Qantas's capital structure and financial performance during the global financial crisis

Qantas

The global financial crisis began in 2008 in the United States and quickly spread. Most major world economies -- and many minor ones as well -- have suffered over the past few years from suppressed demand, exacerbated by government cutbacks that have increased unemployment while doing nothing to restore shattered consumer confidence. The impact on the global airline industry was significant. The 2000s were already a difficult decade for many firms in the industry, the result of the September 11th, 2001 terrorist attacks and then the economic crisis (Ghosh, 2010). The Air Transport Association reported that the industry lost $4.7 billion (USD) in 2009 (de Bruyn, 2009). While 2010 saw the industry recover somewhat (Ghosh, 2010), the decade was on the whole a challenge for many carriers.

For its part, Qantas weathered the financial crisis well, posting a profit in 2008/2009 (Qantas 2010 Annual Report). The company continued to be profitable in fiscal 2010, posting a profit before tax of $377 million. The company attributes this success due to its "decisive response" (Ibid). This response included deferring aircraft deliveries, capacity reductions and job cuts in order to lower the airline's cost structure (Govindasamy, 2009). While the Australian economy held up better than most during the crisis (Eslake, 2009), Qantas saw reduced revenue on its lucrative international routes (2010 Qantas Annual Report). This paper will further analyze the financial condition of Qantas, including analysis on the impacts of the global economic crisis.

Capital Structure

The capital structure of an organization refers to the balance of debt and equity capital that is used to finance the firm's operations (Loth, 2006). The optimal capital structure for a firm is based on the nature of the business and the point of the business life cycle in which the company can be categorized. Debt costs less than equity, but leverage is also a source of risk for firms because it represents a demand on free cash flow. When cash flow is low, the demand still exists. Equity financing need not represent any drag on free cash flow, but it costs more. Most firms have a target range for their capital structure that they prefer to work within, but they can deviate from this range during times of financial distress.

At the end of the 2010 fiscal year (June 30, 2010), the capital structure for Qantas was 70% debt and 30% equity. The largest component of the liabilities was interest-bearing liabilities (bonds and debentures) and this accounted for 25.6% of the entire capital structure. These included secured bank loans (53.2%), unsecured bank loans (14.5%), other unsecured loans (20.3%) and lease/hire purchase liabilities (8.6%). In comparison, the pre-economic crisis capital structure at the end of fiscal 2007 (June 30, 2007) was 68.4% debt and 31.5% equity. Not only is this almost identical to the capital structure in 2010, but the company's total size is almost identical between these two time periods as well. In 2007, total assets were $19.6 billion, and in 2010 it was $19.91 billion, only 1.5% larger (2007 Qantas Annual Report).

Economic Crisis

For most parts of the world, the global economic crisis resulting in a shift in capital market conditions. Global equity markets tanked and credit markets dried up. The situation in Australia was somewhat different. Eslake (2009) notes that the ASX suffered sharp declines as there were fears about exports declining, with many of Australia's major customers suffering the impacts of the recession. There was also a lack of business confidence in Australia at the time. However, Qantas was unlikely to be interested in going to the equity markets to raise funds and as a result the book value of its issued capital has only increased $300 million over the course of the crisis (it recorded $514 million in proceeds from the issue of shares in 2009). The company's retained earnings declined $437 million during that time, a decline of 27.4%. This can be attributed to disbursements for plant, property and equipment, which were strong net cash outflows over the course of the crisis. Despite deferring some deliveries, Qantas increased its fleet size by 5.8%, or 14 aircraft, from 2009 to 2010 (2010 Qantas Annual Report).

Eslake (2009) notes that Australian banks remained solvent throughout the crisis. Due to tight financial controls, Australian banks were not heavily invested in the mortgage-backed securities that brought down many banks in many other Western nations. As a result, Australian banks remained profitable throughout the crisis, and they did not need capital injections from governments. Their lending terms were "more demanding" but they continued to lend throughout the course of the crisis. This is evident at Qantas, which was able to borrow throughout the crisis. The company borrowed $1.448 billion in fiscal 2009 and $1.352 billion in fiscal 2010 (2010 Qantas Annual Report).

What this shows is that Qantas did not need to change its strategy with respect to its capital structure as a result of the global economic crisis. Australian banks remained healthy, and Qantas being a well-established firm was able to continue borrowing throughout the crisis. Because Qantas was also able to continue with profitability during the crisis, the firm had no reason to take on extra debt in order to finance its operations. It was able to finance operations through retained earnings, which decreased, and through the issue of stock. The company's stock issue came in 2009, when market conditions were difficult and Australian stocks had experienced strong declines in value. This did not deter Qantas, the company was able to raise fund successfully (Smith, 2009). The issue was conducted during the depths of the crisis in order to "bolster its balance sheet" (Ibid). The company saw a need to maintain its capital structure, and knew that with retained earnings set to decline in lockstep with profits, an equity issue would be needed in order to maintain the 70/30 capital structure that it covets. The company executed the issue with UBS and Macquarie as underwriters, showing that the market for share issues of major firms remained robust even during the depths of the financial crisis. The move was proactive, occurring in February 2009. This was strategic -- Qantas knew that its financial position at the time was strong. It had plenty of cash on its balance sheet - $2.5 billion (Smith, 2009). With a strong financial position, it would be able to raise capital. If it waited and the economic downturn hurt its balance sheet, Qantas may not have been able to raise capital so easily.

Conclusion

There is no need for Qantas to restructure its debt to maximize shareholder wealth. The company's size is not changing, which means to increase the book value of the company's equity would imply engaging in share buybacks. This is a poor use of the company's capital, since the global economy remains weak and since Qantas faces intense competition on numerous fronts. While increasing the debt component of the capital structure would lower the overall cost of capital, it would also increase the risk that the company faces. The operating environment is turbulent, not just from competition but from high fuel costs as well. This implies that any additional risk would compromise the security that Qantas currently has with respect to meeting its debt service obligations.

While Qantas' balance sheet looks remarkably unchanged as the result of the global economic crisis, this is only because of the proactive measures the company took at the outset of the crisis. The equity issue allowed the company to maintain its capital structure at a time when profits (and therefore retained earnings) were declining sharply. The company also made a number of tactical operational moves that helped it weather the crisis. When the airline business was stronger in the mid-00s, it invested heavily in Jetstar and that unit propped up the flagship brand, which suffered as its international routes saw declines in demand. The response of the company to the crisis was excellent, and in light of that and the current operating environment there is no need at all to alter the capital structure of Qantas.

Works Cited:

de Bruyn, C. (2009). Global airline industry to suffer $4.7 billion loss this year. Engineering News. Retrieved October 9, 2011 from http://www.engineeringnews.co.za/article/global-airline-industry-to-suffer-47bn-loss-this-year-iata-2009-03-24