Virgin has delivered a much improved performance in 1H16, driven by improved operating performance and lower fuel costs. The company is targeting a significant improvement in credit metrics by FY17
Virgin has reported its financial results for the first half of the financial year (1H16). The result reflects a significant improvement in the financial performance of the business. Some of the key highlights from the 1H16 result are as follows:
- Revenues were up 12% to $2.66bn, highlighting the improved operating conditions in the domestic aviation sector
- Underlying profit before tax up eightfold to $81.5m, group EBIT up threefold to $161.4m
- Tigerair was EBIT positive generating $13.9m for the half year, a strong turnaround of +$38.7m
- The international business still turning around, with an EBIT loss of ($30.8m) an improvement of $8.7m. The company is targeting the international business to be profitable in FY17
Importantly, Virgin’s earnings uplift was not entirely about fuel costs. Fuel (net of foreign currency) made up $33.8m of the circa $71m total uplift in underlying profit. The remaining improvement in underlying profit was made up of operational improvements (net of higher interest costs) across the business. Virgin expects to gain an increasing exposure to the recent decline in oil prices as legacy fuel hedging contracts roll off in FY17.
By all measures, Virgin remains a highly leveraged company on current metrics, with financial leverage (measured by net debt / EBITDA) reducing from 6.8x at 1H15 to 5.7x in 1H16. However, we note the significant improvement in earnings, favourable tailwinds for the Australian aviation industry (end of capacity war and price increases, lower fuel costs, and operational efficiencies). We also note the improvement in financial leverage was achieved against the backdrop of an unfavourable currency impact associated with its US dollar debt balances. The Virgin bond has a relatively weak credit rating of B-/B3 we believe the credit story is improving for this business.
In recent rating commentary, Moody’s has stated
“The rating could be upgraded if Virgin is able to improve its financial profile such that adjusted debt-to-EBITDA improves to less than 6.0x on a sustained basis. This would likely be caused by continued improvement in the supply demand dynamics in the domestic market and continued increases in the company's exposure to the more stable and profitable corporate and government sector, leading to improving yields and profitability.”
Virgin’s net debt / EBITDA ratio of 5.7x for 1H16 is within the threshold described by Moody’s for a rating upgrade, and if the company can sustain these improved metrics, we would expect to see a rating upgrade on Virgin. The company is targeting a financial leverage ratio of between 4.0x-4.5x by FY17 highlighting that the company will seek to continue to improve its credit position in the coming years.
The Virgin US dollar bond maturing in November 2019 is currently priced at an indicative yield to maturity of 7.9% per annum. Despite the improved earnings result, we didn’t see a meaningful rally in the bonds post results announcement, which probably has more to do with the broader state of markets at the moment than it does about the specific Virgin credit story. We believe the bond represents good value in the context of an improving credit story and favourable domestic aviation sector dynamics.
A link to the company’s announcement is available here.
Please contact your FIIG representative for further information on the Virgin USD bond. Quoted pricing is indicative and subject to change. Available to wholesale investors only.