Macquarie Bank looks to BUY Virgin – is the airline now an attractive investment?

Written by Sergeo Domtchenko 

It is fair to say that the coronavirus is not hanging around to take any hostages. On Monday evening, Virgin Australia (ASX: VAH) became the highest-profile casualty of the pandemic. Virgin soon announced its intention to enter voluntary administration.

The thought of voluntary administration came off the back of Virgin, dismissing 16,000 employees and the Federal government denying Virgin’s application for a $1.4 billion ‘bail out’ loan. Scott Morrison stood his ground, saying that, “Virgin’s shareholders have deep pockets, and we have no interest in using taxpayer money to bailout a group of billionaires”.

Since then,  Virgin entered a trading halt. Upon entering into administration, Virgin owed $4.8 billion in debt. Consequently, the credit rating agency ‘Fitch’ downgraded Virgin’s credit rating last month. According to Ms Amaro, “Virgin is burning through cash at a rate that will see them burn out around September”.

Deloitte Has a Huge Task Ahead of Itself

Deloitte faces a difficult task in navigating Virgin through COVID-19. Our viewers to understand that Virgin isn’t being sold off. Instead, an independent third party, Deloitte, will analyse the financial structure of the company and provide recovery strategies.

Fortunately for Deloitte, there are several ways that they can choose to restructure Virgin (according to aviation journalists). These include:

  • Downsizing the size of Virgin’s fleet = minimise levels of excess capacity on routes.
  • Selling off TigerAir. An excellent way of injecting liquidity into Virgin.
  • Reducing the number of international routes.
  • Increasing the number of domestic route services.
  • Reducing its airfares to appeal more to price-sensitive customers.
  • Taking advantage of the ridiculously low oil prices by loading up on oil barrels.

The Bidding War is Heating Up

In light of the government’s absence, an array of hungry companies are approaching Deloitte. Ultimately, creating a bidding war. While Mr. Strawbridge from Deloitte is not disclosing the  details of any potential buyers, he did say,  “Up to 20 individual companies are interested in Virgin Australia”.

The most prominent buyers amongst the group  include Wesfarmers (ASX: WES) and Macquarie Group (ASX: MQG). While non-binding offers are not due to till mid-May, both companies’ presence in Australia will serve as an invaluable asset. Moreover, Macquarie Bank has experience in running airports and other transport infrastructure. Thus, making MQG a suitable candidate.

The bidding war has also transpired a State of Origin dual between the Queensland and NSW state governments. On Tuesday, the Queensland government stated that it is willing to provide $200 million to Virgin Australia. However, the company must maintain its headquarters in Brisbane.

Following this, the NSW government said that it is willing to support Virgin, so long as it moves its headquarters to the new Badgery Creek airport that is due to open in 2025. Knowing how much the airline adds to Queensland’s economy, this prompted Queensland’s state development minister to tell NSW to “back right off”. It will be interesting to see who comes out on top in this enthralling bidding war.

Is Virgin Worth the Investment?

Before I start, I am obliged to remind our viewers that this is not advice, only general commentary from my extensive research in this area.

Virgin’s trading halt and entrance into voluntary administration captivated investors. However, Investing in Virgin holds significant risks. First, the company has a debt bill of $4.8 billion. Virgin’s outstanding debt is them to hold a D/E ratio of 930.9%. Moreover, even before COVID-19, Virgin had insufficient liquidity to meet its current financial obligations.

However, it is not all gloom and doom for Virgin. In 2019, the airline grew revenue year-on-year coupled with a remarkable gross profit ratio of 79.8%. Also, for the past two years, Virgin recorded outstanding cash flow to assets analysis of 0.9. When compared to the generally accepted standard of 0.3, this highlights the efficient nature of Virgin’s asset structure.

Where Virgin falls over is its expense ratio. For 2019, the airline recorded an expense ratio of 78.6%. This means that the company was only left with an operating profit of 1.2% before we account for interest expenses and taxation.

A Final Word

I do see Virgin Australia coming out as a much stronger company on the other side of this administration. (opinion not advice) The most significant areas that Virgin needs to improve include increasing its liquidity, reducing its D/E ratio, and reducing its expense ratio. If a potential buyer is found, the first two problems should resolve themselves. Also, the integration of automated systems should reduce Virgin’s expenses moving forward. Thus making the airline, in my opinion, a viable investment.

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The information above should not be taken as financial advice. Youth Investment Group has no liability for personal financial interests or investment decisions. You should make your own investment decisions based upon your own research and what you believe is best for you.

Written by Sergeo Domtchenko, Associate of YIG.

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