Australia | Jun 14 2007
By Greg Peel
Since May 1 the price of Virgin Blue Holdings (VBA) has fallen 13.4% while the ASX 200 has risen 0.6%. This is enough for the analysts at Credit Suisse to raise their rating to Outperform, as they are wont to do in such circumstances. It is simply a model-triggered upgrade with no supporting argument beyond the maths.
The FNArena B/H/S ratio now stands at 6/2/0 for Virgin, but that has also been bolstered by an upgrade today from Merrill Lynch. Merrills was a bit more expansive on its reasoning.
It is true that the Virgin price has been in the doldrums, mostly since April. In the meantime we’ve suffered the whole Qantas (QAN) circus, including the sudden realisation from management post the APA takeover failure that the company was indeed in a much better position than first thought. One of the biggest threats to Virgin has been, however, the imminent entry to the discount domestic market of Singapore-based Tiger Airways.
Third airlines have a sorry history in this country, mostly because Qantas and the now defunct Ansett were always able to successfully squeeze out any competition. The question was always raised, however, as to whether Australia really did have the population to justify three competing domestic carriers. Two things are different today, although the golden rule is to never say “things are different this time”.
Firstly, Tiger is a foreign discount airline with an established market presence in Asia, as opposed to a local start-up forced to operate out of a tin shed. Secondly, the mining boom and general strong state of the Australian economy has meant a lot more people in either ties or hard hats flying hither and thither more regularly. Merrills notes that the strong Australian domestic operating environment was again confirmed yesterday when Qantas released its April traffic figures. Says Merrills:
“We think capacity usage is so tight that loads and pricing will remain firm in FY08 even assuming Tiger enters late calendar 2007.”
Merrills also thinks Tiger’s entry could well be delayed, but either way the airline is only targeting 3% market share. The analysts suggest that both Qantas and Virgin are already “spilling revenue”, meaning they could probably sell more tickets if they had the capacity. In other words, Tiger could come in and pick up some business without actually having any effect on margins.
Merrills has increased its FY08 profit forecast for Virgin by 27% to $219m. 64% of this rise is as a result of increasing load factor assumptions by 2% to 80.4%. The rest is made up mostly from a 1% increase in yield assumption and a slight reduction in leasing cost assumption.
The analysts have established a target of $3.00 to accompany the Buy rating. Merrills only sets targets when it recommends a Buy. The puts the stock at a PE of 14.6x which assumes Virgin should trade at a premium to Qantas based on fleet age and free cash, but at a 15% discount to the broad market due to the innate volatility of airlines.
The average target in the FNArena database now stands at $2.90 with the stock already posting a solid morning – up 6% to $2.48.