Moody’s gives Qantas its second junk rating: What now for the national carrier?

Credit ratings agency Moody’s yesterday downgraded Qantas shares to junk status. It’s the second ratings agency to do so, after Standard & Poor’s first downgraded the airline in December. This means both international ratings agencies that rate Qantas (Fitch does not) now have given it a junk rating.

A junk rating is one below BBB, and means a company is considered to pose a high risk for lenders and investors.

For Australia’s national carrier, the downgrade will make accessing new debt more expensive. It could see it pay interest rates as high as 12% to 15% per annum, and puts pressure on the government to help the airline out, IG Markets market strategist Evan Lucas tells SmartCompany.

In its ratings statement, Moody’s senior vice president Ian Lewis wrote that Qantas’ response to Virgin’s threatening its market share had “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.”

Qantas CFO Gareth Evans downplayed the impact of the announcement, saying the announcement underlined the importance of continuing the company’s transformation.

“We will make the necessary decisions now – however tough they might be – to ensure we remain strong and disciplined in the years ahead,’’ he said.

‘‘Earnings conditions have deteriorated rapidly in recent months and we now face some of the most challenging circumstances in our history, including an uneven playing field in Australian aviation. We continue to talk to the Australian government about options for resolving this situation,’’ he added.

The downgrade was expected by the market, Lucas says.

“In December, Moody’s threatened to downgrade the airline when Standard & Poor’s did, but didn’t. So yesterday’s downgrade was not unexpected,” he says.

Qantas’ share price actually rose 2 cents to $1.12 yesterday. Lucas says this suggests most traders see the downgrade as putting pressure on the government do something to help the national carrier. But the politics of the situation is difficult, as no single solution currently has bipartisan support.

“There could be a change in the Qantas Sales Act to allow more foreign investment, or you could have government taking a stake in the airline, or you could have the government guarantee Qantas’ debt.

“All but the first of those are technically protectionist and not market-friendly, and none are likely to achieve bipartisan support. That makes Qantas a bit of a political football. But until we get some government action, it’s going to be a very rocky road for Qantas.”

Airlines have always been tricky to manage. As Richard Branson once said, the easiest way to go from being a billionaire to a millionaire is to buy an airline.

But Qantas’ woes are part of a global downturn in the aviation industry, which Qantas is especially exposed to because of its legacy as a government-owned business with public-sector-style labour agreements.

“Aviation across the globe isn’t a place investors want to be,” Lucas says. “Margins are being squeezed daily. Airlines face high operating costs, and consumer demand is dropping the other way. So companies like Qantas are squashed in both directions. Making a profit is tough, and expensive credit doesn’t help.”

Qantas still faces structural issues. Its international arm is well and truly in the red, posting huge yearly losses despite a slight improvement last year and a tie-up with Emirates.

“It’s a long way from breaking even,” Lucas says. “And Jetstar Asia hasn’t been anywhere near as strong as they forecast, which is important because they want to move to a model with a low-cost budget brand and a premium brand. Jetstar Asia has faced regulatory issues in Hong Kong, in Japan, and huge competition from Air Asia and budget airlines coming out of China. It’s difficult for that brand to work.”

And domestically, Virgin continues to hammer Qantas’ most profitable routes, offering discounted pricing, more flights, and a Qantas-level style of service. “Because of that, you’re seeing a brand recognition transfer from Qantas to Virgin,” Lucas says.

However, Virgin hasn’t made a profit in five years, and its share price hasn’t moved. Lucas says it’s far less volatile than Qantas because it’s 75% owned by three major international airlines – Singapore Airlines, Air New Zealand and Etihad.

All these issues make it extremely difficult for Qantas, and likely government would offer something to ease the squeeze.

A government debt guarantee would take away the risk in lending to a company like Qantas, and thus significantly decrease its costs of borrowing. Lucas says the biggest difficulty for Qantas in the coming weeks will be negotiating the political aspects of its situation.

“But here’s the thing. If Qantas does deteriorate, and deteriorate fast, the Australian people will be called upon to bail it out either directly or indirectly.”

In an interview with The Australian Financial Review published today, trade and investment minister Andrew Robb said industries have to embrace change, and the government would not stand in the way of the economy restructuring.

However, he revealed that the government is in discussions with Qantas.

“The Prime Minister has asked ­Qantas to make the case about the survival plan that they think should be put in place,” Robb said.

“They have focused on their inability to seed foreign investment into their operation… So we’re working with them and I think all of these things need to be explored.”