Tuesday 10 February 2015 by Alen Golubovic Company updates

Qantas and Virgin flying high

Virgin’s recent quarterly performance provides another signal that the domestic airlines are in for a good year. With favourable headwinds for both Qantas and Virgin, now is a good time to review your portfolio allocation to domestic airline bonds.

Virgin’s second quarter performance highlights that trading conditions for the two domestic carriers are better than was expected at the start of the reporting year. Virgin beat its earlier guidance by delivering an underlying profit in the first half of FY15. Even its budget carrier Tigerair delivered a small profit, well ahead of previous profitability targets for 2017. This is despite Virgin only realising a $7m benefit from lower fuel prices. As its fuel hedges roll over into new contracts which reflect the falling oil price, we expect to see further improvements in performance in 2H15.

With Qantas due to report later this month, the market is eagerly awaiting a healthy profit for 1H15. Guidance is for a 1H15 operating profit of about $400m and the company is predicting its strongest semi-annual earnings in four years. A solid performance will most likely shift the rating agencies’ outlook on Qantas from negative to stable. If Qantas can consistently maintain this improved performance and reduce its debt levels as a result, then we can see the possibility of company returning to an investment grade rating in the next 12-24 months.

The improvement in operating conditions for Qantas and Virgin isn’t just about falling oil prices. Competition has also diminished. Domestic airlines cut the number of available seats by about 3% from a year earlier in November, according to government data. That’s the fastest pace of decline since October 2011, when Qantas grounded its global fleet amid industrial action, and compares to a five-year average annual capacity increase of 4%. With the airlines backing away from earlier capacity ‘wars’, margins on domestic routes are improving as a result of the capacity reductions.

FIIG currently offers bonds from each airline at the following indicative yields to maturity:

  • Qantas 2020 – 5.33% (retail and wholesale investors)
  • Qantas 2021 – 5.53% (wholesale investors only)
  • Qantas 2022 – 5.56% (wholesale investors only)
  • Virgin Australian 2019 US dollar bond – 7.34% (in US dollars) (wholesale investors only)

See the links below to view the full research reports for Qantas and Virgin.

Qantas – Retail or Wholesale only (login required)
Virgin - Wholesale only (login required)

Please note that bonds from both companies carry sub investment grade credit ratings. Qantas has a stronger credit rating than Virgin, and as such carries a lower credit risk.

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