Investors in Qantas bonds since March 2013 have benefited substantially from positive operating conditions and a return of the bonds to investment grade. Credit investors now have better options
As an household name and regular issuer into the domestic corporate bond market, Qantas has been somewhat of a rarity. The marketplace is dominated by resources and financials, and the credit has found its way into many portfolios simply for diversification purposes. Following a ratings downgrade in 2013, we encouraged clients to target the bonds as a “fallen angel” – a strategy that has borne fruit. The bonds have rallied strongly and should no longer be attractive to active investors on an outright basis.
Peak versus current returns for Qantas bonds:
Source: Bloomberg, FIIG Securities
|Issue ||Peak date ||Peak mid yield to maturity ||Current mid yield to maturity ||Change |
|Qantas 6.5% 27Apr20 ||10/12/2013 ||7.795% ||3.3578% ||-4.22% |
|Qantas 7.50% 11Jun21 ||11/06/2014 ||7.448% ||3.825% ||-3.62% |
|Qantas 7.75% 19May22 ||14/05/2014 ||7.704% ||3.906% ||-3.80% |
Prices accurate as at 5 May 2017 but subject to change
Operating conditions for airlines globally are excellent at the moment and the sector has outperformed the broader market, as measured by the NYSE Arca Airline Index normalised against the S&P500 shown in Figure 1. Figure 1
Source: Bloomberg, XAL Index vs SPX Index
Performance has been largely driven by fuel prices, but Qantas has also benefited from an end to the ‘capacity war’ with Virgin Australia. Lower input costs have not meant cheaper fares for consumers, however – the Australian Bureau of Infrastructure, Transport and Regional Economics data shows that March 2017 marked the highest level in domestic airfares for five years as shown in Figure 2. Figure 2
Source: BITRE, Moody's1
The sum of these factors is bond pricing that we believe is beyond fair value. The airline sector can be a very difficult industry for long term credit investors – in our view, it is a sector that benefits from active trading and continual monitoring. There are several factors outside an airline management’s control that can cause a severe case of turbulence for credit and equity investors, such as:
- Higher oil prices,
- Deep pocketed new entrants,
- Diseases (avian flu, etc.),
- General economic conditions
Further, in a worst case scenario where the airline goes through bankruptcy, senior unsecured bondholders should – on average – expect less than 10c per $1 recovery.
The rally in prices on Qantas’ bonds has been significant enough that active investors should be comfortable selling positions down, even in the absence of an immediate substitute. The credit story has played out and there are sizeable profits to realise.
Passive investors who were attracted to the bonds for their high income cashflow should also consider using profits to diversify their portfolios. While the 6.50% to 7.75% coupon payment is not easy to replace, most investors bought the bonds while they were rated sub investment grade. We recommend a sale to purchase a portfolio of diversified high yield bonds, which achieves a greater risk and reward outcome.
1 The indexes are 13 month moving averages indexed to 100 at July 2003. The indexes are constructed from BITRE’s monthly survey of airline internet booking sites. The series is a price index of the lowest available fare in each fare class, weighted over selected routes and therefore does not measure real airline yields, or average fares paid by passengers.