Sri Lankan Airlines to be sold off; Virgin Australia presents questions for Etihad which leads to the bigger questions over the Qantas position; and the Indian parliament ratifies the biggest shake-up in its aviation history

Dino D'Amore
By Dino D'Amore June 15, 2016 22:34

Sri Lankan Airlines to be sold off; Virgin Australia presents questions for Etihad which leads to the bigger questions over the Qantas position; and the Indian parliament ratifies the biggest shake-up in its aviation history

Sri Lanka has committed to reforming government finances and the public sector, which includes selling off SriLankan Airlines. In a letter of intent to the International Monetary Fund this week, the government promises a “resolution strategy” or sale of SriLankan Airlines by September 2016. As part of the $1.5 billion dollar three-year IMF support arrangement, the government intends to record the fiscal cost of non-commercial obligations and subsidies for SOEs in the central government budget, starting in 2017.
Airport and Aviation Services Limited will also be privatized.

Following a three-month review of its finances, Virgin Australia will remove some ATRs and all E190 aircraft from its fleet over the next three years (which had been used to serve mining industry traffic). This news comes as a blow to NAC, which now has near monopolistic control over Embraer aircraft in the leasing sector. No doubt this will create a glut of E190s on the market and it might be that NAC would be interested in removing those aircraft from the market at speed. Virgin confirmed that the 40 737Max order is safe.

Virgin Australia will also cut its 10,000 strong workforce by an undisclosed but “significant number” to cut costs. Given that around 2000 were added to service domestic routes and aircraft over the past few years that are now being cut back/removed, it could be argued that the force will be cut by at least that number.

The Australian carrier also plans to raise $852 million to help pay down its debt, which helped fund its expansion to a full-service airline from a budget carrier over the past five years. The fund raising will be on top of the group’s recently announced $159 million share placement to China’s biggest private airline operator HNA Group, giving the company $1.01 billion in new equity capital. Virgin’s latest capital raising will see existing investors receive one share for every share they already own at 21 cents each in a non-renounceable offer. That news triggered the obvious sharp sell-off in Virgin, with the stock closing 3.5 cents lower, or 11.9%, at A$0.26 cents.

“Our renewed capital structure will strengthen our balance sheet, provide additional liquidity and help fund initiatives to improve earnings and cash flow,” Virgin chief executive John Borghetti said on Wednesday.

Virgin’s restructuring plan comes on the back of two new Chinese shareholders taking stakes in the airline. Chinese conglomerate Nanshan Group last week agreed to buy a 19.98% stake from Air New Zealand. While last month HNA came to a strategic commercial alliance with the airline which will see the two companies start direct flights on the increasingly busy China-Australia route from next year. The alliance includes code-sharing, frequent flyer programs and lounge access.

Virgin expects net free cash flow savings to increase to $300 million annually by the end of fiscal 2019 as a result of the proposed cost cutting. The company also expects to spend between $200 million and $250 million on restructuring costs, and to incur between $150 million to $200 million in noncash impairments over the next three years.

So will Etihad look to exit Virgin Australia? The fact is that the Australian market is too important to leave to chance as Emirates has shown with Qantas. Etihad could this year complete some sort of deal with SriLankan Airlines that would fit nicely into its portfolio of distressed turnarounds, but Etihad has a problem with Virgin Australia in that its significance on the board is greatly diminished along with the value of its holding. Etihad is though, for the moment, better off in the boardroom of an Australian major rather than out of it altogether.

The fact is that Virgin Australia is still an airline which, as it stands, would run in the red were it not for low fuel prices at this time, as recent figures attest. As such, the real side to this story lies not with Etihad’s next move but just over the proverbial shoulder of Virgin Australia at the door of the now mighty Qantas.

The future for Qantas?

Credit Suisse analyst Paul Butler has hit the nail on the head when he stated that the Virgin Australia investments of late could act as a catalyst for the Chinese to take a stake in Qantas:

“The recent attention on Virgin Australia could raise interest in Qantas from Chinese airlines. A significant minority share in Qantas along with a strategic alliance could enable a Chinese airline to gain a stronger market position on routes between Australia and China…“It is possible for any of the three major Chinese companies to target a stake in Qantas, but it is more likely that China Southern or China Eastern would be interested, as they have a greater focus on the Australian market.”

Qantas already has partnerships with China Southern and China Eastern and codeshares with them on routes between Australia and China. Yesterday, Qantas completed its $500 million share buyback. It means the airline has returned $1 billion to shareholders in the past 12 months after handing over $505m to shareholders in the form of a 23c-a-share distribution in August 2015.

The buyback, which kicked off in March, has seen 143.6 million shares bought back at a weighted average price of $3.4819 a share. Now, with Qantas shares trading at a 12-month low of $2.88, the airline is an obvious target for any airline looking to invest in the Australian market. The strategic value and current opportunity for investors is surely not going to be overlooked. Where Qantas is concerned this extends to China and the Middle East and one would hope SIA would try again for the airline in this situation. Once again Qantas management have surpassed all expectations and planted their company into a terrific position.

Meanwhile in India, the 5/20 rule has gone! After many news stories here on the subject we have a definitive run down of what will affect airlines in India in the near future: The Indian Union Cabinet today reportedly approved the proposed aviation policy, which includes the capping of airfares at Rs2,500 for an hour-long flight. It also confirms that the 5/20 rule will be replaced by 0/20 rule, which implies that airlines will be allowed to fly abroad only if they have 20 aircraft, but there would be no restriction on the number of years of operation, thus the way is open for Vistara and AirAsia India to start international operations if 20 aircraft are tipped into their fleets at speed. The Cabinet also approved cap of Rs 1,200 airfare for flights of 30 minutes or less.

Calling the policy a “game changer,” Civil Aviation Minister Ashok Gajapathi Raju tweeted that the country’s aviation sector is poised to become the world’s third largest by 2022.
Significantly, India’s domestic air traffic market logged the fastest growth in the world for the 13th consecutive month in April. The market grew at nearly 22% during the month.
India’s domestic traffic soared 21.8%, marking the 20th month of double-digit traffic growth and the 13th consecutive month it has led the domestic markets.

At the same time Indian airline stocks bounced back today after crude oil prices declined. SpiceJet (up 4.75%), Jet Airways (India) (up 1.99%) and InterGlobe Aviation (up 3.05%). Brent for August 2016 settlement was currently off 51 cents at $49.32 a barrel. The Brent August contract lost 52 cents or 1.03% to settle at $49.83 a barrel yesterday, 14 June 2016.

What is being purchased by Chinese companies today may well soon be purchased by Indian companies in 2030, a date that should have come far sooner. Indian democracy will catch-up with its Chinese competitors if it can maintain political stability and economic prudence.

Dino D'Amore
By Dino D'Amore June 15, 2016 22:34