TEXT-S&P revises Delta Air Lines outlook to positive

Fri May 25, 2012 10:55am EDT

Overview	
     -- U.S.-based Delta Air Lines is generating free cash flow, and we 	
believe its credit measures will gradually improve as the company repays debt.	
     -- We are affirming our 'B' corporate credit rating and our other ratings 	
on Delta while revising the outlook to positive from stable. 	
     -- We could raise ratings if the improvement in financial measures occurs 	
more rapidly than we currently expect, resulting in funds flow to debt rising 	
into the mid-teens percent area.	
	
Rating Action	
On May 25, 2012, Standard & Poor's Ratings Services affirmed its ratings, 	
including the 'B' corporate credit rating (CCR), on Atlanta-based Delta Air 	
Lines Inc. We revised the outlook to positive from stable.	
	
Rationale	
We expect that the company will continue to generate satisfactory earnings and 	
cash flow and will use free cash flow to gradually reduce debt. The revision 	
of the rating outlook reflects the potential for an upgrade if credit measures 	
improve from earnings and cash flow gains occurring more rapidly than we 	
currently anticipate.	
	
Our CCR reflects a heavy, albeit declining, debt and lease burden, as well as 	
substantial pension underfunding and risks associated with the 	
price-competitive, cyclical, and capital-intensive airline industry. The 	
ratings also reflect the company's enhanced competitive position and synergies 	
from its 2008 merger with Northwest Airlines Corp. (parent of Northwest 	
Airlines Inc.). We expect 2012 adjusted EBITDA coverage in the 2.2x-2.6x range 	
and funds from operations (FFO) to debt of 11%-13%, with slightly better 	
results in 2013. Under our criteria, we categorize Delta's business risk 	
profile as "weak," its financial profile as "highly leveraged," and its 	
liquidity as "adequate."	
	
Delta's weak business risk profile is based in part on the high risks of the 	
U.S. airline industry. We also consider that Delta has one of the better 	
competitive positions among the U.S. airlines, and its operating profitability 	
is currently good, though subject to risks from volatile fuel prices and U.S. 	
and global economic conditions. Delta's merger with Northwest Airlines in 2008 	
combined two airlines whose route networks had minimal overlap and which 	
together created a more comprehensive system. Until the subsequent merger of 	
UAL Corp. (parent of United Air Lines Inc.) and Continental Airlines Inc., 	
Delta had the U.S. airline industry's best overall route network, and one of 	
the best among airlines globally. Delta is now the second-largest U.S. 	
airline, with dominant market shares at major hubs Atlanta, Detroit and 	
Minneapolis/St. Paul; secondary hubs at Cincinnati, Memphis, and Salt Lake 	
City; and solid positions in the New York area, the Pacific, and 	
trans-Atlantic. A comprehensive route network makes it easier to attract 	
passengers, particularly more lucrative business passengers.	
	
Standard & Poor's economists foresee continued sluggish U.S. economic growth, 	
with real GDP growth of 2.1% in 2012 and 2.4% in 2013. Despite the soft 	
economy, Delta and most other U.S. airlines continue to report robust 	
year-over-year revenue gains (13.6% higher consolidated passenger revenue per 	
available seat mile for the first quarter). The revenue outlook benefits from 	
the airline industry's readiness to pare back capacity--Delta recently said it 	
would cut more flights later in 2012, and low-cost giant Southwest Airlines 	
just deferred 30 upcoming jet deliveries--and strong corporate profits 	
supporting business travel, both of which help the balance of supply and 	
demand. Still, we believe that year-over-year revenue gains will slow later 	
this year. 	
	
Our base case forecast includes the following assumptions:	
     -- Consolidated passenger revenue per available seat mile will increase 	
by a mid-single-digit percentage in 2012, then slow to low-single-digit 	
percent gains in 2013;	
     -- Crude oil (West Texas Intermediate; WTI) will average $105 in 2012 and 	
$113 in 2013;	
     -- Operating costs, excluding fuel, per available seat mile will increase 	
by a mid-single-digit percentage and then level off next year; and	
     -- Capital spending will total about $1.6 billion this year.	
	
Delta's recently announced tentative contract with its pilots raises pay but 	
gives the airline flexibility to replace 50-seat regional jets (operated by 	
its owned regional airline Comair or by outside regional partner airlines) 	
with larger regional jets, which should reduce fuel consumption per available 	
seat mile. Our forecast includes capital expenditures relating to Delta's 	
planned acquisition of an oil refinery near Philadelphia and modest jet fuel 	
cost savings (well below Delta's forecast eventual annual savings) in 2013. We 	
also incorporate added aircraft lease commitments relating to Delta's recently 	
announced tentative agreement with Southwest Airlines Co. to assume leases on 	
88 B717s through 2016.	
	
Adjusted credit measures arising from our forecast include EBITDA interest 	
coverage of 2.2x-2.8x and FFO to debt of 12%-14% through 2013. Delta remains 	
highly leveraged; we expect that adjusted debt to EBITDA will decrease 	
gradually but remain more than 5x. Our ratio guidelines for a highly leveraged 	
financial profile include less than 12% FFO to debt and more than 5x debt to 	
EBITDA. Similar to other airlines, Delta is a large user of operating leases; 	
accordingly, its adjusted debt to EBITDAR (earnings before interest, taxes, 	
depreciation, amortization, and rent) is less elevated than debt to EBITDA, 	
but still high at about 5x. Although Delta and Northwest reduced their debt 	
burdens in their respective Chapter 11 bankruptcy reorganizations, the only 	
major pension plan terminated was Delta's pilots' plan. Accordingly, Delta's 	
retiree liabilities are significantly greater than those of United 	
Continental. Our analysis of the company's financial profile also considers 	
the potential volatility of results. The main risk to our forecast is the 	
potential for European sovereign debt problems triggering a more serious 	
global economic slowdown.	
	
Liquidity	
We believe liquidity is adequate. The company had $5.1 billion of unrestricted 	
cash and short-term investments and availability under its credit facilities 	
as of March 31, 2012, equal to 15% of trailing-12-month revenues. This places 	
it below average among the U.S. airlines, which average in the low- to mid-20% 	
area, but Delta is also generating free cash flow, which most others are not, 	
or not to the same extent.	
	
In accordance with Standard & Poor's methodology and assumptions, we believe 	
the relevant aspects of Delta's liquidity are:	
     -- Cash sources covering cash uses in excess of 1.2x (the minimum 	
threshold for an adequate designation) for the next year;	
     -- Our expectation that net sources will be positive in 2012 and 2013 	
even with a 15% decline in EBITDA, consistent with our criteria standard;	
     -- Our expectation that Delta will remain in compliance with its 	
financial covenants--including the minimum 1.2x fixed charge coverage and $2 	
billion liquidity (unrestricted cash and short-term investments and revolving 	
credit availability) that various secured loan agreements require--even if 	
EBITDA were to decline by 20% during the next year;	
     -- Our belief that Delta's ability to absorb high-impact, low-probability 	
events with limited refinancing is likely, given the company's free cash flow 	
generation and refinancing that has smoothed out future debt maturities; and	
     -- Its prudent financial risk management, including long-term balance 	
sheet goals and targeted debt reduction.	
	
We expect sources of funds to consist of:	
	
     -- Cash (in excess of minimum levels required by covenants), 	
     -- Funds from operations (as reported, not fully adjusted, based on our 	
expectations) of $2 billion-$2.5 billion in 2012, and	
     -- Undrawn credit facilities ($1.825 billion as of March 31, 2012).	
	
Major uses of funds include:	
	
     -- Debt maturities of $1.6 billion, and	
     -- Capital expenditures of about $1.6 in 2012.	
	
Delta's credit facilities have various covenants, the most restrictive of 	
which include the following:	
	
     -- Fixed-charge coverage (EBITDAR [adding back noncash charges plus 	
aircraft rents] to cash interest plus cash aircraft rents) for successive 	
trailing-12-month periods of 1.2x; and	
     -- Minimum unrestricted cash and short-term investments of $1 billion, 	
and minimum liquidity (including undrawn revolving credit facilities) of $2 	
billion.	
	
Covenants also include collateral coverage tests relating to specific assets 	
that secure individual debt facilities or issues.	
	
Recovery analysis	
Our rating on Delta's first-lien secured debt is 'BB-' (two notches higher 	
than the corporate credit rating), and the recovery rating is '1', indicating 	
our expectation that lenders would receive very high (90% to 100%) recovery of 	
principal in a payment default.	
	
Our ratings on Delta's second-lien term loan and second-lien notes are 'B+' 	
(one notch above the corporate credit rating), and the recovery ratings are 	
'2', indicating our expectation that lenders would receive significant (70% to 	
90%) recovery in a payment default.	
 	

Outlook	
The outlook is positive. We expect a gradual improvement in Delta's earnings 	
and credit measures. If these gains, combined with debt reduction, generate 	
adjusted funds flow to debt in the mid-teens percent area, we could raise our 	
ratings. This could occur if oil prices moderate and economic growth in the 	
U.S. and globally does not slow down significantly. Conversely, if higher fuel 	
prices or weaker revenues (which could result from the European sovereign debt 	
crisis accelerating the global economic slowdown) cause funds flow to debt to 	
remain about 10%, we could revise the outlook to stable.	
	
Related Criteria And Research	
     -- Methodology And Assumptions: Liquidity Descriptors for Global 	
Corporate Issuers, Sept. 28, 2011	
     -- Key Credit Factors: Criteria For Rating The Airline Industry, Oct. 22, 	
2010	
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 	
May 27, 2009	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
     -- Criteria for Rating Aircraft-Backed Debt and Enhanced Equipment Trust 	
Certificates, Sept. 12, 2002	
	
Ratings List	
Ratings Affirmed; Outlook Revised	
                                        To                 From	
	
Delta Air Lines Inc.	
 Corporate credit rating                B/Positive/--      B/Stable/-- 	
 Senior secured                         BB-	
  Recovery rating                       1	
 Senior secured (second-lien)           B+	
  Recovery rating                       2	
 Senior unsecured airport rev bonds     CCC+	
 Equipment trust certificates	
  Delta 2002-1G1                        BB+ (sf)	
  Delta 2002-1G2                        BB+ (sf)          	
  Delta 2007-1A                         BBB+ (sf)          	
  Delta 2007-1B                         BB (sf)            	
  Delta 2007-1C                         B (sf)            	
  Delta 2009-1A                         A- (sf)            	
  Delta 2009-1B                         BBB- (sf)          	
  Delta 2010-1A                         A- (sf)            	
  Delta 2010-1B                         BB+ (sf)	
  Delta 2010-2A                         A- (sf)	
  Delta 2010-2B                         BB (sf)	
  Delta 2011-1A                         A- (sf)	
  Delta 2011-1B                         BB (sf)	
	
Northwest Airlines Inc.	
 Equipment trust certificates	
  Northwest 1999-2A                     A- (sf)           	
  Northwest 2000-1G                     BB (sf)	
  Northwest 2001-1A1                    A- (sf)          	
  Northwest 2001-1B                     BB+ (sf)	
  Northwest 2001-2A                     A (sf)             	
  Northwest 2002-1G1                    A- (sf)            	
  Northwest 2002-1G2                    BBB- (sf)          	
  Northwest 2002-1C1                    BB (sf)            	
  Northwest 2007-1A                     BBB (sf)	
  Northwest 2007-1B                     BB (sf)