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Case Study – Virgin
Cambridge University Press 1 © Hickey et al 2018
Cambridge Year 12 (HSC) Business Studies Fourth Edition
2019 Updates
Chapter 15A – Finance at Virgin Australia
Chapter objectives
In this chapter, students will:
• investigate the role of financial management at Virgin Australia
• analyse the influences on financial management at Virgin Australia
• explain the processes of financial management at Virgin Australia
• evaluate financial management strategies at Virgin Australia.
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Case Study – Virgin
Cambridge University Press 2 © Hickey et al 2018
15.1 Role of financial management
Strategic role of financial management
Virgin Blue began as a low-cost airline servicing the Australian domestic market.
Strategic planning has enabled this business to grow and become a major
competitor to Qantas as a domestic carrier. The business has also expanded to
provide premium services to the local and international market. As early as 2001, the
company recognised the significant need for finance and completed an agreement
with Patrick Corporation to invest $260 million in Virgin Blue in exchange for a 50 per
cent share of the company. As Patrick Corporation is an Australian company and
eventually owned more than 60 per cent of Virgin Blue, Virgin Blue was therefore
also classified as Australian-owned.
Source 15A.1 Virgin Blue and Virgin Australia logos
Virgin Australia is a business heavily reliant on finance due to its need for large-scale
assets such as aircraft and equipment for maintenance facilities. It has a staff of 10
151 in Australia, including employees from its subsidiaries, and significant fuel costs
to operate its fleet of 133 aircraft.
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Case Study – Virgin
Cambridge University Press 3 © Hickey et al 2018
Source 15A.2 The finance department is made up of several divisions.
Objectives of financial management
In the 2011 financial year Virgin Australia introduced a strategic plan based on its
Game Change program. In Virgin’s 2014 Annual Report the company explained that
the overall goal of this strategy was ‘… designed to position the Group as the airline
of choice in all market segments and ensure delivery of sustainable earnings
benefits to the business in the future’ (p. 17). The strategy is divided into several
phases (also outlined in the 2014 Annual Report) and through successful application
the first and second phases were achieved earlier than planned.
Game Change Program Phase 1, 2011 aimed to:
1 Ensure Virgin Australia’s capacity is closely aligned to profitability
2 Establish a virtual global network through strategic airline alliances
3 Grow Virgin Australia’s share of the Australian corporate business from 10 per
cent to 20 per cent
4 Maintain Virgin Australia’s strong presence in the leisure market
5 Enhance Virgin Australia’s already strong brand in Australia and in overseas
markets.
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Case Study – Virgin
Cambridge University Press 4 © Hickey et al 2018
Phase 2: Game On, 2013 financial year, was based on the following key strategies:
1 Implementing a business efficiency project
2 Building a transformational loyalty business
3 Increasing access to global markets
4 Further enhancing the guest experience through in-flight and on-the-ground
innovation
5 Continuing to develop Virgin Australia’s people and service excellence.
Game On revolved around driving new growth opportunities for the business, while
retaining a cost-efficient, flexible business model. In line with the Game Change
program, Virgin Australia acquired 100 per cent of SkyWest Airlines (a Western
Australian operation) in May 2013 to develop a new growth charter market in
regional Australia to service clients in the resource industry. In July 2013, through
the acquisition of 60 per cent of Tigerair Australia, the airline re-entered the budget
travel market segment. By the end of the 2014 financial year, Virgin had also
acquired 25 per cent of the domestic revenue of the corporate and government
market segment (5% over its goal of 20% in aim number 3 of Phase 1).
Source 15A.3 The acquisition of SkyWest and Tigerair have been identified as reasons for Virgin’s losses in 2013 and 2014.
Virgin has now moved on to Phase 3: Virgin Vision 2017, a three-year strategy that
intends:
1 Capitalising on growth business opportunities
2 Driving yield enhancement
3 Implementing a new cost program
4 Optimising the Balance Sheet
5 Setting a new standard in customer experience
6 Developing Virgin Australia’s people to their full capacity.
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Case Study – Virgin
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Collectively, the phases are directed to enabling Virgin to deliver a sustainable and
profitable business over the long term. While still ongoing, the Virgin Vision 2017 has
provided goals for Virgin staff to work towards. In 2018, through the Better Business
program, Virgin has continued to place a high priority on improving its cash flow
situation and overall efficiency levels. This program, covering a three-year period,
incorporated a review of Virgin’s capital structure and significant steps to strengthen
the balance sheet. As part of the growth business opportunities, Virgin’s Velocity
Frequent Flyer Program achieved 9.1 million members by July 2018. In 2018 Virgin
Australia was awarded ‘Best Domestic Airline’ by the Australian Federation of Travel
Agents; achieved a five-star rating by the Airline Passenger Experience Association;
and was rated ‘Best Business Class’ and fourth globally by Airline Ratings.
Additionally, it was awarded ‘Program of the Year’, ‘Best Elite Program’, ‘Best
Customer Service’ and ‘Best Redemption Ability’ in the Freddie Awards.
Short-term and long-term
2018 delivered a significant improvement on previous years for Virgin Australia. An
underlying profit before tax of $109.6 million delivered a $113.3 million boost on the
2017 financial year result, and the highest result since 2008.
The group reported a Statutory Loss after Tax of $653.3 million for the 2018 financial
year. This was mainly driven by approximately $573.3 million in non-cash accounting
adjustments (e.g. depreciation) and continued restructuring charges from the Better
Business program.
There was a lot of work done at the group level in order to stabilise the company’s
financial situation, including smaller shareholders with holdings of $500 or less,
exiting their shareholdings through a buy-back where 19 800 shareholders exited
their ownership. This resulted in 0.15 per cent of the group’s issued capital being
bought back and cancelled. Since 2017, business changes have included:
• improvement of 108 per cent in net cash flow from operating activities
• 113.1 per cent improvement in free cash flow
• 13 per cent improvement in financial leverage
• Velocity Frequent Flyers increased membership to 9.1 million
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Case Study – Virgin
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• continued improvement from the Better Business program such as cash flow
savings of $324 million for 2018.
Virgin Australia’s strategic plans are heavily reliant on financial management.
Financial objectives include long-term growth, future profitability and solvency. In the
short term, tactical and operational financial plans are developed so that the airline
remains efficient by eliminating unnecessary expenses, ensures adequate cash
inflow to maintain liquidity and continues to maintain its customers with superior
service to ensure loyalty to the Virgin brand. This required all of the interdependent
functions of the business to work collectively to achieve the business’s goals.
Management ensures that it will always have sufficient liquidity to meet liabilities
when they fall due, and that it maintains sufficient cash, securities and lines of credit
to ensure its liquidity. At the end of the 2018 financial year, Virgin held cash and
cash equivalents supported through debt and equity financing of $1415.5 million and
an unrestricted cash balance of $1000.8 million.
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Case Study – Virgin
Cambridge University Press 7 © Hickey et al 2018
15.2 Influences on financial management
Internal sources of finance
Retained profit
Source 15A.4 Retained profit for financial years since 2011
End of financial year Retained profit
2011 $220.2m
2012 $243m
2013 $212.1m
2014 ($143.5m)
2015 $253.6m
2016 $332.1m
2017 ($734.8m)
2018 ($1415.8m)
Source 15A.5 Operating segments results 2018
2018 $m
2017 $m
Movement $m
Movement %
Revenue and income
Virgin Australia Domestic 3 664.0 3 439.6 224.4 6.5
Virgin Australia International 1 120.3 999.0 121.3 12.1
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Case Study – Virgin
Cambridge University Press 8 © Hickey et al 2018
Velocity 372.0 371.0 1.0 0.3
Tigerair Australia 570.6 543.3 27.3 5.0
Segment EBIT
Virgin Australia Domestic 246.1 92.9 153.2 164.9
Virgin Australia International (12.8) 0.5 (13.3) N/M
Velocity 110.1 142.8 (32.7) (22.9)
Tigerair Australia (36.2) (24.3) (11.9) (49.0)
Source 15A.5 shows that all segments have seen an increase in revenue for the
2018 financial year. However, both Tigerair and the international segments suffered
increased costs resulting in negative profits.
External sources of finance
Debt
Virgin Australia utilises bank loans and leasing finance for several of its aircraft.
Source 15A.6 Debt finance used by Virgin in the 2018 financial year
Carrying/drawn amount
$m
Facility limit $m
Currency Calendar year of principal repayments
2018 2017 2018 2017
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Case Study – Virgin
Cambridge University Press 9 © Hickey et al 2018
Secured bank
loans
––Aircraft AUD 2018–30 262.2 84.6 262.2 123.7
––Aircraft USD 2018–28 898.6 1 125.1 898.6 1 125.1
––Other AUD 2020 220.6 218.3 224.1 264.4
Unsecured loans
––Other AUD N/A – – 1.2 12.2
––Unsecured
bonds
AUD 2023 148.1 – 148.1 –
––Unsecured
bonds
USD 2019–21 1 003.5 964.8 1 003.5 964.8
Finance leases AUD 2018–47 23.1 40.5 23.1 40.5
Finance leases USD 2018–20 12.0 – 12.0 –
Standby letters of
credit and bank
guarantees
AUD and
USD
2018–27 179.9 122.2 220.5 162.2
2 748.0 2555.5 2 793.3 2 692.9
Overview of company performance
Source 15A.7 provides summary information on the group’s financial performance
and the effect on shareholder wealth for the five years to 30 June 2018.
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Case Study – Virgin
Cambridge University Press 10 © Hickey et al 2018
Source 15A.7 Overview of company performance 2018
Financial year 2018 2017 2016 2015 2014
Segment EBIT ($m) 259.5 164.1 210.6 65.9 (126.0)
Underlying group profit/(loss)
before tax ($m)
109.6 (3.7) 41.0 (49.1) (211.7)
Net (loss)/profit attributable to
owners ($m)
(681.0) (220.3) (260.9) (110.8) (353.8)
Share price ($) 0.22 0.16 0.21 0.43 0.43
Change in share price ($) 0.06 (0.05) (0.22) – –
Dividends paid ($m) – – – – –
EPS (cents) (8.1) (2.8) (7.4) (3.2) (11.4)
ROIC (%) 10.5 8.3 8.9 6.1 1.7
Equity
As early as 2002, Virgin Blue’s agreement with Patrick Corporation was essentially
for it to invest $260 million in the airline in exchange for 50 per cent ownership. Virgin
Australia is a public company floated on the Australian Securities Exchange (ASX)
as Virgin Blue Holdings Limited in 2003.
As more growth finance was needed, more equity was obtained. More recently:
• on 1 July 2015, Virgin Australia launched its Cargo business, offering cargo
space on over 3000 flights per week across the group’s network, with access
to specialist cargo handling terminals in all major Australian airports
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Case Study – Virgin
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• on 31 May 2016, Virgin Australia formed an alliance with HNA Aviation Group
Co. Ltd (HNA). The alliance included codesharing, frequent flyer programs,
tourism, and $158 million new shares to HNA.
• on 10 June 2016, Air New Zealand Limited sold most of its shares (19.98%) to
China’s Nanshan Group
• on 15 June 2016, the Board announced it would raise equity of $852.0 million
through a fully underwritten one for one pro-rata non-renounceable
entitlement offer of $852.0 million.
Air New Zealand’s strategy to gain access to the Australian domestic airline market
has been through investment in Virgin of approximately $400 million over the years.
No dividends were paid to shareholders for the 2016, 2017 or 2018 financial years.
On 30 June 2018 the share price of Virgin Australia Holdings was 22 cents per
share, down from a high of 43 cents per share in 2014–15.
The group issued 342 million fully paid ordinary shares to HNA in September 2016.
In 2018, total equity decreased by $478.8 million due to a statutory loss after tax of
$653.3 million; as well as an equity redistribution (such as the share buy-back) of
$47.1 million.
Influence of government
Virgin Australia had to pay $47.9 million in carbon tax in the 2013 financial year.
Plans to pass this on to passengers as a carbon surcharge were abandoned due to
the strong and aggressive price competition in the marketplace with Qantas. This tax
was an expense for the business and impacted on the final profit figures. (This tax
has since been repealed.)
The two major competitors in the industry are Virgin Australia and Qantas. Virgin is
not subject to the same foreign ownership restrictions as Qantas due to the Qantas
Sale Act 1992 and amendment Bill in 2014 to repeal section 3 to allow Qantas to be
included as an Australian International airline allowing foreign ownership to increase
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Case Study – Virgin
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from 25 to 49 per cent. This increased the competitiveness of Qantas in relation to
Virgin Australia.
Also, several of Virgin’s main shareholders are individually backed by their own
governments; for example, the Singapore government’s investment and holding
company currently owns 56 per cent of Singapore Airlines.
The goods and services tax (GST) is recognised as part of the cost of assets
purchased and therefore as part of the expense. All accounts receivable and
accounts payable are recorded with the amount of GST included.
The airline is subject to a 30 per cent company tax rate in Australia as its
headquarters are registered in Australia. The airline is also subject to airport
charges, navigation and station operations passengers’ charges at all destinations.
In addition, all ownership proposals and agreements need to be reviewed by the
Australian Securities and Investments Commission (ASIC) and ASX in order to
evaluate their effect on consumers and competitors and to ensure that stakeholders
are not disadvantaged.
Global market influences
Virgin Australia’s market risk management takes part in hedging to attempt to
discount the threat of increased international interest rates and volatile exchange
rates, using forward foreign exchange contracts due to the weakening Australian
dollar, as well as contracts for fuel, which result in increased costs and planning
problems. Derivative financial instrument asset balances have increased by $275
million to $284 million in 2018. The Virgin board has determined hedging limits for
financial risk under the authorised limits set by the Australian Treasury Risk
Management Policy.
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Case Study – Virgin
Cambridge University Press 13 © Hickey et al 2018
15.3 Processes of financial management
Planning and implementing
Financial needs
While the 2018 result is a $467.5 million increase on 2017, the result was a loss after
tax of $653.3 million. Revenue was up, with a $373.4 million increase on the year
before, but factors including fleet improvements, maintenance and resourcing that
are part of the longer-term plans meant that operating expenditure was also up. The
weaker Australian dollar also had a significant impact on fuel costs, as well as
significant amortisation and depreciation of assets and the payment of deferred
taxation.
The company uses budgets as both planning and control tools. Monthly actual
results are compared to budgets that were approved by the Board and periodically
used to prepare revised forecasts for the year. Since 2014 the Board has directly
linked financial performance to senior executives’ overall remuneration, providing a
weighting on short-term incentives on their ability to remain within the budgeted
costs and achieve overall financial performance for their departments.
Virgin has introduced several record systems to enable the business to better
analyse its initiatives. It has a Flight Data Management Program as part of its safety
management system, using a database to analyse flight data to identify risk. Data is
recorded on flight, cabin and ground operations crews to analyse fatigue risk. Virgin
also introduced SabreSonic, an international online booking system.
Financial risks eventuate from changes in fuel prices, landing fees, government
policy, industrial action, safety problems such as pandemics, terrorism and natural
disasters such as the Bali volcanic eruption of 2018, as well as currency, liquidity and
credit risks.
Financial controls include budgets, hedging and derivatives, and ongoing risk
assessment undertaken to determine their impacts for future financial years.
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Monitoring and controlling
Cash Flow Statement
Below is Virgin Australia’s Consolidated Cash Flow Statement for the financial year
ended 30 June 2018.
Source 15A.8 Consolidated cash flow statement
Note 2018 $m
2017 $m
Cash flows from operating activities
Cash receipts from customers 6 099.7 5 657.1
Cash payments to suppliers and employees (5 366.0) (5 131.2)
Cash generated from operating activities 733.7 525.9
Cash payments for business restructuring
expenses
(44.8) (121.8)
Finance income received 19.2 17.0
Finance costs paid (137.7) (147.2)
Net cash from operating activities B6 570.4 273.9
Cash flows from investing activities
Acquisition of property, plant and equipment (546.5) (436.7)
Proceeds on disposal of property, plant and
equipment
D1 7.7 188.0
Acquisition of intangible assets (44.4) (37.2)
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Payments for other deposits (56.8) (48.4)
Proceeds from other deposits 77.0 1.2
Dividends from equity-accounted investee – 1.5
Net cash used in investing activities (excluding aircraft operating lease refinancing)
(563.0) (331.6)
Aircraft operating lease refinancing (5.7) –
Net cash used in investing activities (568.7) (331.6)
Cash flows from financing activities
Proceeds from borrowings 356.9 557.0
Repayment of borrowings (307.1) (1098.9)
Payments of transaction costs related to
borrowings
(6.0) (13.1)
Net proceeds from share issue – 931.4
Net payment for share buy-back E4 (5.3) –
Equity distributions paid to non-controlling
interests
F5 (47.1) (38.2)
Net cash (used in)/from financing activities
(8.6) 338.2
Net increase/(decrease) in cash and cash equivalents
(6.9) 280.5
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Cash and cash equivalents at 1 July 1 396.1 1 123.8
Effect of exchange rate fluctuations on cash
and cash equivalents
26.3 (8.2)
Cash and cash equivalents at 30 June E2 1 415.5 1 396.1
The consolidated statement of cash flows should be read in conjunction with the
accompanying notes to the consolidated financial statements. Note: At the end of the
financial year for 2018, the Cash Flow Statement leaves the business in an improved
liquidity position compared with 2017. In 2018 cash and cash equivalents were
$1415.5 million while in 2017 they were $1396.1 million.
Income Statement
Below is Virgin Australia’s Consolidated Income Statement for the financial year
ended 30 June 2018.
Source 15A.9 Income statement
Note 2018 $m
Restated 2017 $m
Revenue and income
Airline passenger revenue B3 4 623.4 4 275.3
Other ancillary revenue B3 793.8 765.3
Other income 3.5 3.8
Net foreign exchange gains – 2.9
Revenue and income 5 420.7 5 047.3
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Operating expenditure
Aircraft operating lease expenses B4 (389.0) (426.2)
Airport charges, navigation and station
operations
(1 060.7) (1 023.8)
Contract and other maintenance expenses (246.4) (242.6)
Commissions and other marketing and
reservations expenses
(467.4) (430.0)
Fuel and oil (985.5) (898.4)
Labour and staff related expenses (1 246.7) (1 219.2)
Impairment losses on assets classified as
held for sale
D1 – (7.8)
Impairment losses on cash-generating units B4 (120.8) –
Impairment losses on other assets B4 (47.8) (65.9)
Onerous contract expenses C6 (58.5) (29.6)
Other expenses from ordinary activities B4 (512.9) (516.9)
Depreciation and amortisation (337.3) (309.7)
Ineffectiveness on cash flow hedges – 0.7
Net operating expenditure (5 473.0) (5 169.4)
Share of net profit of equity-accounted
investee
F2 3.5 2.1
Loss before net finance costs and tax (48.8) (120.0)
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Finance income 19.2 16.9
Finance costs B4 (171.8) (186.5)
Net finance costs (152.6) (169.6)
Loss before tax (201.4) (289.6)
Income tax (expense)/benefit B5 (451.9) 103.8
Loss (653.3) (185.8)
Attributable to:
Owners of the Company (681.0) (220.3)
Non-controlling interests F5 27.7 34.5
(653.3) (185.8)
Earnings per share Cents Cents
Basic earnings per share B2 (8.1) (2.8)
Diluted earnings per share B2 (8.1) (2.8)
The consolidated statement of financial position should be read in conjunction with
the accompanying notes to the consolidated financial statements.
Airline passenger revenue is made up of passenger ticket sales, while other revenue
is earned from the provision of other related services such as freight, on-board sales
and other product revenue.
Virgin Australia’s total revenue increased by approximately 7 per cent from the 2017
to 2018 financial year results. This was mainly due to an increase in passenger
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revenue, which increased by $67.9 million, and the Velocity Frequent Flyers
program.
Smaller increases in net operating expenses during 2016 were due to:
• operating lease expenses of $37.2 million more than 2017
• increased airport charges of $36.9 million on 2017
• increase in commissions and other marketing and reservations expenses of
$37.4 million.
However, the majority of the net operating expenditure increased in 2018 due to
provisions and impairment losses. The onerous contract provision (for a reduction in
older aircraft in the fleet) accounts for $246.4 million in expenditure. A further $58.5
million came through impairment losses that have come about due to planned
optimisation of the current fleet – maintenance, engineering, leasehold agreements,
etc. Other factors were depreciation and amortisation (such as for intellectual
property and goodwill) of $337.3 million.
Balance Sheet
Below is Virgin Australia’s Balance Sheet explaining its financial position as at 30
June 2018.
Source 15A.10 Balance sheet
Note 2018 $m
Restated 2017 $m
Current assets
Cash and cash equivalents E2 1 415.5 1 396.1
Receivables C1 281.6 308.9
Inventories C2 47.6 46.3
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Derivative financial instruments E7 220.0 2.4
Other financial assets C3 12.1 25.2
Assets classified as held for sale D1 – 4.3
Other C4 2.7 4.3
Total current assets 1 979.5 1 787.5
Non-current assets
Receivables C1 191.6 162.4
Derivative financial instruments E7 64.0 6.6
Other financial assets C3 284.2 292.5
Investment accounted for using the equity
method
F2 8.2 4.6
Deferred tax assets B5 – 554.2
Property, plant and equipment D2 3 031.0 2 916.6
Intangible assets D3 617.0 617.2
Other C4 12.9 14.2
Total non-current assets 4 208.9 4 568.3
Total assets 6 188.4 6 355.8
Current liabilities
Payables C5 807.5 679.9
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Interest-bearing liabilities E3 295.1 280.9
Derivative financial instruments E7 6.6 57.1
Provisions C6 269.0 234.2
Unearned revenue C7 1 142.1 1 074.2
Other 3.6 22.0
Total current liabilities 2 523.9 2 348.3
Non-current liabilities
Payables C5 5.6 6.3
Interest-bearing liabilities E3 2 273.0 2 152.4
Derivative financial instruments E7 0.2 6.4
Provisions C6 277.6 263.5
Other 13.1 5.1
Total non-current liabilities 2 569.5 2 433.7
Total liabilities 5 093.4 4 782.0
Net assets 1 095.0 1 573.8
Equity
Share capital E4 2 238.9 2 243.7
Reserves 268.3 58.8
Retained earnings (1 415.8) (734.8)
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Equity attributable to the owners of the
Company
1 091.4 1 567.7
Non-controlling interests F5 3.6 6.1
Total equity 1 095.0 1 573.8
The consolidated statement of financial position should be read in conjunction with
the accompanying notes to the consolidated financial statements.
Virgin Australia has decreased its total assets by $167.4 million to $6188.4 million in
2018.
Liabilities have increased by $311.4 million to $5093.4 million in 2018. This is mainly
due to provisions which involve ‘onerous contracts’ – wherein the company has to
meet the obligations of a contract but is not expected to actually recoup enough to
get the benefits of the contract. In 2018, as part of a review, Virgin announced that it
would continue to improve its fleet, both through maintenance and letting go of some
of its older aircraft. The costs associated with this account for the majority of the
liability increase.
Total equity decreased by $478.8 million to $1095 million in 2018, largely due to
significant increases in retained earnings.
Source 15A.11 Virgin Velocity program – 9.1 million members 2018
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Financial ratios
Source 15A.12 Financial ratios
Risk 2018 2017
Liquidity Current ratio
Current assets/ current liabilities
1979.5/2523.9 = 0.78:1 (78c in current assets to pay for each $1 of current liability)
1787.5/2348.3 = 0.76:1 (76c in current assets to pay for each $1 of current liability)
Gearing Debt to equity
Total liabilities/ total equity
5093.4/1095.0 = 4.65:1 ($4.65 debt for every $1 of equity) = 82% debt finance
4782.0/1573.8 = 3.04:1 ($3.04 debt for every $1 of equity) = 75.2% debt finance (i.e. 3.04/4.04
Revenue load factor
Revenue passenger kilometres as a % of available seat kilometres
80% 80.2%
Passen-gers carried
24.85m 24.17m
An efficiency ratio
Financial expenses ratio
Financial expenses/ sales revenue
169.6/4985.7 = 3.4% 93.2/4706.0 = 1.098%
Profitability
Return on equity
Earnings per share
(8.1%) (2.8%)
Limitations of financial reports
Financial statements need to be read with the notes to the financial statements. In
Virgin’s case, these additional notes include 52 pages of its 2018 annual financial
report. The details are explained in the statements and reasoning behind the
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decisions made. In its case, Virgin explains that its repositioning strategies are aimed
at driving further growth opportunities for the company and an improvement in future
results.
Property, plant and equipment are recorded at historical cost. The cost of these
assets are capitalised as their historical cost includes expenditure that was directly
attributed to their acquisition; for example, major cyclical maintenance costs on
aircraft are capitalised to the value of the aircraft. Transaction costs for equity raising
are capitalised and offset against share capital. Other assets are set at fair value,
based on current market value. At the time of purchase, SkyWest and Tigerair
assets were included through a fair value assessment. (Virgin did not acquire them
as an original purchase and therefore they cannot be valued at historical cost.)
Assets with finite lives are depreciated based on their estimated economic life for
use by Virgin and reviewed each year.
Source 15A.13 Estimated useful life of assets in years
2018 2017
Buildings 10–40 10–40
Aircraft and aeronautic related assets
––Modifications to leased aircraft 6–13 6–13
––Rotables and maintenance parts 9–33 9–33
––Airframe, engines and landing gear 4–22 4–20
––Major cyclical maintenance 1–10 1–10
Plant and equipment
––Leasehold improvements 1–15 1–15
––Other 5–33 5–33
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Computer equipment 3–5 3–5
Finance leased assets
––Buildings 34 34
––Aeronautic related assets 4–5 4–5
Liabilities for wages, salaries and annual leave required within 12 months are
included in payables and provisions. Provision is also made for long service leave,
employee bonus plans, superannuation plans, share-based payments to employees
and termination benefits such as redundancy payments.
Ethical issues relating to financial reports
The group follows Virgin’s Guide to Business Conduct and Code of Conduct, which
are both available on the business’s website. According to the Directors’ Report, ‘the
independence of directors is based on their capacity to put the best interests of the
Company and its shareholders ahead of all other interest’. In addition, they support
the ‘Group’s belief that business objectives are best achieved through acting at all
times fairly, honestly and with integrity’. The business has further developed policy
documents that highlight its belief in dealing fairly with its stakeholders such as:
• Keeping Our Workplace Fair policy
• A Fair Go policy
• Gifts policy
• Whistleblower policy (protecting them from adverse behaviour)
• Ethics Hotline (operated through an external independent provider)
• Securities Trading Policy (ensuring that all employees and directors are aware
of the legal restrictions on trading while in the possession of unpublished
sensitive information).
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Integrity in financial reporting is upheld through:
1 External and internal audits (KPMG and Virgin’s Audit and Risk Management
Committee)
2 Internal controls to manage risk
3 Compliance with legal, accounting and regulatory requirements and policies.
The CEO and the CFO declare in writing to the Board that the financial records of
the Company for the 2017 and 2018 financial years have been properly maintained
and the annual report complies with Accounting Standards and presents a fair and
true view of the financial position and operating results for the year.
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15.4 Financial management strategies
Cash flow management
Virgin ensures that it pays its bills when due. In 2018 it held $1415.5 million in cash
and cash equivalents, increased from 2015 through debt collection. It also held an
unrestricted cash balance of $1000.8 million (up $15 million on the year before).
Virgin has made cash flow a key concern for its business and through the Better
Business program has improved its cash flow management position.
Working capital management
Control of current assets
Receivables: The group had $191.6 million in non-current receivables in 2018 and
an increase of $29.2 million from 2017. This was due to maintenance prepayments
in relation to leased aircraft; and $281.6 million for current receivables, a decrease of
$388.9 million from 2017.
The average credit period for receivables is 14 days, whereas in 2017 it was 16
days. If the customer does not pay the account within the required time period, all
credit for that customer stops. There is no interest charged on trade receivables.
Control of current liabilities
Finance leases are capitalised and amortised over the life of the lease, or over the
life of the asset if they intend keeping the asset. Operating leases are recorded in the
Income Statement as an expense. Aircraft operating lease rentals accounted for
$389.0 million during the 2018 financial period and $426.2 million for 2017. The
group leases buildings and telecommunications and aeronautical related assets. In
2018 the group entered into a financial lease for telecommunications infrastructure
as well as the sale and leaseback of the Brisbane Hangar and five Fokker F100
aircraft. This will be leased until 2047 at which time the group has an option to
extend the lease for an additional 15 years till 2062.
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In 2018 the group’s current liabilities were greater than its current assets by $544.4
million, including a current liability for unearned revenue of $1142.1 million. This was
a decrease from the 2017 figure of $560.8 million with unearned revenue of $1074.2
million. Unearned revenue is revenue received in advance and deferred until
carriage is performed. Virgin is aiming to target cost savings through its Better
Business program, which involves changes to its organisational structure, supply
chain, engineering, maintenance and operations. It is aiming for $300 million per
year in net free cash flow savings by the end of 2019. Included in this is the
proposed sale of all Embraer E190s and Tigerair A320s.
Profitability management
Source 15A.14 Net Loss/Profit after tax
Net Loss/Profit after tax
2018 2017 2016 2015 2014 2013 2012
Losses
recorded
as ( )
(653.3m)* (185.8m) (224.7m) (93.8m) ($355.6m) (98.1m) 22.8m
* The 2018 decrease is attributed to the movement in tax expense of $555.7 million as Virgin
domestic and Velocity segments were profitable.
Virgin Australia is now established in all market segments and estimated to have the
lowest cost base of its competitors.
Cost controls
Profit was recorded from the domestic segment, as well as the Velocity Frequent
Flyer program.
Future cost-saving measures include ‘efficiency initiatives’ such as supply chain and
procurement changes; maintenance and engineering efficiency; improved training for
crews and ground operation to minimise disruptions; and the extensive fleet
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changes. Reductions were also in restructuring costs and aircraft operating lease
expenses of $37.2 million through its fleet simplification program. Improved finance
costs also led to savings of $17 million. Increased costs arose from airport charges
as the volume of Virgin passengers increased.
Revenue controls
Revenue has increased 8 per cent in 2018 to $5420.7 million from $5047.3 million in
2017.
The largest revenue increase is due to the primary target of airline passenger
revenue and the Velocity program. 2018 saw an increase of $348 million in ticket
sales.
One of Virgin’s most successful strategies has been the use of its loyalty program:
Velocity Frequent Flyer, with 9.1 million reward members.
Successful strategic alliances have created a worldwide network for international
flights flying to 464 destinations across five continents, including 40 city and regional
destinations in Australia. Virgin Australia has strategic alliances with the following
five key airline partners:
• Air New Zealand, resulting in growth in trans-Tasman services (especially for
the ski season), although this was stopped in October 2018, enabling Virgin to
compete in its own right for flights between Australia and New Zealand.
• Delta Air Lines for a trans-Pacific alliance, with access to more than 356
destinations in 65 countries.
• Etihad Airways, with 57 aircraft, 1000 flights per week servicing 67
destinations in 45 countries.
• Singapore Airlines, with an additional 75 destinations, mostly across Asia.
• HNA Aviation Group, including Hong Kong Airlines and Hong Kong Express.
Virgin Australia believes that the Asian and Middle Eastern market will be the two
largest growth areas in the near future.
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Global financial management
Exchange rates
Due to its international operations, foreign currency transactions are changed to
Australian currency (or to the entity’s home currency if its registered office is
overseas) at the rates ruling at the date of the transaction. Virgin often completes
transactions in $US such as for the purchase of fuel, aircraft, lease payments, sale of
passenger tickets, and then converts it to the Australian dollar.
Methods of international payments
Letter of credit: Virgin has standby letters of credit available for $124.7 million for the
2016 financial year and $127.3 million for the 2015 financial year.
Hedging
The majority of transactions for fuel, aircraft, lease payments and the sale of
passenger tickets are completed in $US, which is the currency for most of the
group’s asset base. The group enters into fuel contracts in Australian dollars and
then forwards exchange and option contracts to purchase $US.
Source 15A.15 Virgin’s forward foreign exchange and fuel hedging, 2018
2018 $m
2017 $m
Current assets
Forward foreign exchange contracts – cash flow hedges 38.0 1.0
Fuel hedging contracts – cash flow hedges 182.0 1.4
220.0 2.4
Non-current assets
Forward foreign exchange contracts – cash flow hedges 20.1 3.8
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Fuel hedging contracts – cash flow hedges 43.9 2.8
64.0 6.6
Current liabilities
Forward foreign exchange contracts – cash flow hedges 4.2 42.4
Fuel hedging contracts – cash flow hedges 2.4 14.7
6.6 57.1
Non-current liabilities
Forward foreign exchange contracts – cash flow hedges 0.2 5.3
Fuel hedging contracts – cash flow hedges – 1.1
0.2 6.4
Virgin uses derivatives to hedge its foreign currency through forward foreign
exchange contracts, fuel prices, interest rate risk exposure through interest rate
swap contracts and specific asset purchases denominated in foreign currencies. This
is to offset the volatility of changes in the fair value of cash flows of the hedged items
in the foreign exchange and commodities market. Regarding fuel hedging, the group
operated at a gain of $82.9 million in 2018, to be settled in the 2019 financial year.
This is not always a benefit, but in 2017 it had a loss of $10.9 million. The group
does not allow or take part in hedging for speculative trading purposes and only for
market risk management. Hedging strategies can provide protection from a sudden
and significant increase in jet fuel prices; however, they do not eliminate the
disadvantage if the price falls.
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The tiered hedging policy introduced in 2011 was especially for fuel costs and aimed
to provide a greater certainty in the short term, while maintaining flexibility in the long
term.
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15.5 Conclusion
Virgin Australia is a rapidly growing business that caters for domestic and
international aircraft passenger and freight services. It has sourced equity and debt
finance to enable the carrier to position itself as a major competitor in a difficult and
volatile marketplace. Virgin management have sought to provide solid benefits to
Virgin Australia’s major shareholders through strategic alliances, substantial benefits
to its employees and a valued service to its customers. It has made significant
contributions to the community and taken a responsible approach to the environment
worldwide. Management’s vision for the future has been materialised in strategic
planning through the Game Change program and the Better Business program. It
has undertaken significant investment in both physical assets and development of its
workforce. Virgin Australia has achieved strong improvements through the Better
Business program such as decreased costs, increased cash flow and improving the
capital position of the group. It has further consolidated its Australian domestic
aviation market segment and leveraged international opportunities, especially in the
Asian growth market, as well as investing in the Velocity business in order to drive
further growth.
Virgin’s vision is to become the sustainability leader within the aviation industry.
Major aviation-based shareholders support Virgin and provide each other with
substantial alliances for future growth. Virgin is in a very good position to capitalise
on market recovery.
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Chapter questions
Multiple-choice questions
1 Virgin Australia's future growth is directed towards:
a the United States
b Europe
c New Zealand
d Asia
2 The prime function of Virgin Australia is as:
a A domestic carrier
b An international carrier
c A local and international carrier
d A freight carrier
3 Virgin Australia’s financial objectives include:
a Short-term growth and maintaining current profitability
b Long-term growth, future profitability and liquidity
c The elimination of unnecessary expenses and maintaining current
profitability
d Improving current liquidity and short-term growth
4 Virgin's Better Business program aims to improve:
a Future growth
b Operations
c Liquidity
d Budgets
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5 Virgin Australia’s financial management strategy has:
a Not as yet returned a statutory profit
b Improved operations
c Improved liquidity
d Improved budgets
Short-answer questions
1 Identify the main ways that Virgin Australia plans to remain efficient in the short
term.
2 What is Virgin Australia’s legal structure?
3 Identify the four main global market influences that potentially affect Virgin
Australia.
4 How can the Velocity Frequent Flyers program provide revenue for the Virgin
Group?
5 Identify the financial risks that Virgin Australia could face through global financial
transactions.
Extended-response question
Analyse the methods and the sources of finance used by Virgin Australia to expand
globally.