Sydney: Qantas Airways Ltd’s bond risk fell to a three-and-a-half month low as investors bet cooperation with Emirates will pull the Australian airline back from the brink of a junk credit rating.
Credit-default swaps that insure against non-payment on the Sydney-based airline’s debt tumbled 55 basis points this month to 357 basis points on Thursday, set for the sharpest two-week decline since October, CMA data show. The contracts cost 160 basis points less than the average for global peers on September 10, close to the widest advantage since June.
Qantas says the 10-year accord with Emirates on pricing, sales, schedules and loyalty programmes announced on September 6 can end 1.2 million Australian dollars (Dh4.66 million, $1.3 million) a day in losses on international routes. That’s boosting prospects the company can retain its status alongside Southwest Airlines Co. as the only carrier worldwide rated investment grade by both Standard & Poor’s and Moody’s Investors Service.
“There was a risk they’d lose their investment grade,” John Sorrell, head of credit at Tyndall Investment Management Ltd in Sydney, said by phone. “The deal doesn’t completely rescue them but there’s a lot of positives to it. Probably the Emirates deal will hold them in place for the moment.”
Tyndall, which manages A$23 billion of assets, doesn’t hold Qantas’s debt, Sorrell said.
The Emirates deal should allow the company’s international unit to break even by 2015, Qantas Chief Executive Officer Alan Joyce said on September 9.
The airline posted its first annual loss in at least 17 years last month as fuel costs climbed, demand from Europe sagged and the strong Australian dollar hurt the nation’s tourism industry.
The so-called Aussie, the world’s fifth-most traded currency, bought $1.0575 as of 3:20pm in Sydney yesterday, 42 per cent higher than the 20-year average of 74.5 US cents. The Reserve Bank of Australia has set the developed world’s highest benchmark interest rates to manage a record mining boom, fuelling demand for the nation’s assets.
Australian 10-year bond yields reached 3.30 per cent on Friday, the highest level since August 24. The gap to similar-dated Treasuries was 155 basis points, or 1.55 percentage points.
The Emirates deal will improve Qantas’s outlook by cutting losses on European operations and renewing the airline’s ability to expand in Asia, Qantas CEO Joyce said last week. He had told an Australian parliamentary inquiry February 6 that rating companies may drop the airline to junk status if it can’t close the gap between cash flow and capital spending, creating a “vicious circle” as higher borrowing costs make it harder for the carrier to upgrade its fleet.
About half of the A$1 million revenue Qantas typically generates on flights between Australia and Europe is being eaten up by fuel costs, Joyce said at an annual results briefing in Sydney August 23.
“The steps we have taken to transform our business and the Emirates partnership position us to meet the goals of our international turnaround plan,” Thomas Woodward, a Sydney-based spokesman for the airline, said by e-mail September 11. “The group is well-placed.”
Qantas has a 65 per cent market share in Australia, its budget carrier Jetstar is the largest in the Asia-Pacific region, and its loyalty programme is the company’s most profitable major unit with A$342 million of operating income in the 2011 financial year, the last period for which a breakdown is available.
Interest Payments
Still, interest payments last year leapt 37 per cent to their highest level on record as net debt climbed to double its level in 2008. Relative to earnings before interest, tax, depreciation, and amortization, net debt is at its highest level since 2006.
Qantas default swaps are more than two and a half times as expensive as for Southwest Airlines, which were at a seven-month low of 133 basis points on Wednesday. Contracts on Deutsche Lufthansa AG, which Moody’s puts at junk, traded at 216.2, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. Moody’s rates Qantas Baa3, its lowest investment grade.
The Markit iTraxx Australia index of credit-default swaps that gauges perceptions of corporate bond risk declined 8 basis points to 138 as of 10:24am in Sydney, Westpac Banking Corp prices show. The gauge is set for its lowest close since March 21, according to data provider CMA.
The extra return investors demand to hold corporate notes in Australia instead of federal government securities fell to 218 basis points yesterday, the lowest in almost a year.
The yield premium on Qantas’ $513.6 million of 6.05 per cent bonds maturing in April 2016 shrank 65 basis points to 454 basis points since reaching a record 519 on June 22, according to BNP Paribas SA prices.
The spread on Southwest Airlines’ $300 million of 5.75 per cent bonds due in December 2016 expanded 21 basis points to 208 in the same period, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
While the Australian carrier’s long-haul business was facing “structural pressures” due to rising capacity, competition, high fuel costs and a weak global economy, “we expect Qantas’s earnings in its international operations to improve” as a result of the Emirates alliance, May Zhong, a Melbourne-based analyst for S&P, wrote in an opinion September 7.
Qantas needs to have a more conservative outlook on finance, Stephen Nash, a Sydney-based director at Fiig Securities Ltd, said by phone.
“Airlines generally have a habit of flying in and out of Chapter 11,” he said, referring to a form of bankruptcy proceedings under US law. There have been 193 bankruptcies in the US airline sector since deregulation in 1979, according to data from Airlines for America, an industry group.
While the Emirates deal was a “positive development,” it may take some time for the benefits to be seen, S&P’s Zhong wrote in last week’s report.
“We view the industry risk to be increasing significantly in the Asian market due to intensifying competition,” she wrote. “More and more Asian carriers- who have much lower cost bases - have aggressively stepped up capacity to increase market share.”
Qantas, which hasn’t proposed a full-year dividend since 2008, is also hanging onto cash by cutting spending plans.
The airline cancelled a firm order for 35 Boeing Co. 787 Dreamliners worth about $8.5 billion at list prices and received $433 million from Boeing, including more than $300 million in compensation payments, as a result of delays.
Qantas also is pushing back until as late as 2021 eight Airbus SAS A380s that were slated for delivery as soon as next year, with only two due to be delivered before 2017. The aircraft cost $390 million each, according to current list prices.
Capital spending was A$2.13 billion in the year through June, according to data compiled by Bloomberg, and the company forecasts A$1.9 billion to be spent next year and again in 2014.
That compares to a February forecast of as much as A$2.5 billion this year and A$2.3 billion in 2013.
The Emirates deal “buys a lot of breathing space,” Fiig’s Nash said. “It’s a very good choice for Qantas. Emirates are well supported, they’ve got a great fleet, and it’s going to be a hard combination to compete against.”
