Bloomberg News

Emirates Pulls Qantas Back From Brink of Junk

September 13, 2012

Emirates Pulls Qantas Back From Brink of Junk

An Emirates Airline flight attendant stands in front of a Qantas Airways Ltd. aircraft during a media event in Sydney. Photographer: Brendon Thorne/Bloomberg

Qantas (QAN) Airways Ltd.’s bond risk fell to a 3 1/2-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 358 basis points on Sept. 12, 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 Sept. 10, close to the widest advantage since June.

Qantas says the 10-year accord with Emirates on pricing, sales, schedules and loyalty programs it announced Sept. 6 can end A$1.2 million ($1.3 million) in daily losses on international routes. That’s boosting prospects the company can retain its status alongside Southwest Airlines Co. as the only carrier worldwide rated as 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.

Breaking Even

The Emirates deal should allow the company’s international unit to break even by 2015, Qantas Chief Executive Officer Alan Joyce said Sept. 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 $1.0454 yesterday as of 5 p.m., more than 40 percent higher than the 20-year average of 74.47 U.S. cents. The Reserve Bank of Australia has set the developed world’s highest benchmark interest rates to manage a record mining boom, fueling demand for the nation’s assets.

Australian 10-year bond yields reached a 2 1/2-week high of 3.25 percent yesterday in Sydney, before closing at 3.22 percent. The gap to similar-dated Treasuries was 148 basis points, or 1.48 percentage points.

Cutting Losses

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 Feb. 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 Aug. 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 Sept. 11. “The group is well-placed.”

Qantas has a 65 percent market share in Australia, its budget carrier Jetstar is the largest in the Asia-Pacific region, and its loyalty program 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 percent 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 2 1/2 times as expensive as for Southwest Airlines, which were at a seven-month low of 133 basis points on Sept. 12. Contracts on Deutsche Lufthansa AG (LHA), which Moody’s puts at junk, traded at 216.7, 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 was at 146 basis points yesterday, according to Markit Group Ltd.

The extra return investors demand to hold corporate notes in Australia instead of federal government securities fell to 220 basis points on Sept. 12, the lowest in almost a year.

Yield Premiums

The yield premium on Qantas’ $513.6 million of 6.05 percent bonds maturing in April 2016 shrank 64 basis points to 455 basis points since reaching a record 519 on June 22, according to BNP Paribas SA prices.

The spread on Southwest Airlines (LUV:US)’ $300 million of 5.75 percent bonds due in December 2016 expanded 34 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 Sept. 7.

Qantas needs to have a more conservative outlook on finance, Stephen Nash, a Sydney-based director at Fiig Securities Ltd., said by phone.

Airline Bankruptcies

“Airlines generally have a habit of flying in and out of Chapter 11,” he said, referring to a form of bankruptcy proceedings under U.S. law. There have been 193 bankruptcies in the U.S. 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.”

Dreamliners Scrapped

Qantas, which hasn’t proposed a full-year dividend since 2008, is also hanging onto cash by cutting spending plans.

The airline canceled a firm order for 35 Boeing Co. (BA:US) 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.”

To contact the reporter on this story: David Fickling in Sydney at

To contact the editor responsible for this story: Anjali Cordeiro at

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