Standard & Poor’s just downgraded Qantas’ credit rating, warning that further cuts could be on the horizon.
The new BB+/B rating puts Qantas in the “speculative” range; S&P’s previously had Qantas at the lower end of its investment-grade ratings.
Qantas went into a trading halt this morning, pending S&P’s announcement. It has yet to resume trading.
Here’s the full announcement:
Qantas Airways Downgraded To ‘BB+/B’, Outlook Negative; Senior Unsecured Issue Rating Lowered To ‘BB+’, On Watch Negative
MELBOURNE (Standard & Poor’s) Dec. 6, 2013—Standard & Poor’s Ratings Services lowered its corporate credit rating on Australian airline Qantas Airways Ltd. to ‘BB+/B’, from ‘BBB-/A-3’. The outlook is negative. We also lowered our senior unsecured debt ratings on Qantas to ‘BB+’, from ‘BBB-‘, and placed the issue ratings on CreditWatch with negative implications.
The downgrades reflect our view that intense competition in the airline industry has weakened Qantas’ business risk profile to “fair” from “satisfactory”, and financial risk profile to “significant” from “intermediate”. We don’t expect Qantas to recover to a credit profile commensurate with a ‘BBB-‘ rating in the near term. We recognize that Qantas has strong financial flexibility and a good track record of responding to earnings pressures through cost cutting and other measures. However, we believe in the current circumstances, the benefits would take time to realize and the positive impact would not be sufficient to outweigh the pressure on Qantas’ stand-alone credit profile.
A structural shift in the domestic competitive landscape has weakened Qantas’ business risk profile. Additions to capacity have accelerated significantly over the past 12 months in both corporate and leisure travel-a trend that is unlikely to ease given our expectation that Qantas will aggressively seek to maintain its established market share. Virgin Australia has become a more formidable competitor to Qantas, partly as a result of its dual brand strategy and well-capitalized shareholders. These competitive pressures have eroded Qantas’ yield and threatened its strong and defendable position in its domestic market. In addition, high fuel costs and weak demand have exacerbated the impact. In our view, the profitability of Qantas’ domestic operation is key to the group’s competitive position and long-term viability. In addition, the material benefits of Qantas’ partnership with Emirates Airways have yet to prove to be sufficient to offset the mounting competition in its international operations.
To arrest the downward earnings trend, Qantas is embarking on a number of initiatives including accelerating a program that targets A$2 billion in cost reduction over three years, review of all planned capital expenditures, and potential asset sales. Notwithstanding Qantas’ good track record of executing these cost-cutting strategies to preserve cash and improve its cost position, we believe the benefits would take time to realize and it’s unlikely to offset the cyclical and structural headwinds facing Qantas.
Our assessment of Qantas “significant” financial risk profile factors in a material spike in its leverage (measured by adjusted debt to EBITDA) and weakening in operating cash flows in fiscal 2014 due to the significant loss incurred. However, we expect a slow recovery of Qantas’ key credit metrics from fiscal 2015 onward, due to the benefits of Qantas’ cost-cutting initiatives, capital expenditure deferral, as well as our expectation that a less intense competitive environment will lead to improvement in yields.
Our assessment of Qantas “fair” business risk profile reflects the highly competitive and cyclical nature of the airline industry, high fuel costs, stiffer competition across Qantas’ route network, and Qantas’ dual-brand strategy and strong domestic market position. This and the “significant” financial risk assessment results in a ‘bb’ initial analytical outcome (“anchor”) under the Standard & Poor’s corporate rating criteria that became effective Nov. 19, 2013. This outcome is uplifted by one notch, reflecting Qantas significant financial flexibility, to derive the ‘BB+’ corporate credit rating.
We assume fuel prices will not increase materially in our forecast. In the absence of material asset sales, our base-case scenario expects Qantas’ adjusted funds from operations (FFO) to debt to drop slightly below 20% in fiscal 2014, but recover to 20%-25% in fiscal 2015. We also expect its adjusted debt to EBITDA to approach 4x in fiscal 2014, but improve to a low 3x in fiscal 2015.
We consider Qantas’ liquidity to be “strong”, based on the following:
• We expect that sources of liquidity in the next 12 months will exceed uses by at least 1.5x. We expect that liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30%.
• The company has a manageable debt-maturity profile in the next two years, with about A$800 million debt maturing in fiscal 2014, and A$1.1 billion in fiscal 2015 (excluding operating leases).
• We note that none of Qantas’ debt facilities have financial covenants. We expect Qantas will continue to hold a sizable unrestricted cash balance of about A$2 billion.
Principal liquidity sources
• Cash of more than A$2 billon;
• Standard & Poor’s estimate of lease adjusted FFO of about 1.4 billion; and
• About A$600 million of undrawn committee facility.
Principal liquidity uses
• Debt maturities of about A$800 million in fiscal 2014; and
• Standard & Poor’s estimate of capital expenditure of A$1.1 billion in fiscal 2014.
The negative outlook reflects the risk of protracted intense competition for domestic market share reducing Qantas’ profitability and outweighing the benefits of the actions undertaken by the airline.
The ratings could be lowered if Qantas fails to arrest the downward trend in its profitability to the extent that credit metrics worsen considerably, including its adjusted FFO-to-debt falling to less than 20% for a prolonged period. A weakening of Qantas’ liquidity position will also put downward pressure on the rating, particularly if we assess Qantas’ unrestricted cash and available liquidity were to decline to less than A$2 billion.
We would revise the outlook to stable if there is improvement in Qantas’ financial risk profile due to less intense competitive behavior by market participants or successful management of these vulnerabilities. The ‘BB+’ issuer credit rating incorporates our expectation that management will undertake a range of initiatives to support Qantas’ credit quality.
Our ‘BB+’ rating on Qantas doesn’t factor in any extraordinary government support. Upward pressure could occur if we assess Qantas to be a government-related entity (GRE) in accordance with our criteria.
We expect to resolve the CreditWatch on the senior unsecured debt when we finalize our assessment of the recovery rating of the debt.
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