have also withdrawn the recovery rating of '3' on the airline's debt followingthe upgrade to investment-grade rating status. The outlook on the long-termrating is stable.
The upgrade follows Qantas' announcement on Nov. 17, 2015, that it has adopteda more conservative financial framework that includes a commitment to maintainfunds from operations (FFO)-to-debt (after Standard & Poor's adjustments) ofgreater than 45% through the cycle.
"We view this framework to be materially more prudent and creditor-friendlythan previously announced policies," said Standard & Poor's credit analystGraeme Ferguson. "Qantas' revised financial framework is more formal,forward-looking, and preemptive. It places greater emphasis on actingpreemptively to protect the balance sheet when the airline anticipates periodsof financial stress."
The financial framework is designed to manage the group's optimal capitalstructure in a manner which is consistent with FFO-to-debt (after Standard &Poor's adjustments) at more than 45% through the cycle. Qantas' principalfinancial levers include shareholder distributions, growth capitalexpenditure; and, potentially, equity raisings.
Our base-case forecast remains unchanged. Relatively benign domestic marketcompetition, structurally lower fuel prices, restructuring initiatives, and alower Australian dollar are expected to translate into the airline recordingan FFO-to-debt of between 45% and 60% over the 2016 and 2017 fiscal yearsending June 30. However, we have revised Qantas' financial risk profile to"modest" from "intermediate" to reflect the reduced likelihood of medium-termvariance to our base-case forecast under the group's revised financialframework.
We are mindful that Qantas has committed to measures that may become lesspalatable to shareholders during periods of financial stress. A key ratingconsideration will be Qantas' willingness to preemptively implementcreditor-friendly policies that, in our opinion, may not necessarily have
broad-based support among shareholders. However, we acknowledge that Qantashas established a sound track-record of responding to earnings pressure in thepast through managing costs and deferring capital expenditure. We believe thatQantas is committed to taking preemptive action, including reducing costs andcapital expenditure and raising equity if necessary, to maintain its target
credit metrics. We do not view Qantas' revised financial framework as apanacea to all downside risk. Rather, we view the revised financial frameworkas a prudent set of measures that support the investment-grade credit ratingon the airline.
Qantas' "fair" business risk profile remains unchanged. However, we believethat a strong and flexible balance sheet is supportive of the airline'sbusiness risk profile in so far as it acts to ward-off competitive threats,particularly in the domestic market.
Mr. Ferguson added: "The stable outlook reflects our view that the group'sstrong balance sheet, conservative approach to capital management, dominantdomestic market position, and a more benign domestic competitive environment,will underpin credit quality at the 'BBB-' rating level."
The rating incorporates our expectation that Qantas will realize an enduringbenefit from previously announced restructuring initiatives while limitingpressure on its balance sheet. We do not forecast a demand-led recovery.However, structurally lower fuel prices, a more-benign domestic marketenvironment, restructuring initiatives, and a lower Australian dollar shouldhelp the further strengthen the airline's credit metrics. In this regard, weexpect Qantas to comfortably exceed FFO-to-debt of 45% over the next 2 years.Further, the stable outlook anticipates that Qantas will maintain its
meaningful financial flexibility and strong liquidity position throughout thecycle. The practical application of Qantas' revised financial policies andmanagement's willingness to act preemptively to protect the airline's balancesheet will be key rating considerations over the medium- to long-term.
We could lower the ratings if the airline's FFO-to-debt is sustained below45%. The airline's metrics could be pressured if proactive capital managementactions are insufficient to offset: an intensification of competition acrossits route network; an appreciation of the Australian dollar; higher fuel costsover the medium-term; the airline being unable to achieve and maintainincremental cost savings; and occurrence of exogenous shocks such as aterrorist or mass-pandemic event. A weakening of Qantas' liquidity positionbelow strong will also put downward pressure on the rating.
Over the medium term, we could raise the rating if we expect Qantas' financialpolicies to sustain FFO-to-debt at more than 60% under a range of variabledemand conditions, competitive tensions, volatile fuel costs, and exogenousshocks. We view upward rating pressure as a result of a strengthening in theairline's business risk profile as less likely over the medium term.