Delta Air Lines thinks this is the year that it will finally receive its long-sought investment grade rating.
“We think an investment grade rating will occur in 2016,” says Richard Anderson, chairman and chief executive of the Atlanta-based carrier, with confidence during an earnings call on 19 January.
He points to the further reduction in adjusted net debt to $6.7 billion at the end of 2015 from $7.3 billion a year earlier in his comments.
Delta has more than halved its debt levels since the end of 2010, when adjusted net debt stood at $15 billion.
The airline’s adjusted net debt to EBITDAR leverage ratio was 1.9x at the end of December, Flightglobal’s analysis shows.
Delta plans further reductions in adjusted net debt to $4 billion by 2020, says Anderson.
But an investment grade rating is more than just reducing debt and leverage.
“It’s a lot easier to post the metrics,” said Jim Barr, a senior research analyst at investment management firm Loomis, Sayles & Company, at the ISTAT Americas conference in March 2015. “It’s one thing to get a one notch upgrade within a single B or a double B category, it’s a more difficult to cross over to investment grade. You have to go above and beyond.”
Delta leads the three US mainline carriers in ratings. It is rated one notch below investment grade at BB+ by both Fitch Ratings and Standard & Poor’s (S&P) and two notches below at Ba2 by Moody’s Investors Service.
This compares to American Airlines and United Airlines, both of which are rated three notches below investment grade by all three ratings agencies.
Only Alaska Airlines and Southwest Airlines have investment grade ratings in the USA.
Fitch, Moody’s and S&P upgraded Delta to its current ratings during 2015. Each cited its improving balance sheet and credit metrics in their comments on the moves.
“Delta’s financial policy has been very conservative, which is probably the most creditor friendly of the big three US carriers,” says Philip Baggaley, an analyst at S&P, in an interview. “Their credit measures could improve somewhat further even though their approaching the debt levels they feel appropriate.”
S&P’s BB+ rating of Delta includes some “cushion” for changes in its credit metrics – either positive or negative – he says. This, coupled with the rating agency’s stable outlook for the airline, suggests it has no plans to review the rating in the near term.
“There’s not much downside risk given how they’ve performed,” says Baggaley. He declines to comment on whether S&P will consider an upgrade for Delta this year, citing instead the stable outlook.
“There is more potential upside than downside risk,” he says.
Fitch and Moody’s both have positive outlooks for Delta, indicating that they may review their respective ratings of the airline within the year.
An investment grade rating from Fitch appears most likely in 2016. The rating agency said when it upgraded Delta in September 2015 that a further upgrade could occur if the airline maintains an adjusted net debt to EBITDAR ratio below about 2x – it calculated a 2.2x ratio at the end of June 2015 – and if it is comfortable that the airline can sustain its financial performance through economic downturns.
Delta has met the first criteria with the 1.9x adjusted net debt to EBITDAR ratio, based on Flightglobal’s analysis. It is likely to maintain this level as debt is only expected to decline further and operating profits are buoyed by the benefits of low fuel prices.
Fitch is not alone in wanting proof that newly financially prudent airlines can weather a cyclical downturn.
“Conventional wisdom says that we need to wait for one complete cycle, see how we all do in an economic downturn,” said Gerry Laderman, then senior vice-president of finance and treasurer at United Airlines, at ISTAT in March. “If we are successful through the downturn, then I think the rating agencies have to reward us for that.”
The consensus is that 2015 may be the peak of the current cycle for airlines. Lower fuel prices are allowing competition to ratchet up in the domestic US market placing pressure on passenger unit revenues and economic uncertainty abroad, including in Latin America and Asia, is pressuring revenues in those markets.
Ed Bastian, president of Delta, forecasts financial pressure in all of its markets through 2016. These include the strong US dollar, though this is expected to subside after the first quarter, lower fuel surcharges and competitive capacity increases. The carrier will focus growth on upgauging its domestic fleet and in markets where it has invested, for example Los Angeles and New York in the USA and Mexico with equity partner Aeromexico internationally.
“While lower fuel prices have resulted in PRASM [passenger revenue per available seat mile] declines for longer than we initially expected, we are getting significantly larger costs savings from fuel that are driving large margin and cash flow improvements,” he says.
All of this is to say it is anyone’s guess whether Delta will receive an investment grade rating in 2016.
Fitch was not immediately available to comment on its positive outlook and Moody’s declines to comment, though a two-notch upgrade from the latter is less likely than a one-notch move by the former.
Delta is the bellwether for airline industry and, when it does achieve investment grade – whether in 2016 or later – will provide a route map to financial prudence for other carriers to follow.
Source: Cirium Dashboard
