Qantas Risk Passes BA as S&P Cuts Debt to Junk: Australia Credit

Qantas Airways Ltd.’s bond risk climbed above lower-rated British Airways Plc for the first time since 2007 as Australia’s largest carrier considers asset sales to help fund new aircraft purchases.

The cost of insuring Qantas against a default rose 65 basis points to 280 basis points on Dec. 6, the most in seven years, after Standard & Poor’s cut its ratings to junk. A 112 basis point jump since May 9 pushed the credit-default swaps past those on British Airways, which lost its S&P investment grade in 2009.

Qantas expects to lose as much as A$300 million ($273 million) in its first half, forcing the airline to either take on debt, issue shares or sell assets to pay for new planes. An internal review looking at divestments, and a proposed sale-and-leaseback arrangement for its fleet, have heightened the uncertainty, according to Westpac Banking Corp.

“If they can’t see a way to a competitive position, then selling assets isn’t a positive move,” Brendon Cooper, head of credit strategy at the bank, said by phone from Sydney. “There’s not a lot of protection for bondholders” if Qantas sells off businesses and planes.

Qantas last week announced 1,000 job losses and a A$2 billion cost-cutting program to compensate for a decline in domestic ticket prices that’s driving losses as it seeks to retain market share amid a challenge from Virgin Australia Holdings Ltd.

The company’s shares dropped to a record low today, touching 95.5 Australian cents intra-day and falling for a sixth straight session. Australia’s dollar traded at 91.03 U.S. cents at 3 p.m. in Sydney and has fallen more than 12 percent this year.

Virgin Competition

Virgin’s shareholders Air New Zealand Ltd., Singapore Airlines Ltd and Etihad Airways PJSC, which have promised to support a A$350 million capital raising the company announced last month, are “pumping money in to continue a loss-making business” Qantas Chief Executive Officer Alan Joyce said in a media call Dec. 5.

The more aggressive behavior of Virgin has changed Australia’s domestic aviation market, S&P credit analyst May Zhong wrote in the Dec. 6 opinion reducing Qantas’s rating to BB+. The Sydney-based carrier had a monopoly on full-service domestic flights for a decade until Virgin quit its budget airline roots by adding business class seats in 2011.

“Virgin Australia has become a more formidable competitor,” in part thanks to its “well-capitalized shareholders,” Zhong wrote. “The profitability of Qantas’ domestic operation is key to the group’s competitive position and long-term viability.”

Junk Rating

The S&P downgrade leaves Qantas at the rating company’s highest junk rating, with a negative outlook. Moody’s Dec. 5 put Qantas’s Baa3 rating, its lowest investment grade, on review for a possible downgrade.

Qantas, one of just four airlines globally with any investment-grade rating, is the only one of 11 global carriers whose default risk has risen this year, according to data compiled by Bloomberg.

Its CDS have been an average of 218 basis points cheaper than those on British Airways in records dating back to October 2004, according to data compiled by Bloomberg. They’re now 57 basis points more costly.

The two carriers have collaborated since Imperial Airways, a forerunner of the U.K. airline that’s now owned by International Consolidated Airlines Group SA, worked together with Qantas on the first London-to-Sydney “kangaroo route” flights in 1935.

Merger Unsuccessful

Qantas and British Airways held ultimately unsuccessful merger talks during the 2008 financial crisis before the British carrier chose to tie up with Iberia Lineas Aer de Espana SA to form IAG.

The downgrade will probably push up the rate on Qantas’s syndicated loans by about 50 basis points, Anthony Moulder, an equity analyst at Citigroup Inc. in Sydney, wrote in a Dec. 6 note to clients.

Andrew McGinnes, a spokesman for Sydney-based Qantas, declined to comment, pointing to a statement Dec. 6 by Chief Financial Officer Gareth Evans highlighting the company’s “strong financial position, including a large cash balance and a significant asset base.”

Qantas had A$6.08 billion in net assets and a gross A$7.32 billion in aircraft and engines at the end of June, according to its latest annual report.

Asset Sales

Management will look at “structural changes that could potentially unlock sources of capital and value” the carrier said Dec. 5. Asked if that could include a sale or spin off of its Jetstar budget carrier or Frequent Flyer loyalty program, Joyce said “nothing’s going to be ruled in or ruled out”.

The carrier could also sell some of its fleet and lease it back, in particular 14 Boeing Co. 787 Dreamliners that Jetstar is due to receive this year and next, Citigroup’s Moulder wrote.

Investor Greg Woolley is preparing a A$5 billion proposal to sell-and-lease back Qantas aircraft, according to an Australian Financial Review report. His assistant Connie Sowter said the article was correct and declined to comment further.

Such sales aren’t particularly attractive, said Michael Bush, head of credit research at National Australia Bank Ltd. in Melbourne.

“While it frees up a bit of cash for the balance sheet, it also comes at a cost of earnings,” he said. A sale of Qantas’s lease on a terminal at Sydney Airport, which Deutsche Bank AG estimates could be worth about A$400 million, is more attractive, Bush said.

Airlines have no place as investment-grade credits in the first place, said Vivek Prabhu, who doesn’t include Qantas debt among about A$4.1 billion in fixed income he helps manage as a senior portfolio manager at Perpetual Ltd. in Sydney.

“An airline is exposed to so many uncertainties -- fuel prices, volcanic ash clouds, weak sales, terrorism, industrial relations,” he said. “It’s not consistent with what we’re looking for from a credit investment.”

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