Fitch Upgrades United Continental Holdings to 'B'; Outlook Stable

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded the issuer default rating (IDR) of United Continental Holdings, Inc. (UAL) and its two airline operating subsidiaries to 'B' from 'B-'. The Rating Outlook is Stable. A full list of all rating changes is included at the end of this release.

The upgrade follows a year of significant debt reduction and strong free cash flow (FCF) generation since the closing of the United-Continental merger on Oct. 1, 2010. In the face of heavy fuel cost pressure during the first half of 2011, UAL has consistently reported industry-leading revenue per available seat mile (RASM) growth while funding heavy debt maturities out of internally generated cash flow.

Fitch expects UAL to report FCF of approximately $1.5 B (4% FCF margin) this year, driven in large part by better than expected passenger RASM growth of 6 - 8% for the year. Recent demand patterns have remained resilient in spite of macroeconomic headwinds, with August consolidated passenger RASM growing by approximately 11% year over year.

Capacity cuts by UAL and other U.S. carriers in the post-Labor Day period are likely to offset potential demand weakness as scheduled seats in under-performing markets (notably in the Atlantic network) are reduced. Unlike previous periods of industry demand softening, U.S. airlines have generally moved in unison to rationalize capacity in response to high jet fuel costs and a more challenging economic outlook. Fitch views this as a positive sign for United and the entire industry as carriers adapt to an operating environment influenced by slow economic growth and high fuel prices.

Merger integration efforts appear to be progressing according to plan, with the carriers set to receive a single operating certificate from the Federal Aviation Administration (FAA) by year end. Full implementation of a common passenger service IT system by 1Q'12 will push the merged carrier closer to network integration and should help drive somewhat better yield management and ancillary revenue growth in 2012. The negotiation of single collective bargaining agreements with all of the unionized work groups remains a significant hurdle that may take months to resolve. However, some progress has been seen recently with agreements on common representation of United and Continental work groups.

Liquidity remains solid, with consolidated unrestricted cash and investments at $8.6 billion as of June 30. At 24% of LTM revenues, this liquidity position is the strongest among U.S. carriers. United has also raised its unencumbered aircraft base to approximately $1.8 billion as collateral is released from maturing secured debt obligations.

The longer-term credit challenge for UAL remains the need to steadily de-lever through consistent direction of FCF to the funding of scheduled maturities (which are somewhat lower at $1.3 billion in 2012). Fitch expects UAL to end 2011 with approximately $12.7 B of total balance sheet debt and Fitch-adjusted leverage (capitalizing both aircraft and facilities rents at 8x) of 4.7 times (x) (vs. 6.3x at the end of 2010). Debt reduction for the year should total approximately $2.4 billion.

Financing needs for new aircraft deliveries (25 scheduled in 2012) will offset some planned debt pay-down. However, UAL's capital spending profile over the next two years is manageable in a relatively stable operating environment with low single-digit RASM growth and jet fuel prices in the range of $3.00 to $3.30 per gallon. Gross capex in 2012 will rise from 2011 levels as a result of increasing aircraft deliveries and greater fleet spending.

The key change in the industry operating environment over the past year has been the sharp spike in energy prices that drove spot jet fuel to over $3.30 per gallon this spring. Prices of crude oil and jet fuel have moderated somewhat in recent weeks, but remain high and volatile relative to expectations earlier in the year. United and its principal competitors paid more than 30% higher average fuel prices in 2Q'11.

While the outlook for fuel costs has improved somewhat with the pull-back in Brent and WTI crude oil prices since July, refining margins remain high and declines in jet fuel prices haven't kept pace with crude. United's 51% fuel hedge protection for the second half of the year will provide some stability, but fuel pressure will likely drive tough unit cost comparisons in the second half of the year.

Recent turmoil in the financial markets and worries about Europe have darkened the outlook for consumer and business spending, and the fall and winter air travel demand outlook is uncertain. Business travel demand, however, does seem to be holding up well, as an early September industry fare hike for non-advanced purchase fares stuck in the market. Continuing fare traction in the face of weak fundamentals bodes well for the industry in its effort to bolster yields and RASM moving into 2012.

UAL's July and August passenger RASM trends out-paced the industry, but growing concerns over demand have led management to cut more capacity out of the third and fourth quarter schedules. The latest schedule changes will drive a reduction of approximately 3% in fourth quarter available seat mile (ASM) capacity. Management now expects consolidated 2012 capacity to be essentially flat versus 2011.

United's fleet plan flexibility represents a significant credit positive in light of the need to adjust capacity in the context of uncertain demand patterns and fuel price volatility. Approximately half of the carrier's current fleet will become unencumbered or come off of lease by 2015.

An upgrade to 'B+' is possible over the next one to two years if UAL continues to generate positive FCF and reduces adjusted debt levels. Any further positive actions would be contingent upon the negotiation of competitive labor contracts that do not drive non-fuel unit costs substantially higher than those of legacy carrier competitors.

A downward revision of the Rating Outlook is possible over the next year if global economic stress crimps air travel demand and leads UAL to report declines in passenger unit revenue in 2012. A large fuel price shock, driving spot jet fuel prices above $3.50 per gallon, absent offsetting industry fare actions, could also erode FCF and delay leverage reduction, possibly resulting in a negative action.

Fitch upgrades the ratings of United Continental Holdings as follows:

United Continental Holdings, Inc.

--Issuer Default Rating (IDR) to 'B' from 'B-';

--Senior Unsecured ratings to 'CCC/RR6' from 'CC/RR6'.

United Airlines, Inc.

--Issuer Default Rating (IDR) to 'B' from 'B-';

--Secured Bank Credit Facility to 'BB/RR1' from 'BB-/RR1';

--Senior Secured Notes to 'BB/RR1' from 'BB-/RR1';

-- Senior Unsecured rating to 'CCC/RR6' from 'CC/RR6'.

Continental Airlines, Inc.

--Issuer Default Rating (IDR) to 'B' from 'B-';

--Senior Secured Notes to 'BB/RR1' from 'BB-/RR1';

--Senior Unsecured rating to 'CCC/RR6' from 'CC/RR6';

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 12, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

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