Dark skies

Are Virgin Australia’s bonds headed for a crash landing?

The government has committed millions to helping save both Qantas and Virgin Australia, although the CEO of the former has publicly stated the later doesn’t deserve it. How much Virgin ends up receiving could have a significant impact on its corporate bond holders.

The COVID-19 pandemic and deteriorating economic outlook have impacted the passenger airline industry in many countries, but this toxic mixture along with a whiff of nationalistic rhetoric has racked up the pressure on Virgin Australia Airlines. So-much-so that the country could see its first institutional bond default for almost 20 years.

Last week the country's second-largest carrier reduced domestic capacity by 90%, suspended its Tigerair Australia domestic services effective immediately and stood down 8,000 of the company’s 10,000 strong workforce.

“There has never been a travel environment in Australia as restricted as the one we see today and the extraordinary steps we’ve taken have been in response to the federal and state governments’ latest travel advice,” said chief executive and managing director Paul Scurrah.

The group’s fleet’s 125 aircraft have been grounded and almost all domestic and international flying has been suspended until “at least the middle of June”.

All three international ratings agencies have taken a dim view of the situation.

Last week Moody’s Investors Service downgraded the airline one notch to B3 citing the very sharp decline in passenger traffic since the outbreak of the coronavirus in January.

“Virgin has approximately A$900 million ($556.3 million) of cash on its balance sheet and minimal availability under its credit facilities. While the airline has no new aircraft deliveries until July 2021, and no significant debt maturities until October 2021, significantly lower bookings as it cuts capacity will lead to material cash burn in the short term,” Moody’s warned.

Increased cost reductions would be essential to reduce cash burn and to meet liquidity requirements, the ratings agency warned, something that airliners across the globe are facing.  

It was followed on March 26, by S&P Global Ratings which, even though it concluded that the company was fundamentally well-managed and that the domestic market was, in and of itself, fundamentally sound, downgraded the group five notches to a junk rating of CCC.

“Despite management initiating decisive measures to preserve cash, we nevertheless believe the scale of the COVID-19 exogenous shock has created an immediate and sizable cash outflow,” it said.

And then on 27 March, Fitch Ratings took Virgin Australia down two spots to B-.

“[Virgin Australia’s] liquidity could come under pressure quicker than we previously anticipated should the restrictions on travel be longer than three months or demand remains subdued over the longer term, without the airline obtaining additional liquidity over the coming months,” it said.

Nationalist rhetoric

What has added to the company’s difficulties is rhetoric from the chairman of Qantas, the country’s largest carrier.

Chief executive Alan Joyce has made it very clear that he doesn’t think the Australian government should bail out “badly managed companies” or one “that’s owned by Singaporeans, Chinese, Abu Dhabi and a British billionaire”, according to The Australian newspaper.

The latter is a reference to Virgin Australia’s ownership. The group is 90%-owned by Etihad Airways, Singapore Airlines, Nanshan Group, HNA Group, and Virgin Group.

Of course, the troubles have hit Virgin Australia’s share price. At their lowest point last week, they had crashed 62.5% from where they had started the year.

But attention has been on the company’s debt.

Virgin Australia has a $350 million 7.875% 144a/Reg S five-year bond which matures in October next year. Even though Virgin Australia says that it has allocated $350 million of its cash balance to act as a natural hedge, bond traders are cautious.

Although the paper was trading as high as 104 at the start of the year, it dropped as low as 53.36 last week before being last seen at 63.92 to yield 36.48% according to Markets Insider.

It is an even less pretty picture for the group’s A$150 million 8.25% May 2023s. Although the bonds were trading roughly at par at the start of the year, since then they have slumped and were last seen at a mid-point of 48.04 to yield 51.82%.

Compare this to Qantas' 7.5% onshore 2021s. Demand has been such that they were last seen at almost 104 to yield 5.88%.

However gloomy the outlook, there is a possible silver lining in the form of government support. No one wants a bond default and there has not been one in Australia since the spectacular implosion of HIH Insurance, the country's second-largest insurance company, in 2001.

Scott Morrison’s government has earmarked A$1 billion to help the airline industry and at the weekend deputy prime minister and minister for infrastructure, transport and regional development Michael McCormack confirmed an additional A$198 million regional air network assistance package.

"This package guarantees core routes for domestic air freight will remain open and essential workers remain employed while providing vital financial support for airlines servicing regional and remote locations," McCormack said.

With a clear willingness to support Australia’s aviation industry through the crisis, it might not be clear skies for Virgin Australia, but they are not as cloudy as they look.

¬ Haymarket Media Limited. All rights reserved.