Tuesday 16 September 2014 by FIIG Securities FIIG Securities Legacy

Qantas bond prices reflect survivability

When Qantas recently announced a full-year loss, its long-suffering shareholders who haven’t received a dividend in five years were so excited they drove the stock up 19 per cent

By contrast, the bond rally was small as the bonds, which are lower risk and less volatile than the shares, still pay interest regardless of Qantas’ performance; same company, very different experience.

Qantas currently has three fixed rate bonds maturing in 2020, 2021 and 2022 which presents investors with a bit of a dilemma about which one to buy.

There is little separating the bonds if you compare them on a yield to maturity basis with the 2020 bond yielding 6.72 per cent, the 2021 6.98 per cent and the 2022 7.03 per cent.

Both the 2021 and 2022 bonds were issued after the credit rating agencies downgraded Qantas’s credit rating late last year so these bonds showed greater price appreciation than the 2020 bond when Qantas announced that it would try and regain an “investment grade” credit rating.

When Qantas was downgraded the 2020 bond price fell sharply by 6 per cent but since then it has increased and settled at just under its $100 value at $98.97. The other two bonds are now trading at a premium of $102.74 and $104.20 respectively.

Source: FIIG Securities

Prices accurate as at 9 September but subject to change

Key to any assessment of corporate bonds is an understanding of the company’s “survivability”. Qantas has assets that it can sell to pay interest and repay debt such as airport terminal leases. In the latest set of results it had a large positive operating cash flow of $1.1 billion which enabled it to add $600 million to cash on hand, taking it to $3 billion. The sum, combined with undrawn bank facilities of around $600 million, provides financial flexibility and adds weight to the company’s survivability.

Even though the Qantas share price has been erratic and it faces headwinds being a commodity style service where price is a key differentiator, investors have still bought Qantas bonds for the certainty they provide.

Qantas must pay interest half yearly and must return the $100 face value of the bonds at maturity.  The high fixed rate of return compensates for higher risk. Small allocations to high risk bonds will boost your overall portfolio return.

One-eyed bond fans will invest in high yield bonds instead of shares and the known rate of return on these bonds of over 6.5 per cent will trump dividend yields on many shares.

The range in yield to maturity returns of all three bonds is small. The 2020 bond maturing first is lowest risk, so offers a yield to maturity of 6.72 per cent, 26 basis points or 0.26 percent less than the bond maturing in 2021. This is also the only bond available to retail investors. The increment of 5 basis points for extending the term for an extra year to 2022 is too tight, perhaps signalling that the market too is confident that Qantas is a survivor.