full-year earnings next week.

Because of deteriorating conditions, the expectation is that the airline will at best break even in the second half, but will more probably report a loss.

Merrill Lynch analysts Kevin O’Connor and Nicholas Robison predict the carrier will come in at the lower end of its guidance of $92 million to $97 million net profit and warn it could be as low as $85 million.

They expect no final dividend as the airline is battered by a higher fuel bill for the year and falling yields in the second half.

“We expect a full-year load factor of 80.3 per cent, which is down 0.9 points year on year, and a sharp decline from the 83.2 per cent reported in the first half,” they said.

“The key reason, aside from weakening demand, was acceleration in Virgin Blue Airlines’ capacity growth in the fourth quarter of fiscal 2008.

“Capacity in the first half was up 3.2 per cent, this rose to plus 11.3 per cent in April and plus 17.5 per cent in May.”

“We expect a similar rate of growth in June.”

According to Virgin, the launch of V-Australia and flights to the US, the introduction of its Embraer fleet in Australia and Pacific Blue in New Zealand is expected to cost it about $40 million for the year.

The analysts said the carrier’s “new world strategy ” was the right one to enable it to enter the most profitable Qantas routes and compete for more corporate business.

“Unfortunately, for Virgin Blue Airlines this move has coincided with a downturn in international and domestic demand combined with record fuel prices,” they said.

They expected Virgin to report a $75 million loss in financial 2009, recovering to a $3 million profit in 2010.

They said key drivers of the outlook were jet fuel prices, the speed of recovery of trans-Pacific demand, and how rapidly Virgin and Qantas can adjust capacity to regain domestic pricing power.

Virgin confirmed this week that it was still on track to launch V Australia in December amid rumours that US giant Delta Air Lines was considering a trans-Pacific service to Sydney.

Unconfirmed rumours suggest Delta wants to start a three times weekly Atlanta-Los Angeles-Sydney service late next year using long-range Boeing 777s.

However, the federal Government said yesterday it was not aware of any approach by the US carrier.

Qantas also will report full-year earnings next week and they are expected to be in line with previous guidance.

This week, JPMorgan upgraded the flying kangaroo from neutral to overweight to reflect greater earnings certainty because of the fall in jet fuel prices.

Analysts Matt Crowe and Russell Crichton-Browne, who expect Qantas to report a 2007-08 net profit of $1.03 billion, said the airline’s worst-case fuel bill for fiscal 2009 was 80 per cent, locked in through increased hedging.

They said the combination of recent falling US crude oil prices and a falling exchange rate translated to a cut of 17 per cent in the price of jet fuel in Australian dollars.

They estimated a crude price of $110 to $115 a barrel, combined with lower refining margins of $US20 to $US22 and the weaker Australian dollar would mean a reduction of just $5 million in pre-tax profit for 2008-09.

They predicted Qantas’s yield would reverse six months of declines and grow strongly this financial year.

“We have upgraded our valuation from $3.95 to $4.05,” they said, adding that they had set a new price target for June of $4.25. 

A Report by The Mole from The Australian