Toll Disarms Doors And Cross-Checks

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This story features QANTAS AIRWAYS LIMITED.
For more info SHARE ANALYSIS: QAN
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Toll Holdings’ ((TOL)) CEO Paul Little has been all over the business channels yesterday afternoon and this morning trying to convince his shareholders what an exciting concept it is that they can now decide for themselves what to do with Virgin Blue ((VBA)). What a great flick-pass.

The reality is that Toll never bought a 63% stake in the airline because Toll is a transport logistics company and an airline is a transporter. Toll simply acquired the 63% stake because it bought out transport logistics company Patrick Corp in 2006 after a long and bitter battle. Little would also have shareholders believe that the decision to hand almost the company’s entire stake in Virgin to shareholders through an in specie dividend also had nothing to do with the fact Virgin’s shares have fallen 80% in twelve months. Toll had always intended to sell Virgin anyway.

Toll may have always intended to sell Virgin, but it fannied about. It’s easy to say in retrospect, but by the time we all realised the oil price was going to the moon Toll’s failure to come to an agreement with what were supposedly keen buyers of Virgin has come back to bite them. With Virgin in dire straits as it battles with rising jet fuel costs and falling passenger numbers, Toll’s last ditch efforts to find a buyer were, unsurprisingly, unsuccessful.

It all became too hard. Virgin’s demise has been dragging on the Toll share price like a sea anchor, and something had to give. I know! Dump the problem on the shareholders!

To be fair, it is true that Toll shareholders holding on because they really do want a shareholding in the logistics company can now breathe a sigh of relief and simply dump their new Virgin allocations onto the market if they want. The uncertainty of what was going to happen to the sea anchor has now been removed. The question now, however, is: Is this move good for one or both companies?

As far as analysts are concerned, the short answer is yes, but the long answer is a bit more complicated. Or alternatively one might say the long term benefits are positive, but things are still not so great in the short term.

What remains of Toll Holdings is now purely and simply a transport logistics company, and a powerful one in Australia at that. The removal of the Virgin overhang means that Toll now can be re-rated as such. The longer term prospects for such a business are solid.

But the current economic climate is not exactly doing transport logistics any favours, and commodity boom or not there’s still a limit to how much is being moved by rail and port. Also overhanging Toll is an amount of uncertainty over planned expansion through M&A, specifically in Asia. While management is obviously keen on the plan, analysts are not so convinced. The plan has not been tested, and the uncertainty of its success goes some way to counteracting the upside from the Virgin divestment.

Toll can thus only manage three Buy ratings from FNArena database brokers, along with four Hold ratings. Citi (Buy) this morning suggested potential Toll buyers might look to accumulate on any share price weakness for the longer term play. Merrill Lynch and Deutsche Bank (both Hold), for example, cite the deteriorating macro outlook and Asian uncertainty as reasons to not get excited.

The Toll earnings profile has naturally taken a big hit, as by handing off Virgin the company has effectively taken a $1.3bn write-off. Any FY08 profit now becomes a loss. But the important thing is that Virgin is now gone. The average target has fallen from $8.50 to $8.20.

The situation for Virgin shareholders is equally as unclear. Virgin management is pleased with the outcome, if for no other reason the Toll divestment gets the uncertainty of what was going to happen to 63% of the shares out of the way. This suddenly means there is one helluva lot more potential liquidity in Virgin, and this should provide upside potential for the share price.

However, would you buy an airline right now? The problems which have beset all airlines, and seen Virgin’s shares tank by 80%, are still present. There is no end in sight to high oil prices. Airlines are having difficulty passing on jet fuel cost increases into ticket prices given the economic downturn. Who wants to fly now? And while airlines such as Qantas ((QAN)) have the depth and breadth to reduce capacity, and old planes they can decommission, Virgin does not. Indeed Virgin has very little going for it at all at the moment.

One of the elements of the Virgin overhang on the Toll share price was the possibility Toll might have to inject more capital into its inherited airline to stop it from going under. While that obligation is now lifted from Toll, capital remains as Virgin’s problem alone. Nevertheless, Merrills analysts, for one, concede that their earlier fears Virgin may have to raise more capital very quickly have abated on management advice, but they won’t rule out the possibility at some time down the track.

Yet capital may not have to be raised if Virgin is taken over. Virgin management has pointed out this morning that the opening up of the share register now makes this a much greater possibility.

But we come back to the earlier problem – who wants to buy an airline right now? All airlines are in the same boat, and are madly cutting capacity across the globe. In the US, regional airlines are dropping out of the sky weekly. Yet Virgin insists there are potentially interested parties. These will no doubt be the same parties Toll tried – unsuccessfully – to flog to. Perhaps Toll was asking just too silly a price and these suitors will reappear with more realistic offers. Or maybe Mr Virgin himself – 25% shareholder Richard Branson – will step in for the sake of his brand.

Either way, analysts are not getting too excited about the takeover card. Ratings confirmed by FNArena database brokers since June still have Virgin at four Holds and two Sells, with nothing changing this morning. A takeover would be nice, but the current economic environment provides enough reason not to take the risk. And there will be a few Toll shareholders looking for buyers of their Virgin allocations, no doubt.

The current Virgin average target in the database is 72c.

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