Fundies say Virgin float must be pitched at discount to Qantas

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In 2022, chief executive Jayne Hrdlicka disclosed that Virgin was on track to deliver a profit in financial year 2023, and that its annual cost base was almost $300 million lower than in pre-coronavirus times.

Nonetheless, the experience of the disastrous Virgin Blue IPO of 2003 is still fresh in many investors’ minds.

“I’d be very sceptical; Virgin has a poor track record in terms of the sharemarket and never really traded at a great multiple,” said Matthew Kidman, principal of Centennial Asset Management.

“Airlines are currently doing well from the reopening and the yield they’re getting from the lack of supply, but as supply and travel begins to normalise, it’s hard to see a second airline in Australia doing that well.”

Head of Australian equities at Equity Trustees, Chris Haynes, said the firm would consider investing in Virgin’s IPO if its valuation was strong enough relative to Qantas.

That being so, he acknowledged the airline’s past issues with profitability and questioned the sustainability of the current spike in “revenge travelling”.

“Virgin in the past has been plagued by liquidity and size issues, [and] doesn’t have the breadth of offering that Qantas has,” Mr Haynes said.

“We are moving into a period of likely slowing consumption/discretionary spend, businesses may look to pull back on costs as the economy slows, fuel costs remain an uncertainty, and one must always be careful when buying off private equity.”

Airlines rally

Qantas’ share price has surged nearly 50 per cent over the past six months and is now sitting at its highest level since early 2020, just before the coronavirus-induced market crash. Qantas stock closed at $6.54 on Tuesday.

Goldman Sachs on Tuesday reiterated its “buy” rating on Qantas, noting that the airline’s market capitalisation is 10 per cent above its pre-pandemic level but its enterprise value is 8 per cent below. “We believe the stock is not appropriately pricing Qantas’ improved earnings capacity,” argued Niraj Shah, analyst at Goldman Sachs.

Investors have piled back into the nation’s largest airline after it stunned the market with two huge profit upgrades late last year on the back of booming travel demand and widespread cost-cutting.

The airline’s soaring valuation is expected to place heightened focus on the pricing of Virgin’s potential IPO given the superior market position that Qantas commands.

“I would imagine people would be looking for Virgin to be at some sort of discount [to Qantas], and for the IPO process, will be wanting an attractive valuation as well,” said Stuart Welch, portfolio manager at Alphinity Investment Management.

A key question for management will be whether Virgin has been able to replicate Qantas’ success in cutting costs throughout the pandemic under the watchful eye of Bain.

Back to their roots

The market will also have questions around Virgin’s strategy and positioning, recalling former chief executive John Borghetti’s attempt to transform the airline from the low-cost origins of Virgin Blue to a full-service carrier.

“What’s happened through administration is Virgin seems to have gone back to their roots – it’s neither a full low cost carrier or a full-service airline, so there is a risk that they’re stuck in the middle,” Mr Welch said.

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