NEW YORK--()--Fitch Ratings upgrades JetBlue Airways Corp.'s (JBLU) Issuer Default Rating (IDR) to 'B' from 'B-', and affirms the senior unsecured rating at 'CCC+', while revising the recovery rating to 'RR6' from 'RR5', which applies to approximately $285 million of convertible notes. The Rating Outlook for JBLU is Stable.
KEY RATING DRIVERS
The upgrade reflects JBLU's industry leading unit costs and operating margin, track record of being consistently profitable (even during downturns), improving cash flow and healthy liquidity (including a growing unencumbered aircraft pool) in context of a significantly improved operating environment in the US airline industry. The 'B' rating also incorporates JBLU's lease-adjusted leverage which has improved in recent years, but remains high at approximately 6x on lease-adjusted debt/EBITDAR basis and a growth strategy that is more aggressive than peers.
Despite JBLU's expansion and the devastating impact of Sandy, the company was able to produce a PRASM gain of 3.6% in 2012. This is impressive in context of a 7.6% increase in capacity, and reflects 1.4 point increase in load factor and a 1.5% increase in average fares. Non-fuel costs have also been on the rise, with non-fuel CASM up 3.3% reflecting a sharp increase (+38% y/y) in maintenance costs. Nonetheless, JBLU remained profitable in 2012, with an operating margin of 7.5% up a modest 40 basis points (bps) year-over-year and at the high-end of its peers.
JBLU recorded its highest cash from operations in the tune of $700 million last year, but higher capex including an opportunistic $200 million prefunding of 2013 deliveries led to negative free cash flow (FCF) in 2012, as expected. FCF, along with ROIC, remains a management focus as evidenced in the three consecutive years of solid FCF from 2009-2011. JBLU's higher capex budget for both new A320 deliveries and strategic investments in non-aircraft is expected to pressure FCF this year. The company is budgeting $450 million for aircraft (aircraft deliveries, sharklets etc.) and $245 million non-aircraft strategic investments including $80 million earmarked for building out an international terminal at Terminal 5 at JFK.
JBLU also faces looming debt maturities of ~$1.2 billion during 2013-2015, mainly aircraft backed debt. Fitch expects JBLU to use Brazilian export financing for its EMB 190 deliveries, and fund its other capital commitments through a combination of existing cash, operating cash flow and external funding.
Accordingly, total liquidity, which includes cash, marketable securities and a $125 million line of credit with American Express (for jet-fuel purchase) as a percentage of trailing 12 month revenues, is expected to decline to the mid-to-high teens from levels above 20% seen over the past several years. During the fourth quarter, JBLU upsized its line of credit with Morgan Stanley to $200 million from $100 million. This facility is secured by a portion of its marketable securities, hence, not included in our total liquidity calculation. Furthermore, JBLU is growing its unencumbered pool which now includes 11 unencumbered A320s, considered Tier 1 collateral, up from just one aircraft at year-end 2011.
Fitch's liquidity analysis also incorporates only modest improvement in cash flow, given Fitch's conservative operating assumptions. Management expects year-over-year PRASM to rebound in March based on current booking trends and the Easter/Passover holiday shift into March from April this year. Even with PRASM ramping up after the first quarter, Fitch expects only a modest improvement in operating margin reflecting our expectations for slower PRASM growth for the year and continued maintenance cost inflation. Management's guidance calls for a 1%-3% increase in CASM, excluding fuel and profit-sharing. That said, an increase in fare activity and corporate share (in Boston), higher connecting traffic from its domestic and international partners, and growth in high-margin ancillary revenues should boost total RASM higher than our expectations, and also drive an increase in operating margins, FCF and liquidity.
Near-term operating risks include a spike in jet-fuel prices and a slowdown in the U.S. economy. Fuel risk is partially mitigated by JBLU's conservative hedging initiatives, and more importantly, the much improved operating environment in the domestic airline industry which enables U.S. carriers to raise fares to mitigate rising fuel costs. Especially, in context of a strong economy which should also boost demand for air travel, making it easier for JBLU and its peers to raise fares to alleviate rising fuel costs. Conversely, a weaker macro environment makes JBLU's growth plans more risky when compared to its rated peers who are all keeping capacity constrained. That said, the silver lining in a slowing economy for JBLU and the airline industry is the low energy prices that usually accompany a macro slowdown.
Longer-term operating risks include possible labor inflation. JBLU continues to benefit from lower costs than its peers including a significant labor cost advantage. JBLU currently has some of the youngest pilots and crew members in the country and aims to be peer competitive with wage rates. Therefore, the new pilot rates recently established at its legacy peers could potentially put upward pressure on labor costs. That said, JBLU's employees are not unionized giving the carrier more flexibility with schedule and network changes and without a pension burden, Fitch expects JBLU to maintain its cost advantage over the near term.
Other long-term risks include possible restructuring of the new American network which could shift some of JBLU's current connecting traffic from American at JFK to Philadelphia where US Airways maintains a hub. That said, the new American has not yet announced any network changes and Fitch expects it will be a while before it potentially becomes a material threat to JBLU. Importantly, JBLU's growing list of other domestic and international partners should mitigate some of this risk.
Fitch's recovery analysis is based on a going concern valuation with assumptions that are conservative compared to current market multiples, as well as exit multiples in prior airline bankruptcies. The issue rating for JBLU's converts are affirmed at 'CCC+' reflecting the one-notch upgrade of the IDR as well as downward revision of the recovery rating from 'RR5' to 'RR6'. The recovery rating is lower due to the inclusion the new $200 million secured line of credit and a $514 million construction obligation that was previously not included in Fitch's analysis, which has now lowered recovery prospects for the convertible debentures.
The recommended Outlook is Stable. Fitch could revise the Outlook to Positive if JBLU generates margins and cash flow higher than our expectations and improves its liquidity profile by enhancing its revolver capacity and/or grow its unencumbered base. Conversely, the Outlook would be revised to Negative if JBLU's FCF or liquidity position weakens, especially in a fuel spike or falling demand scenario.
Fitch upgrades JBLU's ratings as follows:
--Issuer Default Rating (IDR) upgraded to 'B' from 'B-';
Fitch revises JBLU's ratings as follows:
--Senior unsecured debt to 'CCC+/RR6' from 'CCC+/RR5'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Aug 14, 2012).
Applicable Criteria and Related Research
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Corporate Rating Methodology