Qantas pilots are trained to avoid storms, but chairman Leigh Clifford and CEO Alan Joyce prefer flying straight into them.

It is a strange kind of leadership. And for Qantas employees and shareholders, strapped into a bumpy flight, there is a frightening view out the window: nothing but tempest and flashes of lightning.

It didn’t need to be that way. The mistake of Clifford and Joyce was to head for Canberra and, having now failed to convince anyone of anything useful, the airline’s future is hostage to the unpredictable politics of the Senate. It’s a fair bet nothing whatsoever will come of it. Certainly Clifford and Joyce are powerless to decide the outcome.

In fact, handing Qantas’ fate to the politicians is an abdication of leadership. As is Clifford and Joyce’s ultimate aim: selling Qantas off to foreign investors who will somehow do a better job running the Spirit of Australia.

Presumably Joyce wields a secret dossier of convincing arguments, because the ones peddled so far barely make sense.

It was only last Thursday Joyce told us it would take too long to remove restrictions in the Qantas Sale Act — months, even — and his airline needed immediate help, in the form of a Commonwealth loan or debt guarantee. Now we know for sure such help will not be forthcoming, there is furious backpedalling going on.

It’s a riddle: if it isn’t in financial trouble, why did Qantas need help? Was it all just a try-on, designed to secure cheap finance?

As Crikey wrote this week, Qantas does have financial issues, especially in the wake of its December credit ratings downgrade: looming refinancings and off-balance sheet liabilities. Ratings agency S&P wrote in January that, if Qantas did not take action, it might default in 2019.

But as Joyce was at pains to explain on Wednesday, when he took to the stage in front of hundreds of businesspeople in a Sydney hotel, Qantas is taking action and such a default will simply “never occur”.

Joyce urged everybody to ignore the media frenzy — although he almost single-handedly created it — and take everything you read in the press with a pinch of salt. To put Qantas financial position in perspective it is perhaps wise to also ignore everything Joyce says, and just look at the market.

Investors are constantly pricing the risk of Qantas going broke. The easiest way to track their judgement is to look at the trade in credit default swaps or CDS — a complex financial instrument used as a kind of hedge or insurance policy, against the risk of a default by a particular borrower. The higher the perceived risk, the greater the cost of the CDS, as measured in basis points (hundredths of a per cent) and related to the interest rate “spread” between the company’s cost of borrowing and the risk-free rate (typically, the bank bill swap rate).

The chart above shows market fears about Qantas’ financial position jumped in the past week, as it became clear no Commonwealth financial assistance would be forthcoming. Interestingly, however, those fears are not as sharp as they were right after Qantas’ profit and credit rating downgrade last December, when there was a real spike. And they are nowhere near as high as they were the last time Qantas had a confected crisis, at the end of 2011, right around the time Clifford and Joyce took a dramatic decision to ground the airline.

Craig Swanger, head of markets at debt brokerage FIIG Securities, says the level of risk implied by current pricing of Qantas CDS implies a between 1:40 and 1:50 chance Qantas will default at any time over the next five years. That’s not the view of armchair commentators, that’s the view of the people with money on the line (admittedly, generally other people’s money).

While there has been volatility in Qantas’ CDS pricing, Swanger told Crikey: “It’s a hell of a lot less than you might think if you arrived here from another planet and picked up the newspapers. It’s miles away from any situation where you’d be thinking, ‘I might not fly Qantas’.”

The trade in Qantas’ corporate bonds, maturing in 2020, implies a similar level of risk, Swanger says, and if the company sought to issue new debt today, even with its sub-investment grade rating, it would be able to borrow at an interest rate spread to the risk-free rate slightly above the CDS level, say 280 basis points. High, but even this is ballpark half the 550bps spread paid by Fortescue, for example, when it had to borrow its way out of trouble after a near-death experience in late 2012, amid a temporary plunge in iron prices.

Last week, right after Joyce released Qantas’ paradoxically better-than-expected half-year loss of $252 million, and confirmed a seemingly random number of 5000 jobs would go, Macquarie aviation analyst Sam Dobson ignored the hoopla and many of his peers and reiterated his “outperform” recommendation. Dobson has just arrived here after covering European aviation and transport for Macquarie; in mid-February he immediately upgraded the brokers’ recommendation on Qantas which, he believes, is fundamentally undervalued at current levels.

At about $1.10, where Qantas shares have traded since the December downgrade, Dobson sees the valuation as compelling: the consensus of various brokers is that the airline will report a $200 million underlying loss before tax in 2014-15. Macquarie is more bullish, expecting Qantas will make a $280 million profit before tax that year. But, on Macquarie’s valuation, the current market price implies Qantas will make a loss of $800 million.

Qantas has some $3 billion in available liquidity — cash or undrawn loan facilities. Is that enough? Dobson admits it is always difficult to know, and airlines like to have lots of cash on hand to cushion against unforeseeable short-term shocks, like volcano eruptions that stop air traffic.

Macquarie has stress-tested the Qantas balance sheet, modelling six months of significantly reduced demand (down 20-25%); on Dobson’s numbers, that would cost the airline $1 billion — money that Qantas has on hand.

The mere fact that Qantas debt is below investment grade is no cause for alarm and the current market pricing of Qantas’ default risk reflects relative ease about creditworthiness and absolutely no sense of panic. Dobson says Air France CDS, for example, soared as high as 1300bps — showing the market clearly expected a near-term default — but even so the airline traded through it and was able to refinance its debts.

“Where Qantas debt is trading, there is certainly no expectation of a near-term default,” Dobson said.

Macquarie estimated a Commonwealth guarantee would have made Qantas’ cost of issuing debt about $20 million cheaper on a pro-rata basis. That’s pre-tax, so the bottom line impact would have been even smaller — assuming a 30% tax rate, roughly $14 million. Significant, sure, but not do-or-die for the airline. Dobson has no problem with any of Qantas’ non-interest bearing liabilities, either — ticket prepayments help Qantas manage working capital, and the extent of its aircraft and other lease obligations, are in line with its industry peers. Dobson told Crikey the whole debt issue was a “furphy”.

But if the debt issue is a furphy, what on earth have Clifford and Joyce been on about for the past few months? The answer is simple: there is nothing wrong with Qantas that new leadership wouldn’t fix.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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