CHICAGO--(BUSINESS WIRE)--Fitch has upgraded Delta Air Lines' (DAL) IDR to 'BB' from 'BB-'. Fitch has also upgraded Delta's Seattle project bonds to 'BB' from 'BB-', and affirmed the Delta 2007-1 class A pass-through trust certificates at 'BBB+'. The Rating Outlook is Positive.
The upgrade reflects significant improvements to Delta's balance sheet, continued solid operating performance, better than expected free cash flow (FCF), and successful efforts to combat operating cost inflation. The ratings are also supported by underlying improvements in the airline industry including consolidation among the legacy carriers and capacity constraints, which have led to an improved risk profile and better profitability for the industry as a whole. Fitch upgraded Delta's ratings to 'BB-'/Positive Outlook in February of this year citing the possibility for further upgrades contingent upon further leverage reduction and sustained or improved operating margins. Since that time Delta has met or exceeded those expectations.
The Positive Outlook reflects Fitch's view that Delta's credit profile will continue to improve over the intermediate term as the company continues to list debt reduction and addressing its underfunded pension plan as key priorities. Several of Delta's key credit metrics, including adjusted leverage and profitability, could potentially support higher ratings. Future upgrades are possible as Fitch's confidence grows in Delta's ability to maintain higher ratings through the inevitable cyclical and secular stresses inherent to the industry.
Delta's underfunded pension plan remains a key overhang on the ratings. The plans were underfunded by $10.1 billion at year-end 2013, leading to sizeable required annual cash contributions. These risks are partially mitigated by Delta's improving cash flow profile, which enables the company to fund its pension requirements while still generating positive FCF, and by Delta's efforts to make pension contributions over and above the required minimums. The international economic environment is also a concern with recent reports of softness in the Eurozone, China, and Brazil weighing on future demand for international travel. Other rating concerns primarily reflect risks inherent to the airline industry. Cyclicality, exposure to exogenous shocks (i.e. war, terrorism, etc.), capital intensity, and sensitivity to global oil prices remain constraining factors on the ratings.
KEY RATING DRIVERS
Improving Credit Metrics: Credit metrics at Delta have continued to improve since Fitch upgraded Delta's rating to 'BB-' in March of this year. Fitch expects further improvement going forward supported by a solid domestic demand environment and by Delta's commitment to future debt reduction. Fitch calculates Delta's adjusted debt/EBITDAR at 2.5x as of Sept. 30, 2014, which is down from 3.2x at year-end 2013 and more than 9x at year-end 2009. Adjusted leverage is now notably lower than all other large North American competitors with the exception of Alaska Air Group, which Fitch rates 'BBB-'. Fitch believes that Delta's improved credit profile puts it in a much stronger position to weather future market downturns. Delta intends to further reduce debt in the near term, setting a net adjusted debt target of $5 billion to be reached by year-end 2016. Fitch views this goal as achievable given the company's capacity to produce FCF, and its track record of bringing down debt since the previous recession.
Managing Costs: The ratings upgrade is supported by Delta's successful efforts to manage its unit costs. Cost per available seat mile (CASM) ex-fuel was flat in the first three quarters of 2014 despite some pressure from salaries and related costs. Fitch expects non-fuel unit cost growth to remain modest in the low single-digit range through 2015. Delta's ongoing re-fleeting effort, aimed at replacing smaller inefficient regional jets with larger 76-seat regional jets (RJs) and 717s is expected to provide some unit cost benefit. Delta is also able to avoid heavy maintenance checks on the small RJs that it intends to retire in coming years. Fitch expects Delta's well-managed unit cost growth along with expectations for modest revenue per available seat mile (RASM) increases to create room for further operating margin expansion in 2015. Margin expansion could be material if fuel costs remain at the lower levels seen in recent weeks.
Fitch notes that the collective bargaining agreement with Delta's pilots becomes amendable in December 2015. Unit costs could face some pressure beyond 2015 depending on the outcome of those negotiations.
Strong FCF and Financial Flexibility: Delta's FCF generation has outpaced Fitch's expectations over the past year. Delta's healthy operating profits and manageable upcoming capex are expected to allow the company to produce sizeable FCFs in the $3 billion range in 2014 and 2015. Delta has now produced positive cash flow in each of the past five years, with cumulative FCF totaling more than $7.3 billion over that time period. The capacity to consistently produce positive FCF, particularly in the sustained high fuel-price environment of recent years, was a key consideration in the ratings upgrade.
Total liquidity as of Sept. 30, 2014 was equal to 16% of LTM revenue. Liquidity consists of $2.5 billion of cash & equivalents, $1.9 billion of short-term investments, and $2 billion of revolver availability. While some of Delta's airline peers have a higher liquidity balance on a cash/revenue basis, Fitch considers DAL's current liquidity balance to be more than adequate to fund near-term requirements, particularly since the company is consistently generating solid cash flow. Fitch's base case forecasts that DAL will generate cumulative cash flow from operations of more than $17 billion between 2014-2016, greatly exceeding anticipated capex, dividends, and debt maturities.
Manageable Cash Obligations: Fitch expects capital expenditures to total between $2 billion-$2.5 billion annually for the next several years, the majority of which will consist of new aircraft deliveries as Delta takes 737-900ERs, A330-300s starting in 2015 and A321s starting in 2016. Debt maturities range from $1 billion to $1.4 billion annually over the next three years. These obligations are manageable in light of Delta' expected cash generation.
Fitch also expects Delta to manage its dividend and share repurchase programs prudently. Delta announced a 50% dividend increase earlier in 2014, increasing the payout to roughly $300 million per year. Delta's board also authorized a $2 billion share repurchase program to be completed by year-end 2016. This comes after the company's May 2013 announcement that it would complete a $500 million repurchase program by the end of 2015. The program was completed nearly two years ahead of schedule, prompting a much larger repurchase allowance. Fitch does not consider shareholder returns at these levels to be constraints on the ratings given Delta's ability to generate cash. However shareholder-friendly activities could present a credit concern in the future if they were pursued at the expense of a healthy balance sheet.
Sizeable Pension Obligations: Delta's underfunded pension plans remain a concern. As of year-end 2013 Delta's defined benefit plans were underfunded by $10.1 billion. Fitch expects that figure to increase at year-end 2014 due to the prevailing interest rate environment. Risks posed by the underfunded plans are partially offset by Delta's efforts to make contributions over and above minimum required funding amounts and by the company's steady FCF generation. Delta contributed $250 million above the minimum required amount in the first half of 2014 bringing the total contribution to $905 million. The company anticipates making similar annual contributions going forward. Nevertheless, pensions are expected to remain a sizeable liability for the foreseeable future.
Strong Operating Results: Operating margins continue to expand, reflecting consistent RASM growth and managed cost pressures. Delta has maintained above-industry-average PRASM growth since fully completing its integration of Northwest with results driven by its formidable route network and an improving share of corporate travel. Fitch believes that operating margins have room for further expansion in coming years as Delta works to revamp its regional jet fleet and its operations in New York continue to mature. Fitch also expects continued modest macroeconomic growth in 2014 and 2015, positive trends in travel demand, and capacity discipline across the industry, which will foster a healthy operating environment. Business travel trends are particularly robust, which is important given Delta's increased focus on growing its share of lucrative corporate travelers.
Delta 2007-1 Pass Through Trust Certificates:
In its review of Delta's ratings, Fitch has also affirmed the ratings for the company's 2007-1 series class A certificates at 'BBB+'. Fitch's senior tranche EETC ratings are primarily based on a top-down analysis of the collateral, and were not affected by the upgrade to Delta's IDR. The ratings are supported by the structure's ability to withstand Fitch's 'BBB' level stress test while maintaining a loan-to-value (LTV) below 100%. This suggests that senior tranche holders would receive full recovery prior to a default, even in a harsh stress scenario. The ratings are also supported by low base LTVs through the life of the transaction, a moderate-to-high affirmation factor, and Delta's improving credit profile.
Future developments that may, individually or collectively, lead to a positive rating action include:
--EBITDAR margins approaching or exceeding 20% (at Sept. 30, 2014: 19.3%);
--Sustained FCF margins of 5% of revenue or higher;
--Continued progress towards reducing underfunded pension balance;
--Sustained funds from operations fixed-charge coverage ratio above 4x (at June 30, 2014: 3.65x).
A negative rating action is not anticipated at this time. However, future actions that may individually or collectively lead to a negative rating action include:
--Increased operating costs, either fuel or non-fuel related, that are not adequately matched by higher ticket prices leading to reduced operating margins;
--A substantial increase in dividends or stock repurchases that comes at the expense of a healthy balance sheet;
--An unexpected and protracted drop in the demand for air travel.
Fitch has taken the following rating actions:
Delta Air Lines, Inc
--IDR upgraded to 'BB' from 'BB-';
--$1.2 billion senior secured revolving credit facility due 2016 affirmed at 'BB+';
--$1.4 billion senior secured term loan due 2017 affirmed at 'BB+'.
--$450 million senior secured revolving credit facility due 2017 affirmed at 'BB+';
--$1.1 billion senior secured term loan B-1 due 2018 affirmed at 'BB+';
--$400 million senior secured term loan B-2 due 2016 affirmed at 'BB+'.
Delta Air Lines 2007-1 Pass-Through Trust:
--DAL 2007-1 class A certificates affirmed at 'BBB+'.
Industrial Development Corporation (IDC) of the Port of Seattle special facilities revenue refunding bonds, series 2012 (Delta Air Lines, Inc. Project):
--$66 million due April 1, 2030 upgraded to 'BB' from 'BB- '.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'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:
Rating Aircraft Enhanced Equipment Trust Certificates
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage