Virgin’s USD 2019 bond has rallied on the recent capital injection and new shareholders. With the credit rating and negative outlook affirmed, now could be a good time to consider taking profits
Since Virgin Australia (‘Virgin’) announced an aggregate of A$1bn in capital raisings, both Moody’s and S&P affirmed their existing credit ratings (B+/B2 corporate rating, B-/B3 bond rating) while retaining a negative outlook on the credit.
The negative outlook appears to be somewhat harsh given the quantum of the capital raise (equal to slightly less than half of 1H16 net debt of A$2.1bn). However, it is understood part of the proceeds will be used to repay the A$425m shareholder loan provided earlier this year, which leaves around A$600m to meet near term funding requirements, such as capital expenditure.
Improvement in credit ratings will require continuing progress from Virgin in improving key credit metrics, such that the airline's lease adjusted net debt to EBITDAR* ratio will remain comfortably below 5x. At 31 December 2015, Virgin’s lease adjusted net debt to EBITDAR ratio was 5.7x which is considered very high.
Noting the high financial leverage, Virgin’s credit rating has historically been underpinned by the implied support of its major airline shareholders (which includes Singapore Airlines, Etihad Airways, Air New Zealand and the Virgin Group). While Virgin’s capital raise has no doubt been a positive for the credit, the shareholder structure has become more complicated with the addition of Chinese conglomerates HNA and Nanshan.
With the most recent capital raising being proposed at a share price of A$0.21 (a 29% discount to the closing share price prior to the announcement), we would expect there is less appetite within the original shareholder group to inject further capital going forward. Offsetting this is the inclusion of Chinese conglomerate shareholders (HNA and Nanshan) who are both supporting the most recent capital raise and are expected to provide Virgin greater access to the fast growing Chinese tourist market.
In the rating agencies’ opinions, the total equity proceeds of around A$1bn (excluding transaction costs) are sufficient to alleviate the near term funding requirements. However, in the rating commentary, it is noted that Virgin has only a limited financial buffer against volatile fuel prices, foreign exchange movements and variable passenger demand and has retained its negative outlook on the credit rating as a result.
Despite what have been very favourable market conditions in the airline sector, Virgin has not been able to improve its earnings profile as successfully as Qantas, with costly fuel hedges offsetting much of the benefits expected from the lower fuel price in recent years (although we understand these hedges have now rolled off). With modest earnings growth and high capital expenditure requirement, the company has not been able to generate positive free cashflow in recent years and has relied on additional debt and equity funding to support the business.
With the bonds having rallied over the past month, now may be a good opportunity to take profits on Virgin. The bonds are rated B-/B3 with a negative outlook from both rating agencies, and a downgrade to ‘CCC’ level ratings may see recent capital gains reversed.
*EBITDAR represents earnings before interest, tax, depreciation, amortisation and aircraft rentals.
Please contact your FIIG representative for further details on the Virgin US dollar bond. Available to wholesale investors only with a minimum face value of USD10,000.