It Gets Worse for Qantas as Credit Rating Cut to Junk by Standard and Poor’s

Qantas Airways Ltd.’s credit rating was cut to junk at Standard & Poor’s a day after the carrier flagged a record first-half loss and 1,000 job cuts. The shares fell to the lowest since July 2012 and bond risk soared.

Australia’s largest airline was cut to BB+, one level below investment grade, S&P said in a statement, citing increased competition and the forecast loss. The move stripped Qantas of the status of being one of just two global airlines with an investment-grade ranking from two ratings companies.

The downgrade may boost interest costs for Qantas, adding to challenges Chief Executive Officer Alan Joyce faces from intensifying competition with Virgin Australia Holdings Ltd. in the domestic market. Joyce, who took a pay cut as part of efforts to save A$2 billion ($1.8 billion) of costs in three years, has called for support from the government — a move Prime Minister Tony Abbott today indicated won’t be considered.

“It seems like there will be more difficult times ahead for Qantas,” said Siyi Lim, an analyst at OCBC Investment Research in Singapore. “They will probably need to streamline their costs a little bit more and do some structural changes.”

The airline’s shares fell 3 percent to A$1.04 at 3:14 p.m. in Sydney, adding to yesterday’s 11 percent tumble. Virgin Australia gained 0.7 percent. Qantas stock has dropped 31 percent this year compared with a 12 percent gain for the benchmark S&P/ASX 200 index.

‘Unprecedented Pressures’

The cost of insuring the debt of Qantas against default surged by 50 basis points to 265 basis points, according to traders at Morgan Stanley. The level is set for the highest close since Dec. 4, 2012, and the move is poised to be the biggest daily increase since Oct. 4, 2011, according to Bloomberg prices.

The rating cut “highlights the unprecedented pressures that the Qantas Group is facing from several external forces,” the carrier’s Chief Financial Officer Gareth Evans said in a statement, adding the move wasn’t unexpected after yesterday’s forecast. “We are in continuing discussions with the Australian Government regarding the uneven playing field.”

The company had a cash balance of A$2.8 billion as of June end, and gross debt was reduced by A$1 billion during the last financial year, according to the statement. The airline paid A$265 million in interest last year.

Bonds, Loans

Qantas has about A$3 billion of bonds and loans maturing before the end of 2021, according to data compiled by Bloomberg. Some A$277 million of debt falls due in 2014, rising to A$450 million in 2015 and A$842 billion in 2016, the data show.

Qantas yesterday said yields, a measure of ticket prices, will be 3.5 percent lower during the six months ending December than they were the previous year. The company will also review capital spending that’s already been cut 37 percent below the original plans.

“Virgin Australia has become a more formidable competitor,” S&P analysts led by May Zhong said in a note. “Competitive pressures have eroded Qantas’ yield and threatened its strong and defendable position in its domestic market.”

The government would consider changing laws that restrict foreign ownership of Qantas to 49 percent should the airline ask and it was the will of the Australian people, Prime Minister Abbott said in a radio interview today. Subsidies to prop up the national carrier wouldn’t be considered, he said.

“If we subsidize Qantas, why don’t we subsidize everyone?,” Abbott said. “That’s just a bottomless pit into which we will descend. Qantas has to get its house in order.”

Moody’s Rating

Moody’s Investors Service yesterday said it may lower its Baa3 rating after Qantas predicted the record first-half loss.

“A credit downgrade won’t close debt markets, but interest costs might go up,” Sean Fenton, a portfolio manager at Tribeca Investment Partners Pty. in Sydney, said by phone yesterday. Qantas has “spent a fair bit of money on fleet renewal — they can taper that back and conserve cash.”

The yield on Qantas’s A$250 million of 6.5 percent notes due 2020 jumped 106 basis points to a record 7.648 percent today, according to prices compiled by Bloomberg. That’s the biggest one-day rise since the bonds were sold in April. The yield on the carrier’s U.S. dollar 6.05 percent notes due 2016 increased 30 basis points to 2.653 percent, the highest level since Nov. 14, Bloomberg-compiled prices show.

Competition for Qantas is increasing as Virgin adds flights to take on its dominant share in Australia’s domestic market. With the carriers’ capacity expansion driving down ticket prices, Qantas will lose between A$250 million and A$300 million in the six months ending Dec. 31 and faces negative free cash flow over the full year, it said yesterday.

Foreign Airlines

Virgin Australia is receiving an unfair level of support from state-controlled foreign airlines that own the majority of the company, Joyce said yesterday.

Virgin, based in Brisbane, announced a A$350 million share sale last month. The offering could increase the combined stake in the company held by state-controlled Air New Zealand Ltd., Singapore Airlines Ltd. and Etihad Airways PJSC to as much as 70 percent. That will also provide funds for a market share contest that has depleted Virgin’s own cash holdings.

“You have three state-owned enterprises pumping money into a loss-making business,” Joyce said on a call with journalists. “Market choice should dictate who the winners and losers are; not government intervention from state-owned airlines.”

Qantas is “blaming Virgin Australia, I think, for very much self-inflicted wounds,” Virgin Group founder and chairman Richard Branson said in an interview with Bloomberg Television today. “What they need to do is get their own house in order and stop complaining when the competition gets too hot.”

With assistance from Jason Scott in Canberra, Kyunghee Park and Katrina Nicholas in Singapore and Chris Bourke in Sydney. Editors: Vipin V. Nair, Terje Langeland. To contact the reporter on this story: David Fickling in Sydney at [email protected]. To contact the editor responsible for this story: Vipin V. Nair at [email protected].