TEXT-Fitch affirms Southwest Airlines at 'BBB'
Sept 25 - Fitch Ratings has affirmed the Issuer Default Rating (IDR) of Southwest Airlines Co. (NYSE: LUV) at 'BBB'. The Rating Outlook is Stable. The ratings apply to approximately $2 billion in outstanding debt. A full list of all ratings is provided at the end of this release. LUV's credit is supported by its competitive strength across its extensive domestic markets, and relatively low cost structure, which has enabled the airline to be consistently profitable even through downturns. In addition, LUV has regularly maintained a strong liquidity profile with a sizeable unencumbered asset pool (~$6.2 billion as of year-end 2011), as most of legacy LUV fleet remains unencumbered. The company is currently in the middle of integrating the operations of AirTran Holdings Inc. (AirTran) which it acquired last year (May 2, 2011) but received the single operating certificate from the FAA in March 2012. Despite a strong second quarter, LUV's operating results have weakened over the last year due to higher costs stemming from the acquisition, fleet enhancements and rising fuel. When combined with higher capital expenditures, increased dividend and a softening macro environment, Fitch expects free cash flow (FCF) to come under pressure this year, especially if PRASM growth lags in a recessionary scenario or jet fuel prices escalate. In addition, management has also increased the share repurchase program by $500 million to $1 billion, with $550 million as of Sept. 6, 2012. Fitch expects LUV to complete the buy-back program through 2013. LUV's incremental shareholder initiatives are a growing concern during a period of muted profitability and cash flow. That said, LUV's liquidity remains strong with $3.7 billion of cash and short-term investments, as of Sept. 4, 2012, as well as $800 million available under its unsecured revolver. Also, FCF generation for this year, while expected to be weak, is sufficient to cover both buybacks and scheduled maturities which are relatively light over the next couple of years. Fitch expects LUV to generate strong FCF starting next year reflecting higher synergies, improved profitability and lower capital expenditure due to the aircraft deferral. Importantly, LUV has repaid $964 million of debt since the AirTran acquisition closed. LUV maintains a strong balance sheet, with total debt of $3.3 billion relative to $3.3 billion of cash and short-term investments as of June 30, 2012. Leverage measured on a debt-to-EBITDA basis is relatively low at 1.9x but once adjusted for operating leases, LUV's leverage is higher in the 3.9x range and comparable to some of its legacy peers, as per Fitch estimates. The integration of the AirTrain acquisition appears to be on track. The company has made significant progress on many fronts -- received the single-operating certificate in March, have ratified agreements with regards to seniority integration for pilots, flight attendants and several other groups, and initiated the fleet transition (including subleasing the 717s to Delta). However, management has adopted a slower pace with regards to the integration of the passenger reservation system. LUV is expected to implement its new international reservation system, Amadeus, in 2014, with full replacement beyond 2014. In the meanwhile, the company is working on being able to connect networks and itineraries by the first quarter of 2013 to assist in driving the expected synergies from the merger. LUV has realized $80 million of pre-tax synergies in first half 2012, with pre-tax $400 million expected in 2013, according to management. LUV's monthly PRASM growth has been tracking in-line with the industry, but is expected to moderate in the second half of the year (3Q'12 PRASM guidance of 2%) reflecting tougher year-over-year comps and potentially weaker demand. Load factors remain strong, but LUV is starting to experience some softness in yields, but overall remains cautiously optimistic on demand. Notably, after growing aggressively for over 40 years, LUV currently has no plans to expand (other than AirTran markets and international service) and is keeping capacity flat for 2012.Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers