Qantas Minds Bonds as Dreamliner Order Pulled: Australia Credit

Qantas Minds Bonds as Dreamliner Order Pulled
Qantas Airways Ltd. aircrafts stand on the tarmac at Sydney International Airport. Photographer: Sergio Dionisio/Bloomberg

Qantas Airways Ltd.’s plans to cut debt for the first time in five years with funds from a canceled $8.5 billion Boeing Co. order have been welcomed by bondholders as its default risk fell the most in Australia.

Contracts insuring against non-payment on the debt of Australia’s biggest carrier tumbled 87 basis points over the past three months, the biggest drop in the nation’s benchmark bond-risk index, to 300 on Nov. 23, CMA data show. The contracts cost 204 basis points less than the average for global peers, about five basis points from the biggest discount since June.

Chief Executive Officer Alan Joyce this year grappled with a loss-making international division and Virgin Australia Holdings Ltd.’s efforts to steal local business travelers, sending bond risk to a record 445 in June and the stock to an all-time low. He responded by forging a partnership with Emirates Airline and canceling the purchase of 35 Boeing 787 Dreamliners ordered before the 2008 global financial crisis, helping raise enough cash to repay A$650 million of debt early.

“Its balance sheet and capital management is quite impressive versus its global peers,” George Boubouras, chief investment officer at UBS AG in Melbourne, said by phone. “Credit conditions have vastly improved.”

Default-swap investors have enjoyed a better performance than shareholders since Qantas’s perceived risk peaked earlier this year, Boubouras said. The 33 percent fall in the bond-insurance contracts from June 28 to Nov. 23 outstrips a 20 percent gain in the shares.

Qantas shares rose 2.8 percent to A$1.31 at the close in Sydney, their highest level in nearly a month, while the benchmark S&P/ASX 200 index gained 0.3 percent.

Debt Reduction

Qantas will reduce debt by A$1 billion in the year through June 2013, the company said Nov. 15. The airline has increased net debt every year since 2008, data compiled by Bloomberg show. It plans to repay its 5.125 percent dollar-denominated bonds in January, five months early, and is also using A$100 million to repurchase its own shares, the company said.

Canceling the Boeing order and selling its stake in a road freight business gave Qantas A$750 million to spend without threatening its credit rating, according to the airline.

The company, the only carrier other than Southwest Airlines Co. to be rated investment-grade by more than one major ratings company, will also gain from a partnership deal with Emirates, helping it to turn around the A$450 million of losses it made on international routes last year.

Qantas reported its first annual loss in at least 17 years in the 12 months through June as a 16 percent rise in fuel prices and the highest labor costs among carriers worth more than $1 billion eroded profit margins for its core business.

Spending Cuts

The carrier has cut back spending plans, canceled its loss-making Frankfurt route, and raised cash from penalty payments related to Boeing’s delays of the 787 Dreamliner.

“We’re now in the second year of our five-year turnaround plan and we’re making clear progress,” Andrew McGinnes, a Sydney-based spokesman for the company, said in an e-mailed statement. The early debt repayment and an associated A$100 million share buyback “reflect the underlying strength of the Qantas Group,” he said.

Under the Emirates plan, the Australian carrier will make Dubai its main hub for European routes instead of Singapore, with passengers traveling on the Gulf airline under codesharing for one of the two legs.

Dubai Hub

That will open up 64 one-stop destinations in Europe, the Middle East and North Africa, compared to 5 at present, and help return the international division to profit, Joyce said Sept. 6.

Qantas credit-default swaps have fallen 144 basis points this half, according to CMA. That’s outpaced the benchmark Markit iTraxx Australia gauge, which fell 51 basis points to 135 on Nov. 23 in Sydney, the data show.

Benchmark 10-year sovereign bond yields jumped 27 basis points last week to 3.30 percent, the steepest climb since the period ended Feb. 10, as signs of a strengthening global economy reduced demand for the safest assets.

The Australian dollar, the world’s fifth-most traded currency, bought $1.0460 as of 10:46 a.m. in Sydney today, taking its advance this month to 0.8 percent.

The cancellation of the Dreamliner order will result in Qantas getting $433 million from Chicago-based Boeing, including more than $300 million in compensation payments, Gareth Evans, the airline’s chief financial officer, said at the time of the Aug. 23 announcement.

A deal announced Oct. 2 -- under which Qantas and government-owned Australia Post swapped stakes in joint-venture freight assets -- will also give the airline net proceeds of more than A$408 million, the company said at the time.

High Volatility

Much of the improvement in Qantas’s CDS has resulted from their high volatility, which has allowed the contracts to benefit disproportionately from a broader rally in credit markets, said Michael Bush, head of credit research at National Australia Bank Ltd.

“It’s been driven by these one-off events, raising capital through, effectively, asset sales and compensation payments,” he said by phone from Melbourne. “It’s hardly as if it’s reflective of improving operating performance: when you look at their guidance it’s clear that’s miserable and staying that way.”

‘Miserable’ Guidance

It’s still too early to tell whether the deal with Emirates will be a long-term positive for the carrier, Bush said. Standard & Poor’s cut Qantas’s debt one level to its lowest investment grade of BBB- on Sept. 7, the day after the announcement of the Emirates agreement.

“Material benefits from the partnership may take some time to eventuate due to the magnitude of Qantas’s losses over the past few years,” Melbourne-based analyst May Zhong wrote in the rating opinion. The carrier holds a Baa3 rating from Moody’s Investors Service, also the lowest investment grade ranking.

The company must take care not to deviate from its current path if it wants to keep debt holders happy, UBS’s Boubouras said.

“They’ve got the benefits from freight, Jetstar, and the strong domestic market,” said Boubouras, referring to Qantas’s budget carrier. “They must maintain the same approach to cost controls and prepare this company for the next 10 years.”

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