Why do investors keep ploughing money into airlines when the lose so much money?

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Posted

October 12, 2017 00:16:25

If you knew a plane couldn’t fly, would you step aboard? Probably not.

Key points:

  • Qantas is $155 million in the red after 9 years of Alan Joyce in charge, while Virgin Australia has lost $1bn in 7 years under John Borghetti
  • Fuel prices have a massive impact on profitability
  • Despite ending a discounting war and fuel prices falling, Virgin still remains deeply unprofitable

So why do so many investors plough so much into airlines that have as much chance of churning out regular profits as a wingless DC-3 would have flying across the Pacific?

“Investor death traps” was the curt dismissal of airlines by arguably the world’s shrewdest investor, Warren Buffet.

Although in Mr Buffet’s case it may be “do as I say, rather than as I do” as his high flying investment vehicle Berkshire Hathaway fessed up to a $US10 billion flutter on four of the bigger airlines in the US earlier this year.

Qantas and Virgin Australia are no means the worst financial performers in the skies, but under their respective and long term bosses Alan Joyce and John Borghetti both have lost more than they have made.

“Warren Buffet famously said that capitalists would have been much better off if one of the Wright brothers had been shot down at Kitty Hawk rather than actually continuing to try and take us to the air,” Motley Fool Head of Research, Scott Phillips told The Business program.

Few airlines consistently make profits

While Qantas has been soaring with big profits in the last three years as fuel prices have fallen, they don’t come close to erasing a $2.8 billion loss in 2014.

And since Alan Joyce took over in November 2008 Qantas has made no money.

Its total after-tax results, which is what is available to shareholders, is a loss of $155 million.

“There aren’t many airlines around the world who consistently make their target returns, just because the business is too complex,” former Qantas Chief Economist, Tony Webber said.

“I mean you’re in a business where if the oil price, or the jet fuel price, increases by $10 in a year, or even $20 in a year, Qantas is out of pocket $300 million to $600 million,” Mr Webber said.

At Virgin Australia, which is only a fraction of the size of Qantas, the situation is far worse.

“If you can’t make money today, when the avgas price has fallen from about $4 a gallon to less than a dollar a gallon, you are not going to be able to make money in the future,” founder of Montgomery Investment Management, Roger Montgomery said.

Virgin shares trade at just 19 cents.

It lost $186 million this year, and in the seven years since John Borghetti was appointed chief executive it has lost $1 billion.

Year Qantas result under Alan Joyce Virgin Australia result under John Borghetti
2017 $853m profit $186m loss
2016 $1.03bn profit $225m loss
2015 $560m profit $94m loss
2014 $2.84bn loss $354m loss
2013 $2m profit $98m loss
2012 $244m loss $23m profit
2011 $249m profit $68m loss
2010 $116m profit
2009 $123m profit
Overall $155m loss $1bn loss

“If Virgin was predominantly based on retail shareholdings and they hadn’t made a return, or a proper return or targeted return for five or six years, I think it would be very difficult for John to hold onto his job,” Tony Webber said.

Virgin Australia ownership

  • Etihad Airlines 21pc
  • Singapore Airlines 20pc
  • Nanshan (China) 20pc
  • HNA Tourism (China) 20pc
  • Richard Branson 10pc
  • Air New Zealand 2.4pc
  • ASX investors 6.6pc

But Virgin Australia is effectively a foreign-owned company with five overseas airlines and Richard Branson owning 93 per cent.

They are apparently taking a long-term view as Mr Borghetti has tried to turn Virgin from a low-cost carrier into a full-service rival to Qantas in the lucrative business traveller market.

“I think it made sense to try, I think the jury is still well and truly out on whether it’s going to be successful,” Motley Fool’s Scott Phillips said.

Discounting war ended but profits still elusive for Virgin

Making that transition has been expensive as Virgin has built the infrastructure to attract business travellers, whilst at the same time, up until a few years ago, waging a capacity war with Qantas.

“In that time, they’ve increased the amount of equity that they’ve asked from shareholders by about $1.7 billion and they’ve also borrowed another $900 million from the bank,” fund manager Roger Montgomery noted.

“With additional capital you would expect profits to rise, but in fact profits have fallen.”

While the capacity wars in the domestic market have settled down in recent times, Motley Fool’s Scott Phillips believes Virgin has stretched itself by trying to service too many destinations.

“When you’ve got too many seats, it doesn’t really matter what your strategy is, it’s simply a matter of too much capacity for too few fliers.

“There’s only two solutions, less seats being sold or more people flying.”

While Qantas and Virgin have both been running at a long-term loss under their current chief executives the big winners have been passengers.

According to the aviation industry’s umbrella body, the International Air Travel Association, ticket prices in 2017 are two-thirds lower than 1995, which means many more people can afford to fly.

But not enough it seems to deliver long term profits, particularly at Virgin.

“It’s very tough, it’s a lot of things moving beyond their control, it’s difficult to risk manage those uncontrollables and they have an exceptionally, very strong quality competitor, that they need to take share from,” Mr Webber said.

The other big winner is Qantas boss Alan Joyce who will be paid around $25 million this year despite his tenure still being well and truly in the red.

Topics:

company-news,

economic-trends,

air-transport,

australia



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