Qantas Risk Tops Air France-KLM on Plan Doubts: Australia Credit

Doubts over Qantas Airways Ltd.’s plan to stem losses pushed bond risk for Australia’s biggest carrier above that of Air France-KLM Group, which is attempting a turnaround from near bankruptcy.

Credit-default swaps protecting against non-payment of Qantas’s debt have risen by as much as 48 basis points since Feb. 28 to 300 on March 13, the highest level since November 2012. It ended last week at 294.5. Risk for Air France-KLM fell to a three-year low on March 7 as the carrier’s Chief Executive Officer Alexandre de Juniac, who said it had been “heading to bankruptcy,” refocused on premium fliers.

Qantas, named Australia’s most highly-regarded brand last year by the Reputation Institute consultancy, has struggled to protect its market share in a price war with Virgin Australia Holdings Ltd. A A$2 billion ($1.8 billion) cost-cutting plan, involving a pay freeze and the lowest capital spending since 1998, may not be enough, according to Kapstream Capital Pty.

“If revenue keeps falling the profit margin might remain very similar despite all the cost cuts,” Raymond Lee, who helps manage about A$6.5 billion at the Sydney-based fund, said by phone. “There hasn’t been any real positive news about the underlying business.”

Annual revenue at the 93-year-old carrier will fall this year for just the fourth time since 1993, according to the median of 12 analyst estimates compiled by Bloomberg.

Losing Control

Qantas will have to borrow money to pay for planes and other capital spending during the year through June due to negative free cash flow, chief executive Alan Joyce forecast Dec. 5. The measure, which shows how much cash is left over from sales once operating costs and capital spending have been paid, has only been positive in one year since Joyce took over in November 2008, according to data compiled by Bloomberg.

“Qantas can control costs as best it can but there are so many factors outside of its control,” Mark Bayley, a credit strategist at Aquasia Pty. in Sydney, said by phone. “For the credit investor the airline sector is just horrendous, there’s very little upside and plenty of downside.”

Qantas has struggled as Virgin Australia has grown to take up more than a third of the country’s aviation market.

Virgin, which used a A$20 million investment from billionaire Richard Branson to start a single route between Brisbane and Sydney in 2000, now gets better revenue per seat with lower costs than formerly state-owned Qantas.

Turn Around

Virgin made just over 12.15 Australian cents of revenue per kilometer for each seat in the six months ended December, the company said Feb. 28, compared to 10.10 cents for Qantas. On domestic routes, Qantas probably pays about 11 cents for non-fuel operating costs compared to Virgin’s 8.1 cents, David Fraser, an analyst at BBY Ltd., wrote in a Jan. 17 note to clients.

Qantas, which was fully privatized in 1995 following 48 years as a government-controlled carrier, isn’t counting on state support and will make the cost cuts regardless, Joyce told a Feb. 27 media conference after it posted a A$235 million first-half net loss.

“The plan we have is the plan that’s needed in order to turn around the business,” he said. It’ll be followed “irrespective of the government involvement or what the government decides to do.”

Andrew McGinnes, a spokesman for the Sydney-based carrier, declined to comment separately for this article.

Risk Perceptions

Perceptions of the risks for Qantas debt holders fell last month on prospects the government would provide a standby debt facility for the company. The airline met four conditions that may entitle it to support, Treasurer Joe Hockey told a media conference in February.

Those hopes were scotched March 3 when Prime Minister Tony Abbott said the government wouldn’t offer a credit guarantee. The airline “is best-placed to compete and to flourish if it is unshackled and un-propped up by government,” he told a media conference that day.

The decision caused the carrier’s CDS contracts to surge. They cost 195 basis points more than the Markit iTraxx Australia benchmark index on March 13, the widest spread since September 2012, data compiled by Bloomberg show.

The spike in Qantas contracts may have been caused by investors who’d sold credit protection getting squeezed as they tried to reduce their exposure, said Aquasia’s Bayley.

Squeezed Out

“Investors may be looking to get out of some of those positions before the CDS become even more illiquid than they are now,” he said.

Qantas won’t be included in the latest version of the Markit iTraxx Australia index when it starts trading March 20, according to a provisional membership list published on its website. Fresh versions of default-swap benchmarks are created every six months when companies are added or dropped depending on their ratings, cost of protection and ease of trading.

Before Qantas forecast its first-half loss on Dec. 5, it was one of just two airlines worldwide, with Southwest Airlines Co., to be judged investment-grade by two separate rating companies. It’s now placed at junk with a Ba2 rating from Moody’s and BB+ at Standard & Poor’s and has a negative outlook from both companies.

“The trajectory for restoration of international’s return to profitability would now appear to be some considerable way off,” Ian Lewis, a Senior Vice President at Moody’s Investors Service in Sydney, wrote in a Feb. 27 statement, referring to Qantas’s international unit. That business lost A$262 million in the first half and won’t now return to profit during 2015, as previously forecast, Joyce said Feb. 27.

“This delay in recovery increases the pressure on the current negative outlook,” Lewis wrote.

Slow Bleed

Joyce believes cost measures, including the deferral of orders for eight Airbus Group NV A380 superjumbos and three Boeing Co. 787-8 Dreamliners, the cutting of about one in seven jobs and a 36 percent drop in his own take-home pay, will be enough to repair Qantas’s balance sheet.

“With the A$2 billion cost reductions coming out, we can get back to profitability and we can be paying down debt,” he told a lunch event in Sydney March 5.

While cutting capex and dropping unprofitable routes may help in the long term, the shrinking of the business could make investors uneasy in the short-term, said Kapstream’s Lee.

“When a company needs to do that, it signals to the market that they’re really struggling,” he said. “Qantas has quite a lot of cash on the balance sheet but it’s going to slowly bleed unless they do something about it.”

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