Fitch Ratings-Chicago-29 April 2019: Fitch Ratings has affirmed Delta Air Lines' (DAL) Long-Term Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook is Stable. Fitch has also affirmed its ratings on Delta's 2019-1 and 2007-1 series of enhanced equipment trust certificates (EETCs). A full list of rating actions follows at the end of this release.
Delta's ratings reflect the company's market position as one of the leading network carriers in the U.S., its manageable debt balances, strong FCF generation and solid operating margins. Delta's credit metrics are supportive of the rating and have remained fairly steady over the past year. Importantly, Fitch believes that Delta will be able to maintain credit metrics supportive of an investment-grade rating even in a moderate-to-harsh economic downturn. Over the intermediate-term, Fitch believes that Delta's ratings could move higher as leverage trends below 2x and as pension obligations continue to decline. The current ratings also reflect Delta's substantial annual cash needs for capital expenditures, dividends and debt maturities. Concerns also include the typical operating leverage of an airline, which leads to noticeable financial sensitivity to economic conditions and input prices.
KEY RATING DRIVERS
Balance Sheet Supports the Ratings: Delta's focus on maintaining a healthy balance sheet is supportive of its rating. Fitch anticipates that adjusted debt/EBITDAR will remain around 2x throughout the forecast period. Fitch calculates Delta's leverage at 2.1, which compares well with other investment-grade peers, being roughly in-line with Ryanair (BBB+) and a half turn lower than British Airways (BBB-). Delta's healthy leverage metrics are partially offset by its remaining pension obligations, which were underfunded by $6.4 billion at year-end 2018. Delta's adjusted leverage metrics remained steady over the past year in part due to Fitch's decision to capitalize aircraft rent using a 7x multiple, a change from the agency's previous approach of capitalizing at 8x. New accounting disclosure around operating leases has also allowed Fitch to refrain from capitalizing items like airport rents.
The change in leverage calculation partially offset higher on balance sheet debt and lower profit margins. Balance sheet debt at March 31, 2019 increased by $1.9 from year-end 2017 as Delta issued debt to fund the construction of its terminals at New York's LaGuardia Airport, and due to a short-term $1 billion unsecured loan issued in the first quarter of 2019, the proceeds of which were used to buy back shares. The loan was a tool that allowed Delta to accelerate repurchases in what is a seasonally weak cash period. Delta plans to repay the loan by year-end. Despite the increase in debt, Fitch views Delta's near-term projected leverage metrics to be solidly supportive of the rating.
Improving Unit Cost Trends: Delta's modest pace of non-fuel unit cost growth remains a credit positive in the near term. The 'One Delta' initiative aimed at cross-functional efficiencies, along with re-fleeting efforts are yielding results and leading to more modest unit cost growth than had been seen prior to 2018. Non-fuel cost per available seat mile (CASM-ex) was flat or down in each of the last three quarters, and Delta is aiming for non-fuel CASM growth of approximately 1%, which Fitch views as achievable given recent trends. Delta expects to take delivery of 87 new aircraft in 2019, which will bring significant fuel efficiency and upgauging benefits over the older narrowbodies that are to be retired.
Cautious Optimism for Travel Demand: Demand for travel is holding up despite uncertainties around the global economic outlook. Trade risks, the Chinese economy, slower growth in emerging markets and Brexit are all reasons for caution. Nevertheless, U.S. carriers are reporting solid first-quarter results, with particularly strong results among business travellers. Barring an unexpected downturn in the near term, Fitch expects modest economic growth to push airline unit revenues marginally higher in 2019, continuing a positive trend that began in 2017. Delta reported a 2.4% increase in total revenue per available seat mile (RASM) in the first quarter and projects 1.5%-3.5% growth in the second quarter.
Increasingly Profitable Credit Card Business: Delta's renewed contract with American Express is expected to contribute incremental margin benefit to already solid levels of profitability. Co-branded credit cards and loyalty programs have become increasingly important contributors to airline profitability. Fitch expects sales of miles to be less volatile than ticket sales in future downturns, acting as a meaningful offset to typical airline cyclicality. Delta announced a renewed and extended relationship with American Express in April, and announced that expected contribution from the contract would increase to nearly $7 billion annually by 2023 from $3.4 billion in 2018.
FCF and Financial Flexibility: Despite a large number of upcoming aircraft deliveries and expectations that Delta will become a cash tax payer in 2020, Fitch expects Delta to continue generating positive FCF. Fitch's forecast incorporates FCF margins in the low single digit range over the next three years, which is down from relatively high levels produced between 2014-2016, but remains quite healthy compared with historical standards for the industry. Consistent cash flows at these levels are important in that Delta should be able to fund its upcoming cash requirements, including aircraft deliveries, without needing to tap the capital markets, though it may do so strategically from time-to-time.
Heavy Capital Spending: Capital spending will remain high this year at around $4.7 billion, down from $5.2 billion last year as the company goes through a major re-fleeting period. Delta expects to take delivery of 87 aircraft in 2019. Capex will remain elevated for the next several years as the company replaces some 35% of its mainline fleet by 2023. Although projected capital spending is high, Fitch believes that the company retains a good deal of financial flexibility that can be exercised in a downturn, including order deferrals, parking older aircraft and financing unencumbered assets, which Delta currently values at around $17 billion.
2019-1: The Class AA certificates were affirmed at 'A+' and the class A certificates were affirmed at 'A-'. Fitch initially rated the 2019-1 transaction in March 2019. Since that time there have been no changes to Fitch's estimates of collateral coverage or other qualitative factors that impact the ratings. LTV ratios in Fitch's stress 'A' level stress case begin at roughly 76% but increase modestly through the life of the transaction to a peak of 94.9% just prior to maturity. EETC transactions are typically structured with principal amortization payments that outpace expected depreciation leading to modestly declining LTVs over time. Fitch assumes that tier 1 aircraft depreciate at 5% per year. Stressed LTVs for the class 'AA' certificates exceed 100% in Fitch's 'AA' stress test through the life of the transaction, thus making the certificates ineligible for ratings in the 'AA' category.
The 'A-' rating on the class A certificates represents a three-notch uplift from Delta's corporate rating consisting of one notch of uplift for a high affirmation factor (maximum is one notch for an investment-grade issuer), a one-notch uplift for the benefit of a liquidity facility, and one notch for superior recovery prospects. Fitch's recovery analysis assumes aircraft value stresses equivalent to a typical cyclical downturn, as represented by Fitch's 'BB' level stress test. Recovery analysis for the Delta 2019-1 class A certificates indicate full recovery through the life of the transaction.
Fitch considers the affirmation factor for this pool of aircraft to be high primarily due to the number of older planes in Delta's fleet that are more likely to be rejected in a distress scenario than the aircraft in this pool.
2007-1: The 'BBB+' rating reflects a two-notch uplift from Delta's IDR of 'BBB-'. The two-notch uplift is based on a moderate-to-high affirmation factor (+1 notch) and the presence of a liquidity facility (+1 notch). Fitch calculates the current LTV ratio for the class A certificates at 65%. LTVs would be expected to increase sharply in a downturn due to the age and desirability of the underlying aircraft.
The affirmation factor is supported by the relatively high proportion of Delta's widebody fleet represented by this pool of aircraft. However, Fitch views the affirmation factor for this pool of aircraft as declining, particularly as Delta begins to receive more and more Airbus A350s and A330-900s, which will replace its 777s and 767s over time. Nonetheless, A moderate-to-high affirmation factor is supported by the proportion of Delta's wide body fleet (18% by fleet count or about 16% by number of seats on widebody aircraft) represented by this pool of aircraft. Affirmation is also limited by cross-default provisions in this transaction, which are only effective upon final maturity, whereas most recent transactions include an immediate cross-default provision.
Fitch is utilizing its bottom-up ratings approach for this transaction as opposed to the top-down approach that is generally used for EETC senior tranches. This approach follows Fitch's EETC criteria that call for the bottom up approach if a transaction fails to pass at least a 'BBB' level stress test. The Delta 2007-1 class A certificates fail to pass Fitch's 'BBB' stress test largely due to declining appraised values for the 777-200ERs in the portfolio.
'BBB-' rating is three notches below Southwest Airlines (A-) and is above its network competitors United Airlines (BB) and American Airlines (BB-). The ratings differential between Delta and Southwest reflects Southwest's longer track record of sustained profitability and FCF generation, lower cost structure and lack of pension obligations. The two notch differential between Delta and United is driven by Delta's more conservative financial policies, better leverage metrics and operating margins, and its successful operational track record since its merger with Northwest Airlines. Delta is also rated in-line with Alaska Air (BBB-). Compared with Delta, Alaska suffers from a degree of geographic concentration, with its primary focus being on the West Coast of the United States. Alaska's leverage metrics are also weaker following its debt funded acquisition of Virgin America. These weaknesses are offset by Alaska's lower cost structure and FCF generation. Alaska's ratings are also supported Fitch's view that leverage will decline over the intermediate term as it de-levers following the Virgin America acquisition.
DAL 2019-1: The 'A+' rating on the class AA certificates is one notch below the British Airways 2018-1 class AA certificates. The two transactions feature similar initial LTVs, high quality collateral pools and underlying issuers rated at 'BBB-'. The primary rating differential is due to the non-amortizing nature of the proposed Delta 2019-1 transaction that causes LTV ratios to rise over time, and to fail Fitch's 'AA' level stress test. The 'A-' rating on the class A certificates is derived through Fitch's bottom-up approach and represents a three-notch uplift from Delta's 'BBB-' IDR. The three-notch uplift is consistent with subordinated tranches in the British Airways 2013-1 and 2018-1 transactions that feature similar affirmation factors and recovery prospects.
DAL 2007-1: The 'BBB+' rating on the senior tranche is one or two notches below many class A certificates that Fitch rates, with the differential being driven by the age and the relative quality of the underlying collateral. Asset values have fallen in recent years for 777-200ERs and 767s causing loan-to-value ratios to increase.
-Low single digit annual capacity growth through the forecast period;
-Continued moderate economic growth in the U.S. over the near-term, translating into steady growth in the demand for air travel;
-Jet Fuel prices equating to roughly $70-$75/barrel Brent crude equivalent on average through the forecast period;
-RASM growth approaching 3% in 2019 followed by modest continued growth thereafter.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
-FCF margins remaining in the mid-to-high single digits as a percentage of revenue;
-EBIT margins remaining in the mid-to-high teens or higher;
-Sustained commitment to conservative financial policies;
-Adjusted debt/EBITDAR sustained around or below 2x (2.1x as of 3/31/2019).
Developments That May, Individually or Collectively, Lead to Negative Rating Action
-An exogenous shock that causes demand for air travel to drop significantly or a fuel shock that is not adequately offset by rising fares;
-Change in management strategy that favors shareholder returns at the expense of a healthy balance sheet;
-Sustained adjusted debt/EBITDAR above 2.5x;
-FCF margins declining to below 1-2% on a sustained basis or FFO fixed-charge coverage falling below 4x on a sustained basis.
Sufficient Liquidity: Delta ended the first quarter of 2019 with $1.9 billion in cash and equivalents and $3 billion in undrawn revolver availability. Total liquidity was equal to 10.6% of LTM revenue. While some airline peers have a higher cash balance on a cash/revenue basis, Fitch considers DAL's current liquidity balance to be more than adequate to fund near-term requirements, particularly since the company is consistently generating solid cash flow. Delta also bolstered its liquidity by entering into a new $2.65 billion unsecured revolver in 2018. The unsecured revolver replaces Delta's secured revolvers that were included in its former bank facilities. The revolvers include a minimum fixed-charge coverage ratio covenant of 1.25 to 1.00, which is consistent with the prior bank facilities. The facilities also include a minimum asset coverage ratio of 1.25 to 1.00.
Fitch's base case forecasts that DAL will generate cumulative cash flow from operations of more than $27.0 billion between 2019-2021, greatly exceeding anticipated capex. Maturities are manageable but material over the next several years. The company has roughly $1.4 billion, and $2.0 billion in principal maturing 2019 and 2020, respectively, excluding the short-term loan that was issued in the first quarter, with sufficient cash on hand and cash flows to cover those obligations.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Delta Air Lines, Inc.
--Long-term IDR at 'BBB-';
--Senior unsecured notes 'BBB-'.
Industrial Development Corporation (IDC) of the Port of Seattle special facilities revenue refunding bonds series 2012 (Delta Air Lines, Inc. Project):
--$66 million due April 1, 2030 at 'BBB-'.
NYTDC Industrial Revenue Bonds:
--Various maturities 'BBB-'.
Delta Air Lines Pass Through Trust Certificates 2019-1:
--Class AA certificates at 'A+';
--Class A certificates at 'A-'.
Delta Air Lines Pass Through Trust Certificates 2007-1:
--Class A certificates at 'BBB+'.
Delta Air Lines, Inc.
Assigned rating of 'BBB-' to Delta's unsecured revolving credit facilities due 2021 and 2023.