Published in The Australian 16 May 2015
Less than a year ago, when Qantas reported a $2.8 billion dollar statutory loss, some commentators were calling the curtain on our domestic carrier
But to their credit, CEO Alan Joyce and his management team have turned the airline around, with some help from a surprise decline in oil prices, and Qantas’ fortunes look a world away from where they were a short time ago.
The airline industry is tough and here have been some spectacular failures. It’s cyclical and characterised by its commodity like service transporting passengers, subjecting it to fierce price discounting. Other risks range from fuel prices, currency and regulation to unforseen and devastating plane crashes.
Qantas has proved more resilient than many investors thought. Management’s focus on its cost base is paying off, closing in on rates achieved by competitors. The company is on track to reduce debt by $1 billon as previously guided, by financial year end. The recent announcement of the possibility it will reinstate dividends after a six year hiatus, sent shares up over 7 per cent.
Even when the company was at its lowest, I always believed that Qantas was a survivor, making it easy to recommend its bonds. The fact that companies must pay bond holders interest and return capital at maturity, combined with the fact that shares are higher risk than bonds as they must be wiped out before bondholders take on any loss, provided the additional comfort to invest in an otherwise high risk sector.
Qantas’ high yielding bonds were attractive from the start, when the first of the three domestic bonds was launched back in April 2013, maturing seven years later, paying a fixed rate of 6.5 per cent per annum.
Since first issue, the April 2020 bond price has moved around depending on company news, market sentiment and interest rates. An improved outlook as well as the expectation of low interest rates saw the bond price recover from $98 in August 2014 to reach a high of $108 last month, only to decline to its current price of $106.
Source: FIIG Securities
The good news over the past week was dwarfed by the expectation of higher interest rates over the next few years, resulting in the pullback - remember higher interest rates leads to lower fixed rate bond prices.
If you bought the Qantas 2020 bond, available to all investors, at the current price of $106, it would have a yield to maturity of 4.74 per cent per annum. That’s a good fixed return in a low interest rate environment.
Qantas has two other longer dated bonds, maturing in June 2021 and May 2022 with yields to maturity of 5.32 per cent per annum and 5.43 per cent per annum, respectively. These bonds benefit from an additional clause where interest is increased if the credit rating agencies downgrade the bonds. While the current conditions make this unlikely, it’s an important benefit for a company in a cyclical, high risk industry. These bonds are only available to sophisticated or wholesale investors.
My pick of the three is the 2021 bond. It has a pick-up of 0.58 per cent over the 2020 bond and matures before the 2022, so is less risky. The higher yield of 0.11 per cent on the 2022 doesn’t compensate enough for the extra year.
Retirees need a replacement income and fixed rate bonds provide certainty. If interest rates continue to rise, fixed rate bond prices will fall further. However, the yield to maturity quoted at the time of purchase will not change and as long as Qantas survives, investors are returned $100 face value of the bond at maturity.
Please note: Prices accurate as at 14 May 2015 but subject to change.