Credit FAQ:

What's Behind Standard & Poor's Downgrade On Qantas Airways Ltd.?

Primary Credit Analyst: May Zhong, Melbourne (61) 3-9631-2164; may.zhong@standardandpoors.com Secondary Contact: Graeme A Ferguson, Melbourne (61) 3-9631-2098; graeme.ferguson@standardandpoors.com

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Credit FAQ:

What's Behind Standard & Poor's Downgrade On Qantas Airways Ltd.?

On 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. Here, we elaborate the reasons for the downgrade and compare the airline with its peers.

Frequently Asked Questions

Why did Standard & Poor's downgrade Qantas, and why is it still on a negative outlook?
The lowering of the ratings reflects our view that the rapidly evolving competitive landscape for Australian airlines has weakened Qantas' business risk profile to "fair" from "satisfactory", and financial risk profile to "significant" from "intermediate". In our opinion, the scale and magnitude of Qantas' earnings downgrade announced on Dec. 5, 2013, went beyond a cyclical weakness, and indicated the acceleration of a more-permanent structural trend. We do not 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. We expect the cyclical and structural headwinds facing the airline to persist, which could hinder a timely recovery of its financial risk profile and credit metrics. The negative outlook reflects the risk that a protracted battle for domestic market share could outweigh the benefits of Qantas' meaningful financial flexibility.

Why didn't Standard & Poor's place the ratings on CreditWatch negative first before downgrading the airline?
Key to the previous investment-grade rating was the strength of Qantas' domestic operations, which underpinned the group's profitability and long-term viability. The shift in Qantas' earnings trajectory within a short period of time and the magnitude of expected losses indicate that competition across its domestic route network is considerably more intense than our previous baseline expectations. In our view, there has been a structural shift in the competitive landscape that has eroded Qantas' yield, which questions its previously unassailable position in its domestic market. To this end, we no longer consider Qantas' business risk profile to be commensurate with the "satisfactory" category. We recognize that Qantas has strong financial flexibility and is embarking on a number of initiatives including cost cutting, deferring capital expenditure, and possibly divesting assets. In our view, these initiatives, if successful, should buttress Qantas' balance sheet and liquidity position. However, they are unlikely to offset the cyclical and structural headwinds facing Qantas. In addition, while a sizable asset sale may provide much-needed financial support to the

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Credit FAQ: What's Behind Standard & Poor's Downgrade On Qantas Airways Ltd.?

group in the near term; it does not address the underlying structural issues. We are also mindful of any changes to the quality of Qantas' earnings mix as the result of any potential asset divestment.

How does Qantas' credit quality compare to its global peers, including investment-grade ones?
Following the downgrade on Qantas, Standard & Poor's has only two airlines with an investment-grade rating: Deutsche Lufthansa A.G. (Lufthansa, BBB-/Stable/A-3) and Southwest Airlines Co. (BBB-/Stable). In our view, Qantas' most relevant peers are Lufthansa and British Airways PLC (BA, BB/Stable), given their status as full-service airlines, national flag carriers, and their principal exposure to high-yield premium travel. From a business risk profile perspective, Lufthansa's good geographic diversification reduces its dependence on local economies and somewhat forms a buffer against localized event risks. Furthermore, Lufthansa's leading market position in aircraft maintenance, repair and overhaul, and airline catering businesses adds stability to the group's earnings through the lower and different-stage cyclicality of these operations. Qantas has an entrenched market position in Australia, and a dual-brand strategy capturing both premium and budget travels. Similar to Lufthansa, Qantas' business risk profile also benefits from profitable nonflying businessesi.e. its frequent flyer program. Compared to its peers in Asia, Qantas has a relatively high cost base. It also has a competitive disadvantage due to its status as an end-of-line carrier. Australia is typically seen as the final destination for travel routes. BA, on the other hand, has a strong competitive position as the main airline at London Heathrow Airport; however, it has a high profit concentration in its trans-Atlantic network. In terms of earnings prospects, we are forecasting positive earnings growth and improved EBITDA margins in 2013 and 2014 for Lufthansa and BA. Qantas, on the other hand, has weak earnings prospect in the near term. We forecast Lufthansa's credit metrics to be the strongest among the three airlines in the next 12 months. We consider all three airlines as having "strong" liquidity positions.

Will the downgrade have any implication on Qantas' bond or debt documents, particularly whether they include any rating triggers?
Qantas' senior unsecured debt facilities, which include its A$1.63 billion syndicated bank facility and US$513.6 million 144A bonds, contain no financial covenants or ratings triggers. In addition, the bank facility contains a change-in-control clause, which allows the financiers to terminate the facility and declare all outstanding amounts due and payable if they do not unanimously approve a change in ownership of the airline.

What factors could change the outlook back to stable?

We would revise the outlook to stable if the risk of further deterioration in Qantas' earnings or credit metrics recedes. This could arise if Qantas successfully manages its vulnerabilities or if more-accommodating competitive dynamics emerges. The 'BB+' issuer credit rating incorporates our expectation that management will undertake a range of initiatives to support Qantas' credit quality.

What would constitute extraordinary support under Standard & Poor's criteria for government-related entities (GRE)?
The rating does not factor in any extraordinary government intervention in accordance with our GRE criteria. We distinguish between government intervention that enables a timely repayment of a GRE's debt and intervention primarily aimed at supporting employment or operations but might not necessarily reduce the likelihood of default.

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Credit FAQ: What's Behind Standard & Poor's Downgrade On Qantas Airways Ltd.?

We are closely watching the political debate surrounding Qantas and will form an opinion on the matter if a government policy is clearly articulated or when more concrete details emerge, if any.

Related Criteria And Research

Related Criteria
Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010

Related Research
Qantas Airways Downgraded To 'BB+/B', Outlook Negative; Senior Unsecured Debt Rating Lowered To 'BB+', On Watch Negative, Dec. 6, 2013

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