Virgin On The Ridiculous?

This story features QANTAS AIRWAYS LIMITED. For more info SHARE ANALYSIS: QAN

By Chris Shaw

A weak economy is a tough operating environment for an airline and Virgin Blue ((VBA)) is no exception as its fledgling international operation in particular records losses as it attempts to build up its competitive position, while the domestic operations are dealing with a weaker demand environment.

To strengthen its financial position the group has announced an equity raising to generate $231 million via shares issued at $0.20, the immediate impact being a reduction in broker earnings per share forecasts as they factor in the dilutionary impact of the more than one billion new shares to be issued.

According to Bank of America-Merrill Lynch, the capital raising makes sense as while the company has around $475 million in cash on its balance sheet it can only access around $170 million of this as the rest is linked to credit card merchants and aircraft lessors.

By raising the additional funds the broker sees the group as increasing its room for error in the event the economy again turns down or it has to deal with other possible outcomes such as ongoing price wars with competitors or a further outbreak of swine flu.

Along with the capital raising the company has provided earnings guidance indicating a break-even result in FY10 in net profit terms, with cash flows for the year expected to be positive. Here is where it gets interesting among analysts, as there are some significantly different views as to exactly what this implies.

According to UBS the new guidance for FY10 is conservative as the broker is forecasting a net profit next year of around $40 million, which is based on expectations of lower fuel prices and given recent signs of a possible bottoming in the domestic market. Given such an outlook the broker retains its Buy rating, though it concedes the company remains hostage to its economic environment at present.

In contrast Deutsche Bank argues the capital raising is an indication the group’s earnings outlook remains uncertain as the move to raise additional cash suggests management is concerned operating conditions could deteriorate further. Its argument is supported by management comments it intends to try to raise a further $200 million through asset sales and lease-backs. Given these concerns the broker is happy to stick with its Hold rating.

This is matched by RBS Australia as it too sees the current economic environment as being difficult enough that there are no obvious positive catalysts for the stock, especially as while the domestic operations are putting in a credible performance there are still a number of challenges for the international operations.

Currently the broker is factoring in a recovery to modestly positive earnings in FY11 after break-even in FY10, forecasting EPS of 2.1c for the latter year while conceding there are risks to its numbers from the potential of higher oil prices by that time.

 The broker continues to prefer the stock to Qantas ((QAN)) but the existence of earnings risk is preventing it from turning more positive. Other brokers have similar estimates for FY11, with UBS and Deutsche Bank forecasting EPS of 3.0c, the latter cutting its estimate from 9c previously.

BA-Merrill Lynch expects FY11 EPS of 10c and sees the update on the FY10 earnings outlook as reducing market concerns about the company’s financial and operation position, esepcially as it implies no further improvement in operating conditions despite evidence over the past couple of months of an increase in loads on V Australia in particular.

Macquarie is also positive and has upgraded the stock to a Buy given it sees greater upside to FY10 earnings than does management. The broker is urging shareholders to take up the rights at $0.20 if possible, seeing the stock as very good value at that level.

The majority of those covering the stock agree as the FNArena database shows Virgin Blue is rated as Buy five times and Hold three times, with an average price target of $0.50, down from $0.56 reflecting the dilution to earnings from the new shares being issued. 

Shares in Virgin Blue today remain in a trading halt pending the completion of the equity issue.

Click to view our Glossary of Financial Terms