Fitch Ratings has affirmed Etihad Airways PJSC's Long-Term Issuer Default Rating (IDR) at 'A' with a Stable Outlook and senior unsecured rating at 'A'. The agency has also affirmed the senior unsecured ratings at 'A' for Etihad's EMTN programme and for Unity 1 Sukuk Limited's USD3 billion trust certificate issuance programme and trust certificates issued under the programme.

Etihad's 'A' rating continues to be three notches below that of its indirect sole shareholder - the Emirate of Abu Dhabi (AA/Stable) - under Fitch's Government-Related Entities (GRE) Rating criteria.

KEY RATING DRIVERS

'A' Rating Based on Shareholder Links: We continue to rate Etihad three notches below its ultimate sole shareholder, Abu Dhabi. Under the GRE criteria we assess three factors as strong - status, ownership and control; support track record and expectations as well as the socio-political implications of a hypothetical GRE default - while we view the financial implications of a potential GRE default factor as moderate. This assessment resulted in a score of 25 leading to a "top-down minus three" rating approach.

Support Track Record: The strong assessment of the support track record and expectations factor is driven by consistent, timely and large-scale tangible support provided by Abu Dhabi to Etihad in the form of direct equity injections, a shareholder loan and assets transfer. The government is committed to supporting the implementation of Etihad's revised business plan.

The successful implementation of the business plan, evidenced by an improved financial profile may lead to a stronger assessment of the support track record factor since the assessment of this factor under our criteria links the importance of state support to maintaining an adequate financial profile. Etihad has not historically paid and does not intend to pay any dividends.

Ownership: Our assessment of the status, ownership and control factor as strong is underpinned by the fact that Etihad is ultimately 100% owned by Abu Dhabi. Etihad was created by Amiri's (Royal) Decree in 2003 and according to Etihad's Articles of Association, the company shall be directly or indirectly owned by the Emirate of Abu Dhabi. This can only be changed by the Executive Council of the Emirate (eg its executive authority or government). Etihad's board is appointed by the chairman of the Executive Council of Abu Dhabi. The board determines the company's senior executive management.

Implications of a Hypothetical Default: We assess the socio-political implications of Etihad's hypothetical default as strong, due to the company's vital importance for the implementation of the Emirate's 2030 Vision, which aims at development of the economy's non-oil sectors, including tourism, as well as for the development of the transportation hub at Abu Dhabi international airport. Etihad Aviation Group is also a large employer with 21,855 employees, which is around half of the oil and gas sector employment in the Emirate. Almost half of the newly announced top management team are UAE nationals. Etihad is viewed as Abu Dhabi's brand.

We believe that Etihad's hypothetical default is likely to have a moderate impact on the availability and cost of finance of Abu Dhabi and other GREs in the Emirate.

Network and Fleet Optimisation: As part of the transformation plan, Etihad is focusing on the establishment of a financially sustainable, medium-sized airline while remaining Abu Dhabi's economic and brand enabler. The optimisation of the fleet and network is the key aspect of the plan, which the company has managed to implement through the successful renegotiation of aircraft deliveries with the main aircraft original equipment manufacturers and more active network management by cancelling loss-making routes and rebalancing towards more profitable point-to-point traffic. Etihad reduced capacity in 2018 by 4% and plans to cut it by almost 7% in 2019 with moderate growth in line with Abu Dhabi's GDP growth afterwards. As a result, we expect the company to be better positioned amid strong competition in the region and globally and achieve a more sustainable financial profile in the medium term.

Customer Proposition; Cost Efficiencies: We expect Etihad's revised comprehensive strategy, envisaging both revenue and cost management, will underpin gradual improvement in its profitability. The choice model, which offers customers an opportunity to choose the services through unbundled air fares and offerings, along with the focus on point-to-point traffic should support the company's yields. At the same time, its focus on cost management through right sizing of the company, productivity improvement and efficiencies, supplier contract renegotiation and technology enhancement will strengthen its competitive cost position among the Middle Eastern network carriers and increase its competitiveness compared with low cost carriers.

2018 Performance: Etihad somewhat outperformed our expectations in 2018, largely driven by better than expected yield dynamics. This demonstrates the company's ability to implement its transformation plan despite the high execution risk embedded in such large-scale transformation. The company's capacity measured by available seat kilometres (ASK) was slightly lower than expected. Its gross adjusted debt was largely in line with our forecasts but its funds from operations and EBITDA losses improved better than we anticipated.

Weak Financials: Etihad's business plan continues to focus on achievement of financial sustainability and cash flow positive operations. The shareholder committed to supporting the phased recapitalisation of the company. We forecast Etihad will gradually improve its credit metrics over 2019-2023 by slowly reducing its losses and achieving positive EBITDA by 2022. However, we assess the trend in its performance rather than actual figures to see whether it remains on track with restructuring implementation. We are more cautious on yield improvement and cost reduction than the company. We expect the company to remain free cash flow negative due to loss making operations and high capex.

DERIVATION SUMMARY

Despite the planned growth moderation, Etihad will maintain sizeable operations and network and will remain the smallest among the three Middle Eastern carriers. It has a cost advantage compared with European airlines, including British Airways Plc (BA; BBB-/Stable), Lufthansa and Air France-KLM but its unit costs are largely comparable with those of Emirates. However, its unit revenue is lower than that of Emirates, BA and Lufthansa. Etihad's financials are weak compared with Emirates and European peers. We rate it based on a top-down approach, three notches below that of Abu Dhabi, its indirect sole shareholder. The company's standalone credit profile is well below its 'A' state-supported rating.

KEY ASSUMPTIONS

• shareholder support in line with the company's expectations;

• capex in line with the company's plans;

• ASK growth at 1% CAGR over 2018-2023;

• oil price of USD65/bbl for 2019, USD62.5/bbl for 2020 and USD60/bbl for 2021 and USD57.5/bbl thereafter;

• no dividend payments over 2019-2023;

• flat yields over 2019-2023.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating Action

• Financial guarantees by the sole indirect shareholder for a large portion of the company's debt or cross default provisions would be positive for the ratings, but are not considered likely by Fitch.

• Stronger assessment of support track record and expectations factor under the GRE criteria provided that the support leads to an adequate financial profile, other things being equal, may lead to higher score and potentially a higher rating.

Developments That May, Individually or Collectively, Lead to Negative Rating Action

• Weakening of the creditworthiness of the sole indirect shareholder Abu Dhabi could be negative for Etihad's ratings, unless we view the links with the parent as stronger.

• Evidence of weaker ties with Abu Dhabi.

• Evidence of unremedied liquidity challenges, such as the inability to cover the upcoming 12 months' financial obligations from cash and committed facilities.

LIQUIDITY AND DEBT STRUCTURE

Tight Liquidity: Etihad's liquidity position is tight but manageable on the back of shareholder support. Its unrestricted cash position was USD536 million at end-2018, which along with committed credit facilities of USD600 million was not sufficient to cover short-term debt of USD1.8 billion at end-2018. The company's liquidity and risk management framework determines the level for the liquidity reserve ratio, which is currently above the target set by the company.

FX Exposure: Most of Etihad's debt is denominated in US dollars or dollar-pegged currencies. The company uses both FX and interest-rate hedging. The FX risk management policy at Etihad focuses on the forecast net cash-flow position in each currency over time.

Senior Unsecured Rating: The senior unsecured rating is aligned with the company's Long-Term IDR as the ratio of unencumbered assets to unsecured debt is around 2x (at 1.8x in 2018). Unencumbered assets were USD4.8 billion in 2018, which provides an additional source of liquidity.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

Etihad's 'A' rating is three notches below that of its indirect sole shareholder - the Emirate of Abu Dhabi (AA/Stable) under Fitch's GRE criteria.