Flying low: Virgin Australia chief not wasting time as he tries to revive airline

Paul Scurrah hit the ground running as the new chief executive of Virgin Australia and, four months into the role is moving with an urgency that points to the range and depth of destabilising issues within the group.

Virgin’s latest loss only underscores the obvious reality that, whatever its merits as an airline, Virgin is – and has been for years - a very poor business.

At a statutory level the loss of $315.4 million means it has lost almost $1 billion in the past two years and well over $2 billion since its "re-invention" as a Qantas challenger under former long-serving CEO John Borghetti.

Even at an underlying pre-tax level it lost $71.2 million, admittedly buffeted by soaring fuel costs and a plunge in the Australia dollar whose impact was magnified by Virgin’s large exposure to US dollar-denominated debt. That was after posting an underlying profit of $112.3 million profit in the far more favourable first-half environment.

Paul Scurrah, Virgin Australia's new CEO, is cutting 750 head office jobs as the first cut at a bloated $6 billion cost base.Credit: Louise Kennerley

The key flaw in the Virgin business model after it abandoned its value-based positioning under when Borghetti to pursue a more up-market strategy and compete more directly with Qantas was a dramatic increase in its cost base without a commensurate increase in earnings.

Borghetti relinquished Virgin’s critical competitive advantage over Qantas and Jetstar, the low costs that had enabled it to generate more than $1 billion of profits over the previous decade, by gold-plating the business in an attempt to attract full-fare business customers. That strategy was, given the impact on costs and capital intensity, unsuccessful.

The Virgin result under Scurrah represents his first cut at that $6 billion cost base.

At a statutory level, Virgin Australia has lost $1 billion over the past two years.Credit: Bloomberg

There’ll need to be more if Virgin is to become a group capable of generating respectable and sustainable profits on its now much-diminished $600 million equity base, let alone provide the five strategic shareholders that have pumped in about $1.5 billion of new equity into Virgin in recent years with an acceptable return on their investments.

Virgin did grow its revenue base 7.6 per cent to $5.8 billion, so there is something for Scurrah to work with, particularly as most of the revenue is generated with the domestic market.

Virgin has a revenue share of roughly 30 per cent of the domestic market but less than 10 per cent of the domestic profit pool. There’s considerable upside if he can wind back the spending and carve into the cost base and reposition Virgin as the value-based carrier that it once was.

With the result there was a flurry of announcements that make Scurrah’s intent clear, not the least of which was the loss of 750 corporate and head office roles and a new executive super-structure that shifts it from siloed brands with their own mini head office teams to one where the executives will have group responsibilities.

The new structure is largely about costs – Tigerair had its own corporate structure to manage a fleet of only 14 planes, for instance – but also ensuring better co-ordination between the parent brand, Tiger and the regional business and simplifying management of the group.

Scurrah has commissioned reviews of Virgin’s capacity, network and fleet and its supply chain, seeking to improve aircraft utilisation, route profitability and to renegotiate key contracts. Between the organisational changes and the supplier review he hopes to generate $125 million of cost savings.

He needs to, given that on top of the $158 million of extra fuel and foreign exchange in the second half Virgin expects another $100 million of those costs this financial year.

One of the decisions that should help is to continue to shift the currency mix of its borrowings. Last financial year 76 per cent of Virgin’s debt was in US dollars, a peculiar exposure given that Virgin’s revenues are predominantly Australian dollar-denominated. Presumably that glaring mismatch was because the debt was, at face value, low-cost.

The US dollar exposure was reduced to 60 per cent in the latest financial year and will fall below 50 per cent by the end of the financial year, with Virgin scheduled to repay a $US400 million bond issue due in November.

So far, Scurrah is executing the right playbook to create a more stable and profitable business albeit that, in these early days, it is more about stabilising the business than generating meaningful profits.

His first action – before he even formally took up the role – was to reschedule and defer an order of 737 MAX 8 planes that represented, given Virgin’s chronic lack of profitability and relative youthfulness of its fleet, another expensive and unnecessary indulgence for an already overly-indulgent group.

There’s also a review of the ownership of Virgin’s Velocity frequent flyer program, forced on it by its 35 per cent partner, Affinity Equity, wanting to cash out, which may provide Scurrah an opportunity to release some cash himself without sacrificing majority ownership.

Now he’s moved on the excessive costs baked into Virgin’s organisational structure while running reviews on the more complex elements of Virgin’s business; reviews that will provide him with the data he will need to make the continuing and more structural changes to Virgin’s strategy and business model that its abysmal performance since 2010 dictates.