August 26, 2019 / 4:09 AM / 23 days ago

Focus: Turnaround may prove tricky for new Virgin Australia CEO Scurrah

SINGAPORE (Reuters) - Shareholders will press Virgin Australia Holdings’ new CEO Paul Scurrah to present a robust strategic plan on Wednesday, when the airline is expected to report its seventh consecutive annual loss, on top of $1.2 billion worth of red ink over the previous six years.

Aircraft from Australia's second largest airline, Virgin Australia, sit on the tarmac at the domestic terminal of Sydney Airport in Australia, August 19, 2018. Picture taken August 19, 2018. REUTERS/David Gray

With shares trading near all-time lows, Scurrah’s options include cutting costs, restructuring management, rebranding its underperforming budget carrier Tigerair Australia, ending loss-making flights to Hong Kong and tightening control over the loyalty division, seven current and former managers told Reuters on condition of anonymity.

But they say that because of decisions by his long-serving predecessor, John Borghetti, Scurrah may lack room to manoeuvre amid a weakening domestic market.

Borghetti transformed the former budget airline into a more serious rival to his former employer, Qantas Airways Ltd, for lucrative corporate traffic, but in doing so he sometimes made hasty decisions that proved costly for Virgin in the long term, five of the people said.

His legacy at Australia’s No. 2 carrier includes rising costs, expensive fleet and airport contracts, the sale of part of its frequent flyer business, a looming U.S. dollar debt refinancing and a complex share register and boardroom, the sources said.

“I think there were lots of decisions made that were good news up front and the cost to the business came years down the track,” one of the sources said.

When contacted by Reuters, Borghetti declined to comment.

Major Virgin shareholders Singapore Airlines, Etihad Airways, HNA Group, Nanshan Group and Richard Branson’s Virgin Group have baulked at providing more capital, the sources said, and Scurrah has told staff the airline cannot rely on shareholder financing.

Singapore Airlines, Etihad, HNA and Virgin Group declined to comment; Nanshan did not respond to a request for comment.

Virgin referred to a statement by Scurrah that airline needed to be in a position where it could better withstand financial pressures and declined to comment further.

Some strategic changes are likely to be announced on Wednesday, with others later in the year, one of the sources said.

“There is a huge amount of work going on behind the scenes at the moment in terms of looking at the entire strategy of the company,” the source said.

Virgin declined to comment further, citing a blackout period ahead of the release of its results.

FRESH START

Scurrah, who worked in aviation early in his career but had most recently run port operator DP World’s Australian business, took on the top job in late March.

Since then he has issued a profit downgrade, pushed back the delivery of Boeing Co 737 MAX planes by nearly two years to conserve capital, cut some underperforming domestic and New Zealand routes and improved staff travel benefits in an attempt to boost morale.

He has also said the airline would restructure its management team and hire a chief commercial officer and chief operating officer.

Virgin has forecast it will report an annual underlying loss on Wednesday because of weaker demand, a big turnaround from the strong half-year underlying profit Borghetti reported in February.

Under Borghetti, the airline was obsessed with reacting to Qantas rather than developing its own strategy, and divisions paid little regard to how decisions would affect one another, the current and former employees said.

Tony Webber, a former Qantas chief economist who runs an aviation research company, said Borghetti’s strategy of moving upmarket to match Qantas had added too many costs relative to the revenue gains.

“The big thing is to take some costs out of the business, get them as lean as possible without massively reducing their product and go from there,” he said of Virgin.

For Scurrah, looming decisions include whether to rebrand poorly performing budget carrier Tigerair Australia, which has struggled to recover its reputation since regulators grounded it in 2011, before it was owned by Virgin.

“It has too much baggage; that name, it has too much bad history,” said Rico Merkert, a professor of transport at the University of Sydney Business School.

Scurrah also must decide whether to axe flights to Hong Kong launched after HNA invested in the airline. They were not lucrative even before recent anti-government protests hurt travel demand to the city, according to the sources.

CASH DRAIN

Virgin has had negative free cash flow for the last 11 financial years, according to Refinitiv data, which has led it to rely heavily on funding from equity, debt and asset sales. It has a non-investment grade credit rating because of its high debt levels.

That contrasts with Qantas, which has an investment-grade credit rating and reported A$1.24 billion of free cash flow in its annual results last week and has been regularly issuing dividends and buying back shares.

Qantas shares have risen 73% over the last three years, while Virgin shares have fallen 30% over the same period.

Virgin has a $400 million bond maturing in November. The weak Australian dollar - now at $0.67 versus $0.87 in 2014, when the debt was issued, makes for a tougher refinancing task, although it raised A$250 million in February to help prepare for the maturity. Virgin said it could not comment on refinancing plans ahead of its results.

Virgin owns 65% of its Velocity frequent flyer programme but could cut that to 51% to raise cash alongside co-owner Affinity Equity Partners, which is planning to exit through an IPO or trade sale.

But the unit produces cash even when the airline business is not doing well. The current and former employees said Virgin would prefer to own all of Velocity, but it cannot easily afford to buy back Affinity’s stake, which analysts estimate could be worth up to twice as much as the original A$335 million sale price.

Virgin declined to comment.

Reporting by Jamie Freed; Editing by Gerry Doyle

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