CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded the ratings for American Airlines Group Inc. (AAG) and its primary operating subsidiary, American Airlines, Inc. to 'B+' upon the company's expected emergence from bankruptcy and merger with US Airways. Fitch has affirmed the existing ratings for US Airways Group, Inc. and US Airways Inc. at 'B+' following the completion of the merger with American Airlines, equalizing the ratings for all entities in the merged company. The Rating Outlook is Stable.
Fitch has also upgraded the ratings on American's senior secured credit facility and revolver to 'BB+/RR1' from 'BB-/RR1', US Airways' senior unsecured notes to 'B+/RR4' from 'B-/RR6', and US Airways' unsecured convertible notes to 'B-/RR6' from 'CCC/RR6'. A full ratings list is shown below.
Fitch will be reviewing the existing ratings for various enhanced equipment trust certificates (EETCs) issued by US and American. Those ratings will be updated within the next several business days.
The ratings are supported by the significant structural improvements achieved at American through the bankruptcy process which have resulted in improving operating results, the strong recent operating performance of US Airways, and expectations that credit metrics will improve quickly from current levels. The merger between US and American is also expected to produce a single carrier with a broad route structure that is expected to produce material revenue synergies and is much better suited to compete with its large domestic rivals, United and Delta. The projected liquidity position also supports the ratings.
In the near term Fitch remains cautious about the risks involved with executing a merger of this size and complexity. Current ratings are also limited by remaining uncertainties around long-term labor costs to be negotiated through joint collective bargaining agreements, management's priorities around cash deployment, and the unproven nature of the effectiveness of the newly combined route structure.
In addition to integration risks, Fitch notes that the airline industry remains highly cyclical and vulnerable to external shocks. The ratings incorporate Fitch's analysis of various stress scenarios including demand and fuel shocks, in which future results can decline quickly due to the high amount of operating leverage present in the business.
Fitch also notes that there are remaining uncertainties around certain aspects of American's management strategy going forward such as fuel hedging and leverage targets. The board of directors of the merged company also includes new members elected by various creditor groups, and their strategic priorities are yet to be clarified.
KEY RATINGS DRIVERS
Improving Operating Performance
Fitch expects operating performance for the combined carriers to continue to improve over the intermediate term based on a stable demand environment, synergies expected to be achieved through the merger, and cost reductions achieved in bankruptcy. For American, labor costs through the first nine months of 2013 were 16% lower than in the comparable period in 2012, and are now competitive with industry peers. In addition, the company refinanced a large amount of high yield debt, shed some debt outright, and renegotiated contracts with many of its vendors.
In total, American expects to achieve cost savings averaging $2 billion per year through the end of 2017 due to the bankruptcy process. Benefits of American's restructuring are already apparent, with the company posting better operating results thus far in 2013. Cost improvements paired with an improving demand environment allowed AMR to produce an EBITDA margin of 9.2% for the LTM period ended Sept. 30, 2013, compared to 6.1% for full year 2012.
US Airways is also performing well, generating consistent unit revenue growth and keeping costs in check to produce some of the better results seen in the industry in recent years. Through the first nine months of 2013, US Airways' consolidated PRASM was up by 1.8%, which lagged the industry average, though the pace of the company's unit revenue growth picked up in the second half of the year. Meanwhile, CASM ex-fuel increased by a moderate 0.9% leading to an EBITDA margin (calculated by Fitch) of 10.8% for the LTM period ended Sept. 30,2013, up from 8.3% in the same period a year ago.
Looking forward, Fitch expects the new American to add little capacity over the coming year aside from seats added through upgauging to larger narrow-body aircraft. Limited capacity additions combined with a growing demand environment should produce steady unit revenue growth over the near term.
Metrics Expected To Improve
Credit metrics for the combined company are expected to be roughly in line with its 'B' and 'B+' rated North American peers at the time the merger closes. Fitch's base forecast anticipates that metrics could improve quickly over the next 1-2 years, as synergies are realized and the company pays down debt. Fitch calculates AAG's combined adjusted debt/EBITDAR (adjusted for all operating leases) at 5.75x as of Sept. 30, 2013, and Fitch anticipates leverage at the end of 2013 could be 5.2x-5.4x. Leverage could decrease by as much as a full turn compared to Sept. 30, 2013 levels by the end of 2014, if the macroeconomic environment remains healthy, and if synergies are realized as expected.
Expectations for improved cash flow: Fitch forecasts that free cash flow (FCF) for the combined airlines could turn positive in 2014. FCF at American Airlines has been sharply negative over the past several years reflecting high fuel prices, a high cost structure, weak operating results, and bankruptcy related charges. Fitch expects pro-forma FCF for the combined companies to be negative by $1 billion or more for 2013.
Going forward, cost improvements and revenue synergies are expected to provide a boost to cash flow, with Fitch forecasting positive FCF in 2014 and 2015. However, the forecast is sensitive to fuel prices and stable demand for air travel. American has significant upcoming capital spending requirements for aircraft deliveries, which could pressure FCF if operating results come in weaker than expected.
Strengthened Network
Fitch believes that the benefits provided by the combined American/US route structure are supportive of the rating, and that the combined companies will ultimately be healthier than either US or AMR on a stand-alone basis. The merged company will be the largest airline in the world as measured by ASMs, which is important in an industry where scale has strategic value.
The domestic networks of these two carriers featured relatively little overlap prior to the merger, allowing the combined companies to provide significantly expanded connecting opportunities. In particular, American will benefit from US's ability to connect passengers up and down the East Coast. Stand-alone US Airways had relatively limited international capacity. Nevertheless, US Airways flies to several secondary European cities where American currently does not operate, strengthening the company's position in the Atlantic market.
AAG also stands to benefit from a strengthened oneworld Alliance, which will improve its share of global available seat miles relative to the other major alliances both through the addition of US Airways (which will join oneworld from the Star Alliance in March 2014) and from the March 2014 addition of TAM (also formerly of the Star Alliance).
While the combined network is expected to be significantly stronger than either the American or US Airways networks on a stand-alone basis, Fitch remains cautious about the carriers' ability to generate a revenue premium. Fitch notes that United Airlines has struggled to generate revenue growth in excess of its peers following the merger of United and Continental in 2010, despite its enviable route network. The ultimate success of the combined networks should become clearer as the companies move further through the integration process.
Restructured Fleet
The company's fleet renewal efforts are expected to provide cost benefits in the long run. American is scheduled to take delivery of 248 aircraft between 2014-2017, including 80 737s and 110 A320 family aircraft which will be used to replace American's fleet of aging MD-80s. New deliveries will require a heavy capital commitment in the coming years; however, the cost benefits of new generation aircraft compared to American's existing narrow body fleet are expected to be significant. New generation narrow bodies can burn as much as a third less fuel per ASM compared to American's MD-80s, which is an effective way of managing the airline's largest expense. The 737s and A320s will also feature more seats than the MD-80s, helping to lower operating expenses per available seat.
US Airways brings attractive aircraft to the combined fleet. The company has largely completed its fleet renewal effort in recent years, taking delivery of more than 75 aircraft since 2008, primarily consisting of narrowbody A321s used to replace/upgauge LCC's 737 classics and older A320s.
American's new scope agreement with its pilots, which allows the company to fly more large regional jets (RJs), is also expected to be beneficial from a revenue and unit cost standpoint in coming years. The previous pilot agreement set a limit of regional jets with more than 50 seats at 47 aircraft, whereas the new collective bargaining agreement sets the limit at 40% of the company's narrowbody fleet size in 2016. Larger, 70 and 90 seat RJs are much more efficient on a unit cost basis compared the smaller 50 seat RJs which are ill-suited to deal with jet fuel prices hovering around $3.00/gallon as they have in recent years. The addition of larger gauge regional jets will allow the company to match capacity with route demand and better compete with United and Delta which began adding larger regional jets as a key component of their fleet plans in recent years.
Strong Liquidity
The combined companies will enter 2014 with a sizeable liquidity balance, which is supportive of the ratings and provides protection to the downside. As of Sept. 30, 2013, US Airways and American Airlines had a combined cash balance of more than $10 billion. Upon emergence from bankruptcy American will also have access to a $1 billion committed revolving credit facility secured earlier this year. Fitch estimates total available liquidity including the company's undrawn revolver is equivalent to 28.4% of LTM revenue, the highest among North American carriers.
American is also expected to have an unencumbered asset base of more than $3 billion. However, the largest component of the balance will consist of international slots, gates, and routes. Fitch views these assets cautiously as collateral since valuations can vary widely. In contrast, Southwest Airlines has unencumbered aircraft valued at nearly $7 billion. AAG will likely build its unencumbered asset base over the next few years as its pays down existing debt, and takes delivery of new aircraft, some of which may be paid for with cash.
Fitch expects the emergence/merger process to be cash intensive; however, the company's current cash balance is expected to be more than sufficient to cover near-term needs. American forecasts immediate cash needs of roughly $1 billion, and an estimated $1.2 billion of merger related expenses to be spread over the next three years. The company also has a sizeable aircraft delivery schedule in the coming years, with total capital expenditures expected to exceed $3 billion in 2014 (a portion of which has been pre-funded through EETC issuances) and more than $4 billion in 2015.
Improved Balance Sheet
American's debt structure has improved through the bankruptcy process although the combined company will remain highly leveraged. Fitch expects AAG will continue to reduce debt balances over the next several years. The restructuring process eliminated $2.5 billion in unsecured and tax exempt debt, which the company estimates will lead to $1.3 billion in interest and principal savings through 2017. American also successfully refinanced more than 80 aircraft that were previously encumbered under high yield EETCs, secured notes and bank loans, with two favorably priced EETC issuances. US Airways also accessed the capital markets during the year, securing a $1.6 billion term loan and issuing $500 million in unsecured notes, creating a sizeable cash balance.
In addition, AMR renegotiated the financing of some 400 aircraft which it expects to reduce cash obligations by more than $1 billion through 2017. Reduced rental payment will serve to reduce off-balance sheet debt. Fitch estimates that the combined on-balance sheet debt for the two companies as of Sept. 30, 2013 totals roughly $16.5 billion.
Separately, American achieved relief from its pension obligations through the bankruptcy process. American's pilot B plan was terminated outright while all other plans were frozen. The pension changes reached in bankruptcy will help to reduce cash commitments going forward. US Airways has no meaningful pension obligations.
Reduced Risks From Labor
Through its bankruptcy process, American was able to reach new collective bargaining agreements with each of its major labor groups. The company's inability to come to terms with its labor unions was one of the primary reasons for its bankruptcy filing, so having new agreements in place represents a major milestone. A memorandum of understanding is also in place which determines the process for establishing a combined seniority list for the US/American pilot groups, something that has been a sticking point in previous airline mergers.
Fitch notes that joint collective bargaining agreements (JCBAs) between the US and American labor groups must still be negotiated once the two companies are farther along in the integration process. The JCBAs will ultimately determine the increases in labor costs that the company will have to shoulder in the coming years, leaving some risk that higher salaries could pressure margins over the intermediate term. Fitch expects more clarity around this subject as the various labor groups move through the bargaining process in the next 1-2 years.
Modestly Growing Operating Environment
Fitch expects modestly growing demand for air travel in North America in 2014, with traffic expected to rise in the low single digits driven by steady, albeit slow, macroeconomic growth. Fitch anticipates U.S. GDP to grow 2.6% in 2014, with GDP being highly correlated to demand for air travel. Stable demand trends combined with minimal capacity expansion should foster a healthy operating environment for the North American airlines. Domestic traffic was resilient in 2013 despite a lackluster macroeconomic environment and headwinds generated by reduced government spending. Domestic revenue passenger miles (RPMs) were up by 1.7% through October, having posted a year-over-year increase in all but one month in 2013, while international traffic was up 2.5%.
Recovery Ratings:
The notching for American's secured debt (see below) reflects Fitch's recovery expectations under a scenario in which distressed enterprise value is allocated to the various debt classes. Senior debt which is secured both by aircraft and non-aircraft collateral (including slots, gates, routes, ground equipment, etc.) is expected to receive substantial recovery (91%-100%, implying a rating of 'RR1') in a default scenario. Senior unsecured notes at US Airways are expected to exhibit average recovery prospects of between 31%-50%, equal to a Recovery Rating of RR4. Therefore the senior unsecured debt is rated equal to the airline IDR.
RATING SENSITIVITIES
Fitch could consider a positive rating action if merger related synergies outperform management's expectations, and if adjusted leverage declines notably from current levels. Fitch would also look for American to generate sustained unit revenue growth on par with or in excess of peers. Successful control over cost inflation particularly related to labor, will also be a key factor in a potential future upgrade. Fitch will also look for more clarity on certain management strategies, including cash deployment priorities, fuel hedging, and liquidity and leverage targets.
A negative rating action is not anticipated at this time. However, Fitch could consider revising the ratings downward if the company were to experience significant/sustained integration related difficulties. The ratings could also be pressured by an unexpected demand or fuel price shock that materially impacts operating results.
Fitch has taken the following rating actions:
American Airlines Group Inc.
--IDR upgraded to 'B+' from 'D'.
American Airlines, Inc.
--IDR upgraded to 'B+' from 'D'
--Senior
secured credit facility upgraded to 'BB+/RR1' from 'BB-/RR1'
--1st
lien senior secured notes rated 'BB+/RR1'
US Airways Group, Inc.
--IDR affirmed at 'B+',
--Senior
Unsecured Notes upgraded to 'B+/RR4' from 'B-/RR6'
--Senior
Unsecured Convertible Notes upgraded to 'B-/RR6' from 'CCC/RR6'
US Airways, Inc.
--IDR affirmed at 'B+'
--Senior secured
credit facility affirmed at 'BB+/RR1'
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Corporate Rating
Methodology' (Aug. 5, 2013);
--'Recovery Ratings and Notching
Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Recovery Ratings and
Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721836
Corporate
Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=811088
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