Fitch Affirms United's IDR at 'B'; Upgrades Sr. Unsecured & Sr. Subordinates; Outlook Positive

CHICAGO--()--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) for United Continental Holdings, Inc. and its primary operating subsidiary, United Airlines, Inc. at 'B'. The Rating Outlook is Positive.

The rating affirmations follow United's underperformance over the past year compared to Fitch's original expectations and compared to its peers. The Positive Outlook reflects Fitch's continued expectations that operating results and credit metrics at United should improve in the near term. Expectations are supported by the company's sizeable cost cutting efforts, the general improvement and reduced risk profile of the North American airline industry, continued efforts to grow high margin ancillary revenues, and ongoing efforts to improve the balance sheet.

Fitch revised its Outlook on United to Positive a year ago citing progress that the company had made in moving past its integration issues. Fitch still views the company's credit profile as improving, and although the company's operational performance in 2013 represented an incremental improvement as compared to 2012, weaker than expected results in recent quarters indicate that further improvement is warranted before the ratings are considered for an upgrade.

Credit concerns include United's high (but improving) leverage, significant capital requirements in upcoming years to fund new aircraft deliveries, the company's high cost structure as compared to North American peers, and expectations for negative free cash flow in the near term. Fitch is also cautious regarding apparent operational missteps that have caused United to underperform compared to its peers in what has been an otherwise relatively healthy aviation market. Other credit concerns that are typical for the industry include the company's sensitivity to variables like fuel prices, exogenous events (war or terrorism), and the broader economic environment.

Key Rating Drivers:

Cost Reduction to Improve Margins:

Fitch views United's current cost cutting program to be a positive and necessary step towards improving its credit profile. The company announced the program last November with the goal to reduce operating expenses by $2 billion annually by 2017. Half of the savings are slated to come from lower fuel burn as United takes delivery of fuel efficient new planes and implements other fuel saving techniques such as retrofitting older aircraft with new winglets and slim line seats.

United expects the remainder to come from things like improved productivity, maintenance programs, and sourcing/distribution. United currently operates with one of the highest cost bases (as measured by CASM ex-fuel) among its North American peers. Assuming that the program is implemented as planned, Fitch expects operating margins to expand over the intermediate term. United produced an EBITDAR margin of 15% in 2013, which was an improvement from 13.9 in 2012, but was lower than its main rivals Delta and American (16.6% and 18.4% respectively).

Positive operating environment:

The Positive Outlook is also reflective of Fitch's view that the risk profile of the North American airline industry is generally improving. Consolidation and capacity constraint continue to be the overriding themes that are causing the North American airlines to produce consistently strong profits. Fitch expects industry-wide capacity constraint to continue at least for the intermediate term, with the four largest US Airlines (AAL, UAL, DAL, and LUV) planning minimal growth at least for this year. Low capacity growth mixed with steady, if modest, growth in demand for air travel should sustain yields and load factors through 2014.

Pressured Pacific Markets:

Increasing competition across the Pacific may present a headwind in 2014. Chinese carriers have added significant capacity over the past year and are expected to continue growing internationally as they diversify away from an increasingly competitive domestic market in China. Weakness in the Asian market impacts all three of the major American carriers, but has the greatest effect on United, which has the biggest presence there.

Trans Pacific travel accounted for 15.1% of United's 2013 operating revenue compared to 10.8% for Delta and 3% for American. While the increase in competition pressured yields in 2013 and the first quarter of 2014, it is important to note that United's Pacific network remains the best among the legacy carriers and is an important longer-term advantage over both Delta and American.

Weak Free Cash Flow:

Fitch expects free cash flow to be negative in 2014 following two years of negative FCF in 2013 and 2012. United expects gross capital spending to be between $2.9 and $3.1 billion in 2014, up from $2.2 billion in 2013. Roughly two thirds of the projected spending will be related to aircraft. As a result, Fitch expects free cash flow in 2014 to be negative by $500-700 million, similar to 2013 when FCF was -$720 million.

Improving Credit Metrics:

Adjusted debt/EBITDAR as of March 31, 2014 was 5.4x, an improvement from where it stood at 6.0x a year prior. Fitch expects leverage to continue to improve through 2014, though it will largely be driven by growing EBITDAR and not by further debt reduction. United will continue to take out non-aircraft debt when possible.

In the first quarter of this year, United paid off $400 million of 8% unsecured notes due in 2024, and extinguished $200 million in convertible notes with common stock. The company may also decide to pre-pay its $800 million 6.75% secured notes due in 2015 when they become prepayable in September 2014. However, debt that is paid down through the year will be largely offset by new debt taken on to fund aircraft deliveries. Fitch notes that United's efforts to reduce debt are flowing through to the income statement, with total interest charges in 2013 down by $64 million from 2012.

Adequate Liquidity:

As of March 31st 2014, United maintained slightly more than $6 billion in total liquidity including full availability under its $1 billion revolver. Liquidity as a percentage of LTM revenue was 15.7%, which is lower than some of United's North American peers, but is considered adequate for the rating.

Fitch expects upcoming debt maturities to be manageable. Since United will likely continue to fund future aircraft deliveries with debt, as it has in the past, the company is expected to generate sufficient operating cash flow to address debt maturities as they occur. Maturities total $1.5 billion in 2014, $2 billion in 2015, and decline thereafter.

Recovery Ratings:

Fitch has upgraded the ratings on United's senior unsecured debt to 'B/RR4' from 'B-/RR5' and on United's subordinated unsecured debt to 'B-/RR5' from 'CCC+/RR6'. The recovery analysis reflects a scenario in which a going concern enterprise value is allocated to the various debt classes. The rating upgrades reflect United's growing EBITDA base stemming from higher revenues and modestly expanding margins, leading to a higher estimated enterprise value.

Fitch notes that although the current Recovery Ratings anticipate average (RR4) recovery prospects for United's unsecured debt, recovery percentages are highly sensitive to model inputs due to the heavy weighting of United's capital structure towards secured debt. In a range of recovery scenarios Fitch has calculated unsecured recovery percentages both above and below the 'RR'4 range.

Rating Sensitivities:

Future actions that may individually or collectively cause Fitch to take a positive rating action include:

--Adjusted debt/EBITDAR sustained at 4.5-5x;

--FFO fixed charge coverage sustained above 2x;

--Further evidence that United's cost restructuring program is effective (lower CASM growth rates, expanding margins);

--EBITDAR margins expanding to greater than 16%;

--Free cash flow trending towards positive.

Future actions that may individually or collectively cause Fitch to take a negative rating action include:

--Adjusted debt/EBITDAR rising above 6x;

--EBITDAR margins deteriorating into the low double digit range;

--Persistently negative free cash flow.

Fitch has taken the following rating actions:

United Continental Holdings, Inc.

--IDR affirmed at 'B';

--Senior unsecured rating upgraded to 'B/RR4' from 'B-/RR5';

--Senior unsecured convertible notes upgraded to 'B-/RR5' from 'CCC+/RR6'.

United Airlines, Inc.

--IDR affirmed at 'B';

--Secured bank credit facility affirmed at 'BB/RR1';

--Senior secured notes affirmed at 'BB/RR1';

--Senior unsecured rating upgraded to 'B/RR4' from 'B-/RR5'

--Junior subordinated convertible debentures upgraded to 'B-/RR5' from 'CCC+/RR6'.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 5, 2013);

--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2013);

--'Rating Aircraft Enhanced Equipment Trust Certificates' (Sept. 12, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721836

Rating Aircraft Enhanced Equipment Trust Certificates

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717763

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829951

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Contacts

Fitch Ratings
Primary Analyst
Joe Rohlena, CFA, +1-312-368-3112
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig Fraser, +1-212-908-0310
Managing Director
or
Committee Chairperson
Stephen Brown, +1-312-368-3139
Senior Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Joe Rohlena, CFA, +1-312-368-3112
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig Fraser, +1-212-908-0310
Managing Director
or
Committee Chairperson
Stephen Brown, +1-312-368-3139
Senior Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com