CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded the Issuer Default Rating (IDR) for United Continental Holdings, Inc. (UAL) and its airline operating subsidiary, United Airlines, Inc. to 'BB' from 'BB-'. The Rating Outlook is Stable. Fitch has also upgraded the ratings for the subordinated tranches of several United EETCs. A full list of ratings follows at the end of this release.
The upgrade is supported by significant improvements in United's credit metrics in recent years, Fitch's expectations for the company to generate a meaningful amount of FCF over the intermediate term, continued focus on cost control, and general improvements in the risk profile of the U.S. airline industry. Fitch also believes that United's credit profile benefits from the new management team's renewed focus on operational reliability and employee relations, which should have a positive impact on the company's perception with its customer base.
The on-going move away from 50-seat regional jet flying, the introduction of basic economy, and United's new Polaris business class product also have the potential to support operating margins over the intermediate term. United also continues to benefit from relatively low jet fuel prices. Fitch expects that United's total fuel bill will be roughly $1.5 billion lower in 2016 than it was in 2015, providing a substantial benefit to FCF generation.
The Stable Outlook reflects Fitch's view that the recent improvements in United's credit metrics will likely pause or modestly reverse in the near term due to unit cost pressures created by new union contracts, the possibility of higher fuel prices, the absence of future debt reduction, and a soft unit-revenue environment. FCF will also be limited by relatively high capital spending primarily related to a heavy aircraft delivery schedule over the next couple of years. Nevertheless, we expect United's credit metrics over the longer term to be supportive of ratings at least at the 'BB' level.
Other concerns include United's share repurchase activity, which has directed a meaningful amount of cash to shareholders in recent years. United intends to remain flexible with its share repurchase program and does not anticipate repurchases to come at the expense of a healthy balance sheet, but a change to that policy could pressure the ratings. Weak unit revenues experienced over the past two years are not a material concern at this point as they have been largely offset by lower fuel costs. Longer-term revenue weakness would be a concern particularly if unit revenues were to remain pressured in a rising fuel environment. This risk has abated somewhat recently as the unit revenue environment has started to reverse the negative trends experienced over the past two years.
KEY RATING DRIVERS
Stable Debt Balances: United has stated that it does not intend to materially reduce leverage from current levels, which represents a modest change in messaging from its previously articulated goals of reaching $15 billion in gross adjusted debt. Although Fitch viewed management's previously stated goal of further debt reduction favorably, we do not believe that United's current debt levels prevent the company from achieving higher ratings. However, future upgrades are likely to be based on operational improvement, cost control, and relative margin improvement. Current debt levels translate into adjusted leverage ratios that are likely to remain in the mid-3x range in the coming years depending United's margin performance, which is in-line with a 'BB' rating.
Aside from manageable leverage, United's balance sheet benefits from a growing base of unencumbered assets, which the company estimates at around $8 billion in value, and from a manageable pension obligation. United's pension deficit stood at just under $1.5 billion as of year-end 2015. United's ratings are also supported by its position as one of the largest carriers in the world, and the breadth of its route network. Further upgrades could also be warranted if United proves successful in some of its ongoing initiatives, including improving its operational reliability, controlling its cost structure, improving operating margins relative to peers, and winning back customer loyalty.
FCF Expected to Remain Positive: Fitch expects United to generate consistently positive FCF throughout our forecast period. Fuel prices remaining well below pre-2015 levels continue to be a major driver of the company's improved cash flow profile, but United is also benefitting from cost control efforts and up-gauging away from 50-seat regional jet flying. Fitch expects FCF in 2016 to be around $2 billion, down from $2.4 billion in 2015. FCF is likely to trend lower in 2017 and 2018 due to higher capex, and the possibility for moderately shrinking margins driven by higher fuel prices and labor costs. Although we expect FCF to stay positive through the forecast, the projection is sensitive to fuel prices, and could decline quickly if increases in jet fuel were not offset by higher ticket prices.
Heavy Upcoming Deliveries: United is in the midst of an extensive re-fleeting effort. Fitch previously expected 2015 to represent a peak year for capital spending, but recent changes to United's aircraft order book will keep capex high through the next several years. United's updated guidance is for average gross capital spending of between $3.8 billion/year and $4 billion/year for several years. This is up from around $3.6 billion in 2015 and $3.1 billion in 2014. Fitch views this action as primarily a pull-forward of future capital spending rather than a significant increase to overall spending levels.
In early 2016 United added 65 737-700s to its order book (40 in January and 25 in March) as part of its effort to reduce its reliance on 50-seat regional jets. The 737s will begin arriving in 2017. United also decided to accelerate the delivery of some of its 777s and 787s, and will now be taking 14 777-300ERs through next year. The 777s will allow United to accelerate the retirement of its 747 fleet, which has suffered from reliability issues in recent years, and which operate at a unit cost disadvantage to smaller wide-body aircraft. The re-fleeting efforts should provide longer-term benefits, as they allow the carrier to shrink its 50-seat RJ fleet and retire its 747s, but higher capex will limit FCF in the near term.
Recent Union Contracts: Thus far in 2016 United has extended the collective bargaining agreement with its pilot union through 2019, extended its agreement with employees represented by the IAM, and reached an agreement with its flight attendants in what had been a long drawn-out negotiation. The flight attendant contract is notable because the company had been unable to reach an agreement with the group since the United/Continental merger. The new contract will finally allow the company to freely mix and match former United and former Continental crews on all of its flights, something it had not been able to do in the six years since the merger.
Aside from the logistical issues of improved scheduling, the new labor agreements may go a ways towards improving employee relations, which had been rocky at United for several years. The new agreements will put some pressure on unit costs in the near term. However, United has reiterated its long-term target of keeping average annual CASM growth below inflation.
LIQUIDITY
Sufficient Liquidity: United's liquidity position is supportive of the rating. Fitch's liquidity analysis combines current cash on hand with our forecast for two years of operating cash flow compared to upcoming debt maturities and capital expenditures. We estimate that UAL's liquidity is more than sufficient to cover upcoming obligations, while maintaining an adequate cash reserve. As of June 30, 2016, United maintained $6 billion in total liquidity including full availability under its $1.35 billion revolver. Liquidity as a percentage of LTM revenue was 16.3%. Debt maturities in the coming years are manageable at roughly $900 million in 2017 and $1.5 billion in 2018.
EETC Ratings:
Along with the upgrade of United's corporate rating, Fitch has also upgraded several subordinated tranches for United's existing EETCs. Subordinated tranches are rated by notching up from the underlying airline rating; therefore, Fitch has upgraded United's existing B and C tranches commensurate with the upgrade of the IDR. Senior tranche ratings are primarily based on levels of overcollateralization with a secondary dependence on the airline rating; therefore, the ratings for United's existing senior tranche ratings are unchanged. A full list of ratings affected is shown below.
KEY ASSUMPTIONS
Key assumptions in Fitch's rating case include:
--Capacity growth in the low single digits through the forecast period;
--Continued moderate economic growth in the U.S. over the near term, translating into stable demand for air travel;
--Jet fuel prices equating to roughly $55/barrel on average for 2017, increasing to approximately $65/barrel by the end of the forecast period;
--Mid- to high-single-digit RASM decline in 2016 followed by low growth thereafter.
RATING SENSITIVITIES
Future actions that may individually or collectively lead Fitch to take a positive rating action include:
--Adjusted debt/EBITDAR sustained around 3x;
--FFO fixed charge sustained above 3.5x;
--FCF as a percentage of revenue sustained in the mid-single digits;
--Continued improvements in United's operational performance;
--Evidence of improving unit revenues.
Future actions that may individually or collectively lead Fitch to take a negative rating action include:
--Adjusted debt/EBITDAR sustained above 4x;
--EBITDAR margins deteriorating into the low double-digit range;
--Persistently negative or negligible FCF.
EETC Rating Sensitivities:
Subordinated tranche ratings are based off of the underlying airline IDR. As such, Fitch would likely upgrade the B tranches to 'BBB+' if United's IDR were upgraded to 'BB+'. Conversely, if United were downgraded to 'BB-' the B tranches would likewise be downgraded to 'BBB-'. Alternately the subordinated tranches could be downgraded if Fitch's view of the strategic importance of the underlying aircraft were to change.
FULL LIST OF RATING ACTIONS
United Continental Holdings, Inc.
--IDR upgraded to 'BB' from 'BB-';
--Senior unsecured rating upgraded to 'BB/RR4' from 'BB-/RR4'.
United Airlines, Inc.
--IDR upgraded to 'BB' from 'BB-';
--Secured bank credit facility affirmed at 'BB+/RR1'.
United Airlines Pass Through Trust Series 2014-2
--Class B Certificates upgraded to 'BBB' from 'BBB-'.
United Airlines Pass Through Trust Series 2014-1
--Class B Certificates upgraded to 'BBB' from 'BBB-'.
United Airlines Pass Through Trust Series 2013-1
--Class B Certificates upgraded to 'BBB' from 'BBB-'.
Continental Airlines Pass Through Trust Series 2012-2
--Class B Certificates upgraded to 'BBB' from 'BBB-'.
Continental Airlines Pass Through Trust Series 2012-3
--Class C Certificates upgraded to 'BB+' from 'BB'.
Summary of Financial Statement Adjustments
Fitch sets aside a certain amount of cash and revolver availability as 'not readily available' to reflect a minimum amount of cash that may be necessary for the company to carry on day-to-day operations and is thus not immediately available for things like debt payments or capital expenditures. Fitch estimates this amount at roughly 10% of LTM revenue.
Additional information is available on www.fitchratings.com
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Rating Aircraft Enhanced Equipment Trust Certificates (pub. 29 Sep 2016)
https://www.fitchratings.com/site/re/887869
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013710
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013710
Endorsement Policy
https://www.fitchratings.com/regulatory
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