Airline Debt Takes Off as Traffic, Profits Rise: Credit Markets
Bonds of airlines are proving unbeatable two years after the industry struggled with record high fuel prices and an economy in freefall.
Borrowers from Dallas-based Southwest Airlines Co., the world’s biggest discount carrier, to Australia’s Qantas Airways Ltd. led gains of 2.36 percent for the sector last month, topping the Bank of America Merrill Lynch Global Broad Market Corporate index, which was little changed. The increases pushed total returns this year to 15.4 percent, the best of the 17 industries making up the index.
Bondholders have more confidence airlines will have an easier time meeting debt payments as the International Monetary Fund in Washington forecasts the world economy will expand more than 4 percent next year, compared with the average of 3.69 percent from 2000 through 2008. The eight largest U.S. carriers are reporting quarterly profits for the first time since 2007 as the industry holds the line on adding seats.
“Performance has been incredible, and it really doesn’t have to be over,” said William Hochmuth, an analyst at Minneapolis-based Thrivent Financial, which manages $67 billion. “The biggest thing that everyone was focused on in third- quarter earnings was the maintenance of capacity discipline and as long as we have that, there’s pricing power.”
‘Very Good Shape’
United Continental Holdings Inc., Delta Air Lines Inc. and AMR Corp.’s American Airlines said they plan to limit capacity increases to 3.5 percent or less next year. Profit at the eight biggest U.S. airlines was $2.44 billion in the third quarter, beating analysts’ average estimates. Average airfare per mile excluding taxes rose every month this year through August after falling in 2009, according to the Air Transport Association.
“The airlines have had very good financial results through the summer,” said Roger King, a debt analyst at fixed-income research firm CreditSights LLC. “They have a lot of cash and they’ve been able to push out their debt maturities. So from a credit metrics standpoint they’re in very good shape.”
Elsewhere in credit markets, the extra yield investors demand to own company bonds rather than government debt worldwide narrowed for a fourth week, capping the biggest monthly drop since July.
Spreads on company bonds from the U.S. to Europe and Asia shrank 3 basis points last week to 164 basis points, or 1.64 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. That’s a decline of 9 basis points for the month. Average yields of 3.45 percent on Oct. 29 have slid from 4.4 on Dec. 31.
The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 0.6 basis point to a mid-price of 93.8 basis points as of 11:54 a.m. in New York, according to index administrator Markit Group Ltd.
The index, which typically drops as investor confidence improves and rises as it deteriorates, touched the lowest in more than five months Oct. 26 at 92.5 basis points.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point, 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.
New York Times Co., publisher of the namesake newspaper, plans to sell $200 million of senior notes due 2016 to repay debt and other financial obligations. The offering is part of a “refinancing strategy,” the New York-based company said in a statement. The notes will be priced as soon as today, according to a person familiar with the transaction.
Times Co. is offering debt for the first time since borrowing $250 million from companies controlled by Mexican billionaire Carlos Slim in January 2009.
Airlines’ performance for debt investors in October compares with a return of 0.08 percent for corporate bonds worldwide, based on Bank of America Merrill Lynch indexes. Their bonds gained 1.6 percent in September and 1.86 percent in August, versus market gains of 0.22 percent and 2.14 percent.
More than a dozen carriers collapsed in the first half of 2008 as they faced spiraling fuel costs and the worst economic crisis since the Great Depression. Seeking to slash expenses, carriers expanded efforts to charge for snacks and checked bags.
“Airlines are struggling for survival,” Giovanni Bisignani, the chief executive officer of the International Air Transport Association, said in a speech in Istanbul in June 2008. That was a month before crude oil prices reached as high as $145.29 a barrel.
United Leads Rally
Airlines are poised to record their first positive fourth quarter in a decade, according to Michael Derchin, a CRT Capital Group LLC analyst. Before this year’s third quarter, the last time all of the eight largest U.S. airlines were profitable was the same period of 2007.
Bonds from United Airlines were the best-performing last month in the Bank of America Merrill Lynch U.S. Corporates Transportation index, gaining 4.61 percent. United’s $500 million of 9.875 percent notes due August 2013 have climbed to 109.25 cents on the dollar from 99.25 cents on Jan. 13, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority. United and Continental Airlines merged to become United Continental Holdings on Oct. 1.
Atlanta-based Delta’s bonds ranked second in the index, returning 3.06 percent in October.
The reduced supply of aircraft seats is aiding carriers as demand picks up from business travelers, who generally buy tickets closer to their departure dates and pay higher fares.
“In terms of absolute strength of revenue, we’ve achieved a level I think is sustainable at Southwest for at least in the near term,” said Gary Kelly, CEO of Dallas-based Southwest. “I’d call that roughly 12 to 24 months. That’s under the assumption the economy doesn’t slip back into recession and travel demand continues to strengthen.”
Southwest’s bonds rose 1.1 percent in October, according to the Bank of America Merrill Lynch index data. Qantas’s U.S. dollar-denominated bonds returned 0.76 percent. The Sydney-based carrier’s $513.6 million of notes maturing in April 2016 rose 0.98 cent to 110.78 cents in October, Trace data show, and traded today at 110.895.
Credit-default swaps on North American airlines fell to an average 650 to 700 basis points from 900 to 1,000 basis points in June, Bloomberg analyst George Ferguson wrote in an Oct. 25 report.
Contracts on Delta, the world’s second-biggest carrier, tumbled to the lowest in almost three years on Oct. 29. The contracts declined to 570.7 basis points, from 725 at the end of September, CMA prices show. The contracts rose today to 573.4.
Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, and typically fall as investor confidence improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
S&P increased its outlook on Delta, from negative to stable on Oct. 21. “Continued strong earnings, coupled with debt reduction” could lead to an upgrade, S&P said. Delta cut its debt by $750 million in the quarter, it said in a statement.