MIAMI — Virgin America reported a first quarter net loss of $22.4 million on Friday. The figure represents a 50% improvement over the $46.4 million loss the Burlingame, California based carrier recorded in the first quarter of 2013. The airline blamed the loss in part on cancellations due to the rough winter weather in the Northeast and Midwest that hampered results from other US airlines.
Despite the impact of cancellations, operating revenues increased 4.0% year-over-year (YOY) to $313.39 million. The increase was largely led by increased flying. Departures were up 9.9% system wide YOY and block hours per day up 2.9% to 10.6 hours, reflecting the carrier’s move toward adding shorter, higher-yielding routes (average stage length continues to drop, falling 6.9% YOY to 1,406). Capacity as, measured in available seat miles (ASMs) grew 3%, leading in part to a 10.6% increase in passengers carried.
Passenger revenues per ASM was 9.95 cents, down slightly from 9.98 cents in 2013. Yields also fell, dropping 2.8% YOY to 12.56 cents. However, these figures were sharply impacted by the shift of Easter and Passover to April (worth at least two points of PRASM, particularly in April), and the aforementioned weather-related cancellations.
Despite some positive operational signs, the company’s operating revenues couldn’t keep pace with a 3.2% percent YOY increase in operating expenses. With the exception of aircraft fuel and rent, which were down 0.7 and 21.2 percent YOY respectively, every other line item increased. Labor increases predictably led the charge, rising 18.2% YOY, though it should be noted that the number of full-time employees grew 7.6% over 2013 as well. Virgin America is a growing business, but also an aging one (similar to where JetBlue was in the middle of this decade), which leads to rising costs for existing employees (higher wages and more benefits) plus a need for new employees. Additionally, thanks to collective bargaining, these new workers come in at the same labor contract (though they start with lower pay) as existing ones. This creates an interesting dynamic for Virgin America (or any growing airline without a two-tier wage scale) when it starts a new route: revenue and demand take time to spool up, but costs are consistent throughout the life of a route (declining slightly over time with economies of scale).
Other cost-line increases YOY included landing fees (+16.9% to $32mil) driven especially by the launch of flights to Newark in April, and other new routes to Austin, Anchorage, and Las Vegas. Sales and marketing costs rose 34.7% to $24.5 million, and maintenance expenses rose 9.1% to $19.04 million. Costs per ASM (CASM) rose 0.2% to 11.76 cents, while CASM excluding fuel rose 2.4% YOY to 7.59 cents, both of which were about in line with Virgin America’s peers.
Despite the loss, the end of the first quarter undoubtedly brought with it some very promising long-term news. The carrier has now solidified its purchase of slots at both New York LaGuardia and Washington Reagan. Equally, if not more, important, the airline also acquired two gates at the coveted Dallas Love Field airport. The airline plans to leverage the two gates into a focus city beginning in the fourth quarter of this year. The acquisitions will enable the carrier to move even further away from its nearly singular focus on transcontinental operations, and into an increasingly diversified route portfolio.
That diversified route portfolio is critical given that nearly 30% of Virgin America’s revenues are generated by New York (JFK and Newark) markets, as well as the lion’s share of its (marginal) profits. Virgin America’s competitiveness in these transcontinental markets is also being steadily eroded by the evolution of rival carriers. When the carrier launched seven years ago, its First Class product was superior to all but the first class cabins operated by United and American (competitive with their angled business class seats). Today, its premium cabin product has been clearly surpassed by those of Delta, American, United, and JetBlue. Thus diversification is extremely important. Unfortunately, the Dallas Love Field and New York La Guardia operations are difficult for Virgin America to gain a foothold in. Unlike LA and San Francisco, high yield travel in these markets is driven almost exclusively by frequency, schedule, and frequent flyer links, something that Virgin America simply cannot match.
That being said, it would be remiss not to commend Virgin America on the positive evolution to its business model. Over the past year and a half, Virgin has steadily evolved from a growth-focused airline to a profit-focused one. Instead of adding ten aircraft per year (the airline added just one net airframe between Q1 2013 and Q1 2014), Virgin has settled into the pattern of capacity discipline and sustainable growth that has proved successful for other US airlines. This strategic change is due to the changing dynamics of investing in the US airline industry. In the past, airline start-ups were judged (from an investment perspective for an initial public offering [IPO]) on the same metric that start-ups in other industries were: growth. Today, however, recognition of the particular challenges faced by the airline industry has led to investors prioritizing ROIC, operating margin, and other profit target metrics in valuing airlines. The most valuable airlines today (Allegiant and Spirit – on a P/E basis), also have the highest margins. Clearly Virgin America has a ways to go before it achieves consistent profitability. But as it hurtles towards an IPO, there are legitimate reasons for optimism in its finances.
The open question is whether the massive growth at Love Field, Reagan, and La Guardia will cause the carrier to slide back to the dark days of 2009-12. If Virgin America funds this growth by cutting capacity elsewhere as schedules seem to indicate, then the answer to that open question, at least for the moment, is no.