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