ANALYSIS: Virgin America chases profitability

Washington DC
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Low-cost carrier Virgin America could finally see its first full-year operating profit in 2013 after it decided to cancel or defer 50 aircraft deliveries, as the five year-old-carrier continues its efforts to wade out of the red.

The California-based carrier's overhaul of its business strategy echo similar moves made by its low-cost predecessors. New York-based JetBlue made the decision to defer and sell aircraft back in 2006 after it reported its second consecutive quarterly loss, at a time when it was about the same age as Virgin America now.

JetBlue followed this with subsequent aircraft deferrals in the following years - decisions that left it with a fleet size of just over 160 aircraft in end-2010 instead of more than 270. Its capacity discipline years ago appears to have worked - the airline has reported continuous profitability in recent years.

Now privately-held Virgin America, with a smaller fleet of 52 aircraft, is hoping to repeat the feat, albeit in more challenging times as concerns linger over the US economy and volatile fuel prices.

The carrier grew ASMs by 73% from the third quarter of 2010 through the third quarter of 2012, way ahead of the industry ASM growth average of 0.4%, it says. It adds that this growth was required to "establish the airline's core network and to achieve economies of scale".

However, this has hurt the bottom line, a reality that the airline acknowledges. "As the airline absorbed the tail-end of this growth cycle, its entry into new markets created margin pressure which offset gains in more mature markets," says Virgin America.

Launched in 2007, Virgin America now operates to 19 destinations, including three in Mexico. In the last year alone, it launched service to Puerto Vallarta, Palm Springs, Philadelphia, Portland and Washington DC Reagan National.

While the carrier posted an operating profit of $15.8 million for the third quarter and expects an operating profit in the fourth quarter, its chief executive David Cush indicated in recent interviews that the airline will not post a full-year operating income for 2012, and expects to do so only in 2013.

To industry watchers, this full-year profitability has been a moving goalpost in recent years. In 2011, Cush said the carrier hoped to record a small operating profit, only to announce a full-year operating loss of $27.4 million for that year. The airline earlier this year expressed hopes of posting a full-year operating profit in 2012, but has now indicated this will be unlikely.

Virgin America's latest drastic decision to cancel and defer several aircraft deliveries could help remedy the situation. On 16 November, it announced that it will cancel 20 Airbus A320 deliveries, taking its current delivery positions down to 10 from 30. These aircraft will be delivered in 2015 and 2016. Virgin America will also defer delivery dates for 30 A320neos to 2020 through 2022, from 2016 initially. A Virgin America spokeswoman says the airline incurred no financial penalties for the aircraft deferrals and cancellations.

The airline expects to decelerate to a "mid single-digit" available seat mile (ASM) growth rate in "the next several years". This compares with an average ASM growth of 28% annually in the last three years.

Prior to the aircraft order changes, Cush told employees in an October letter that the airline will slash capacity by about 3.5% in the first quarter of 2013 and offer voluntary short-term leave to some staff as it forecasts weaker demand.

Cush has pointed out that the markets the airline operates in for longer than 12 to 18 months eventually mature into profitability. The airline's core markets - those operated for more than two years - achieved an operating margin of 8% in the third quarter and have been profitable year-to-date.

However, this was offset by weaker performance in newer markets added in the last two years as the carrier rapidly expanded.

The airline will add only one aircraft to its fleet in 2013, and with the cutback in capacity, Virgin America could finally end 2013 in the black. Going ahead, however, it might have to confront the consequences of its fleet decision, especially related to the deferrals of the A320neos to 2020 onwards. Other low-cost carriers, such as Spirit Airlines and Southwest Airlines, are slated to take delivery of new re-engined narrowbodies years ahead of Virgin America.

In its five years so far in the industry, Virgin America has achieved darling status among travellers with its on-board wi-fi and service and has succeeded in differentiating itself from other domestic US carriers. But as profitability continues to elude the airline, one can only hope that the carrier's success among travellers is not short-lived.

Set against a backdrop of weak travel demand and fuel prices, Virgin America will have its work cut out for it in the following years. Or as Cush himself put it: "All airlines have faced these same industry challenges, but none have done so as a brand new carrier fuelling 73% capacity growth in the past 24 months."