Qantas junk escape path is clearing: Australia Credit

[SYDNEY] Qantas Airways Ltd.'s path to escaping junk debt status is clearing after jet fuel dropped to a nine-year low and the airline cut A$2 billion (S$2.1 billion) in costs.

Australia's biggest carrier already warrants an investment- grade rating due to a planned A$1 billion debt reduction and a cooling market-share war, Deutsche Bank AG said. UBS Group AG sees cash flow doubling in the year to June and Standard & Poor's said there are "meaningful tailwinds" for measures it uses when examining the company.

The airline, cut to junk by S&P in December 2013 as it headed for a record loss, started turning around just 12 months later when it predicted the strongest semi-annual earnings in four years.

The cost of protecting Qantas debt against non- payment hit a 14-month low of 215 basis points Feb 3, from a peak of 350 last March, credit-default swaps data from CMA show.

"The immediate pressure that was on them from the cash bleed is probably over," Michael Bush, head of credit research at National Australia Bank Ltd. in Melbourne, said by phone. "Once the capacity war ended that was a significant move, and with lower oil prices they'll be starting to see a benefit." Oil-Boom Pain The boom in commodity prices after the 2008 financial crisis proved challenging for Qantas, as the rising price of oil swelled a fuel bill that reached A$4.5 billion last year, accounting for about 28 per cent of costs.

Demand for Australian commodities also lifted the value of the country's currency, encouraging overseas airlines to fly to Australian cities and tap high-paying customers. The competition helped drive Qantas's international unit into losses.

At the same time, Virgin Australia Holdings Ltd. started adding business class seats to compete directly with Qantas on domestic routes. The changes put the supply of airline seats ahead of passenger demand, pushing down prices. Earnings from Qantas's full-cost domestic network fell 92 percent to A$30 million in the year ended June.

Those factors have now reversed. Priced in Australian dollars, the cost of benchmark Singapore jet fuel has fallen 33 percent over the past 12 months, allowing Qantas to buy its cheapest fuel since 2006, according to UBS.

Aussie Drops Australia's currency has weakened 13 percent over the same period, and the number of new seats being added by overseas airlines flying to Australia has slowed, the carrier's outgoing Chief Financial Officer Gareth Evans said in August.

Competition has also diminished. Domestic airlines cut the number of available seats by about 3 percent from a year earlier in November, according to government data. That's the fastest pace of decline since October 2011, when Qantas grounded its global fleet amid industrial action, and compares to a five-year average capacity increase of 4 percent.

Qantas's announcement of plans to cut A$2 billion in costs and 5,000 jobs, made last February when the macroeconomic headwinds were still blowing, will help it benefit from the improved climate.

The programme will save A$600 million in the year to June after a A$204 million benefit last year, Qantas spokesman Andrew McGinnes said by e-mail: "The goal is to deleverage the balance sheet and put the business on a more sustainable footing," he said.

BUYING OPPORTUNITY

Qantas's debt now represents a buying opportunity and creditors of Deutsche Lufthansa AG should switch to the Australian airline, according to Deutsche Bank's Sydney-based credit strategist Gus Medeiros.

While the yield premium over the swap rate on Qantas's 2021 dollar bonds has narrowed, it was still elevated at 337 basis points, he wrote in a Jan 26 note to clients. The spread was at 333 basis points on Thursday, according to Australia & New Zealand Banking Group Ltd. pricing.

"Qantas bonds and CDS are cheap," he wrote, predicting a "material improvement" in its financial profile.

Lufthansa carries a rating of Ba1 at Moody's Investors Service, the same as Qantas. The German carrier's BBB- score at S&P is one level higher than the Australian airline's BB+ score at the firm. Lufthansa's credit default swaps were at just 97 basis points on Wednesday, according to CMA data.

The ratings companies will lift their negative outlooks on Qantas's debt once its first-half results Feb 26 give evidence of better performance, Simon Mitchell, an Sydney-based analyst at UBS, wrote in a Jan. 27 note to clients. Hector Lim, a spokesman for Moody's in the city, declined to comment.

Qantas's credit metrics "are expected to benefit from some meaningful tailwinds," Graeme Ferguson, an associate director at S&P, wrote in an e-mail. The rating company will look to see whether the improving currency, fuel price and domestic market "will persist beyond the near term and flow through to a sustainable recovery in the creditworthiness of the airline."

BLOOMBERG