JUNKED: Moody's Has Downgraded Qantas

Alan JoyceGetty / Greg Wood

Ratings agency Moody’s has downgraded Qantas to junk status, based on increased competition from Virgin Australia.

Moody’s senior vice president Ian Lewis said the downgrade reflected a “marked sharp deterioration in the company’s core domestic business” which had previously been a key supporting factor of its investment grade credit rating.

“As a consequence, we expect these conditions to exacerbate an already high financial leverage.”

Standard & Poor’s, which is the only other agency rating Qantas debt, has already junked it.

Here’s the full statement:

Moody’s Investors Service has today downgraded to Ba2 from Baa3 Qantas Airways Limited’s (“Qantas”) senior unsecured
rating. Qantas’ short term rating has also been downgraded to NP (Not Prime) from P-3. This concludes the review initiated on 5 December 2013 following Qantas’ announcement and market update that it was now expecting an underlying loss before tax of AUD250 to 300 million for the six months ended 31 December 2013.

At the same time, Moody’s has assigned a Corporate Family Rating (CFR) of Ba1 to Qantas. The CFR, which is typically assigned to non-investment grade corporates, reflects Moody’s opinion on Qantas’ ability to honour its financial obligations as if it had a single class of debt and a single consolidated legal entity structure.

The outlook for the ratings is negative.


“The downgrade to Ba2 reflects a worse than expected impact on Qantas’ credit profile of a marked sharp deterioration in the company’s core domestic business, which has been a key supporting factor of its previous investment grade rating”, says Ian Lewis a Moody’s Senior Vice President, adding “As a consequence, we expect these conditions to exacerbate an already high financial leverage.” “Furthermore, the downgrade of the rating to Ba2 incorporates notching, given the material secured debt in Qantas’ capital structure.”, adds Lewis.

“The cause of the deterioration in the operating profile is largely due to the aggressive competitive actions by Qantas’ key domestic competitor, Virgin Australia Holdings Limited (“VAH”, Virgin Australia Enhanced Equipment Notes A-tranche rated Baa2, B-tranche rated Ba3, C-tranche rated B2, D-tranche rated B3). These actions, which include capacity additions, have shifted the market dynamic against Qantas in a structural way.” “As such, we expect that Qantas’ business risk and financial leverage will remain at elevated levels and inconsistent with an investment grade rating.”, Lewis adds.

“Qantas’s domestic business will remain challenged as VAH’s actions, and Qantas’ response to maintain market share, continue to pressure yield.”, Lewis says, adding “In the absence of any additional material countermeasures, we expect Qantas’ Debt/EBITDA ratio to be at or above 5x Debt/EBITDA – well outside the range for its previous investment grade rating”.

“These challenges are incorporated in Qantas’ Ba1 corporate family rating. The Ba2 senior unsecured rating is notched down from the corporate family rating reflecting the higher probability of default in the speculative grade category and the presence of material secured debt in Qantas’ capital structure”, adds Lewis.

The December announcement by Qantas highlights that the domestic business has been impacted far more extensively and rapidly than our previous expectations. “This is a major turnaround from previous years and indeed its most recent full year 2013 results announcement” Lewis says, adding “The material downturn in Qantas’ domestic business also comes at a time
when the carrier is grappling with a turnaround in its loss making international mainline business. As such the business is exposed to execution challenges on two fronts, simultaneously.”

The negative outlook reflects these challenges and the risk of further rating downgrade if Qantas is unable to address these issues and arrest the decline in its credit profile. At the same time we recognize that management has countermeasures available to address its declining profitability, such as further cost reduction, potential asset sales and
reduction of capital expenditure.

Moody’s also notes that the Treasurer of the Australian Commonwealth Government (Aaa stable) has recently commented on the need for a debate on whether Australia requires a national carrier, and that the government would also consider all the options available to help Qantas should the public want it to continue its role as the national carrier.

“Whilst the issue is currently a matter of discussion and the government has not yet detailed how it plans to proceed, a form of government support would, depending on form and structure, also potentially provide support for Qantas’ liquidity position and/or credit profile. Moody’s will observe any potential for positive credit impact when and if such counter-measures are announced and depending on the form of the support.”, adds Lewis.

The rating outlook could be revised to stable if Qantas is able to restore the profitability of both its international and domestic operations to levels that are able to sustain appropriate levels of debt. Financial metrics that Moody’s would look for include Debt/EBITDA remaining below 4.75x on a consistent basis.

On the other hand, further negative ratings pressure could evolve if Qantas is unable to restore the core profitability of its international and domestic businesses or reduce debt to appropriate levels, commensurate with its sustainable earnings. Financial metrics that Moody’s would look for include Debt/EBITDA remaining above 5.0 x on a sustained basis. In addition, a material deterioration in liquidity could impact the carrier’s ratings.

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