Moody's cuts Qantas to junk status

MATT O'SULLIVAN
Last updated 10:00 10/01/2014

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Qantas faces a further increase in the cost of new borrowings after the second of the big two credit ratings agencies downgraded it to junk status, citing a ''sharp deterioration'' in its key domestic business due to stiff competition from Virgin Australia.

A month after Standard & Poor's cut the airline to junk, Qantas suffered further ignominy on Thursday when Moody's downgraded the airline two notches to Ba2, from Baa3, with a negative outlook.

A two-notch downgrade is uncommon, and leaves US carrier Southwest and Air New Zealand as the only airlines Moody's rates investment grade.

It follows Moody's putting Qantas on review last month after the airline warned it would post a first-half loss of up to A$300 million (NZ$323m) and axe at least 1000 jobs.
Qantas has previously gone out of its way to protect what it regarded as its all-important investment-grade rating, but sought to play down the impact of its new junk status on its financial position.

The airline emphasised that its cash reserves and undrawn bank facilities totalled A$3 billion in December - down from A$3.4b in June - and said any significant debt refinancing would not be required until mid-2015.

Qantas will give an insight next month into the likely measures it will adopt from a company-wide strategic review, which includes the potential sale of assets. Much of this will depend on the response from the federal government to Qantas' calls for assistance.

Phillip Bailey, a principal of credit market consultancy ADCM Services, said the carrier's interest bill on new borrowings would rise as a result of the Moody's downgrade.

''With two of the [ratings agencies] having gone, that means that everyone is now going to view them as junk and their cost of debt will go up,'' he said.

But Bailey said existing debt would not be affected.

Qantas' chief financial officer, Gareth Evans, said the downgrade was not unexpected and underlined the importance of decisive action to address an extremely difficult operating environment.

''We will make the necessary decisions now - however tough they might be,'' he said.

Aside from cost-cutting, Evans said substantial reductions in the airline's planned capital expenditure would be vital to ensure it returned to positive free cash flow next financial year.

Moody's senior vice-president Ian Lewis said the downgrade reflected a worse than expected impact on Qantas' credit profile from a sharp deterioration in its core domestic business.

''As a consequence, we expect these conditions to exacerbate an already high financial leverage,'' he said.

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''The cause of the deterioration in the operating profile is largely due to the aggressive competitive actions by Qantas' key domestic competitor, Virgin Australia.''

Lewis said the profit warning last month by Qantas highlighted that its domestic business had been affected ''far more extensively and rapidly than our previous expectations''.

Shares in Qantas closed A2¢ higher at A$1.12 on the Australian Stock Exchange, indicating that investors were not surprised by the downgrade.

What is a junk bond?

- Bonds rated less than BBB by Standard&Poor's, or lower than Baa by Moody's.
- Some investors are not permitted to hold junk bonds.
- They offer a higher yield, but issuers are considered to be at a greater risk of defaulting.

- Sydney Morning Herald

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