Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for Hawaiian Airlines, Inc. (HA, Hawaiian) and its parent company, Hawaiian Holdings, Inc., at 'BB-'. The Rating Outlook is Stable.
The rating affirmation is supported by credit metrics that remain appropriate for the 'BB-' rating despite weakening from a year ago. Hawaiian's operating margins deteriorated over the past year due to higher fuel prices, heavy competition, and modest increases in non-fuel costs. Nevertheless, total adjusted debt/EBITDAR at March 31, 2019 was 2.4x, which is healthy for the rating. Leverage decreased primarily due to new accounting disclosure around operating leases and Fitch's decision to use a 7x multiple on aircraft leases versus previously using an 8x multiple. These changes led to an approximate 0.5x decrease in Fitch's calculated adjusted debt/EBITDAR.
Fitch's primary concerns revolve around increasing competitive capacity to the Hawaiian islands, particularly from Southwest Airlines. We anticipate that increasing capacity to the islands will pressure yields into 2020 and will keep Hawaiian's margins well below levels generated between 2015 and 2018. The ratings also remain constrained by the company's geographic concentration and its reliance on demand for travel to Hawaii from a relatively small number of markets. The company's small size compared to its much larger U.S. peers also remains a limiting factor.
KEY RATING DRIVERS
Credit Metrics Soften but Still Supportive of Rating: Fitch's current forecast anticipates that leverage and profit metrics will decline modestly in 2019 primarily due to heavier competition. Leverage may rise above 3.5x from 2.5x at year-end 2018 before stabilizing or declining modestly in 2020 and 2021. Hawaiian maintains a leverage target of 1.5x-2.5x. Leverage may rise above that target in the near term, but Fitch expects the company to work back towards that target over the next several years. EBIT Margins are expected to be much more modest in the coming years marking a change from the prior few years when Hawaiian generated outsized margins compared to its peers. Margin softness is driven by expectations for lower yields driven by competitive capacity moving in to the market as well as potential near-term cost pressures.
Nevertheless, Fitch projects that Hawaiian's metrics will still compare well to similarly rated peers. American and United Airlines had adjusted debt to EBITDAR metrics of roughly 5x and 3x, respectively, and are both rated in the 'BB' category. Fitch would expect Hawaiian to maintain stronger credit metrics in order to achieve comparable ratings to its peers due to the company's geographic concentration and relatively small size.
Competition is a Watch Item: Additional capacity that Southwest brings to West Coast markets and to Hawaiian inter-island flying is likely to pressure yields into 2020. Hawaiian has weathered heavy competition in the past as when Alaska and United ramped up service to the islands, and Fitch expects the company to manage through this period of rising capacity without material degradation to its credit profile. Nonetheless, Southwest is a particularly tough competitor with a low cost structure and loyal customer base and its presence in the market will remain a watch item over the next 1-2 years.
ANA is also increasing service, flying A380s to Honolulu from Tokyo and Delta was recently granted a slot to fly Honolulu-Tokyo Haneda. Additional competition in Japan puts pressure on Hawaiian's most important international market, though the company's new JV with Japan Airlines will be a meaningful tool to combat that pressure.
Unit Cost Trends to Improve: Hawaiian's non-fuel unit costs have risen at above industry average rates over the past several years and are now a key area of focus for management. Cuts to overhead, process automation, improvements to distribution, and increased flying on efficient A321 NEOs are elements of the company's goal to hit $100 million in annual cost savings by 2021. Cost trends started to improve in 2018 but may be pressured in the near term depending on the timing of achieving a labor contract with Hawaiian's flight attendant union. Hawaiian's execution on cost control will be important as the company deals with competitive pressures.
Solid Near-term Demand: Fitch believes that risks to demand for travel to Hawaii have heightened due to macroeconomic concerns and trade uncertainties, but near-term demand levels remain solid for now. Per Hawaii's Department of Business, Economic Development & Tourism, visitor arrivals to the island were up 3.6% through April of this year, with particular strength in visitors from the U.S. West Coast, partially due to added service from Southwest. However, average length of stay and per visitor daily spending decreased over this time period, representing a cautious signal. Demand for travel to Hawaii has performed well since the last recession and should continue to grow (barring major economic disruptions), although Fitch's outlook has grown more cautious.
Minimal Expected FCF: Fitch expects FCF to be roughly neutral or modestly negative in 2019 driven by lower CFFO generation based on weaker margins. Capital spending will be lower than in 2018 but will remain material as the company plans to take delivery of 6 A321 NEOs in 2019. FCF may improve modestly in 2020 and 2021 as capex comes down. Hawaiian will take only one A321 NEO in 2020 with no other deliveries scheduled until its 787-9s start to arrive in 2021. Fitch expects debt levels to remain fairly flat over the forecast period as Hawaiian should generate sufficient CFFO to fund most aircraft deliveries with cash if it chooses, though it may pursue opportunistic financing options.
Hawaiian's credit metrics are generally in line with or better than airline peers rated in the 'BB' category. Fitch expects Hawaiian's adjusted leverage to rise to mid to high 3x range in 2019 and 2020, which compares with the high 4x to low 5x range at American (BB-) and around 3x at United (BB). Hawaiian's margin profile has been strong compared to peers dating back to 2015. Fitch expects margin's to come down in the near term due to higher competition but to remain in-line with competitors. Hawaiian's ratings remain constrained by its geographic concentration in the Hawaiian market. None of the other North American airlines in Fitch's rated universe exhibit such a high degree of reliance on a single leisure focused destination. Free cash flow generation is also a limiting factor. Fitch expects Hawaiian to generate limited FCF over our forecast period, while higher rated peers like Delta, Alaska, and Southwest typically generate sizeable FCF, creating meaningful financial flexibility.
Capacity growth at 3% in 2019 followed by high single digit growth in 2020 partially driven by Hawaiians' new Japanese routes and low to mid single digit growth thereafter;
Modestly declining yields in 2019 and 2020 reflecting heightened competition followed by low growth thereafter;
Jet fuel prices averaging $2.20/gallon in 2019 and rising modestly thereafter;
Ex-fuel CASM growth in 2019 around 3%, at the high end of management's guidance.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
Sustained adjusted debt/EBITDAR below 3.0x;
FFO Fixed charge coverage at or above 3x;
Expectations for sustained positive FCF generation;
EBITDAR margins sustained around or above 20%.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
Adjusted debt/EBITDAR rising and remaining at or above 4x;
FFO Fixed charge coverage falling below 2x;
A notable drop in tourism to Hawaii caused by a natural disaster or economic downturn;
EBITDAR margins falling and remaining below 15%.
LIQUIDITY AND DEBT STRUCTURE
Fitch considers Hawaiian's liquidity position to be supportive of the rating given the company's manageable maturity schedule and Fitch's projections for adequate generation of CFFO. Liquidity as of March 31, 2019 totaled $735.8 million consisting of $268.6 million of unrestricted cash and equivalents, $232.2 million in short-term investments and full availability under Hawaiian's $235 million secured revolver. Hawaiian renewed and extended its revolver in December 2018 increasing the size from $225 million to $235 million and extending the maturity to December 2022. Total liquidity equated to roughly 27% of LTM revenue. Upcoming maturities are manageable at $92.9 million in the last nine months of 2019 and $30 million in 2020. Projected capex is also modest over the next two years as scheduled aircraft deliveries will slow down in 2019 and 2020 before Hawaiian starts to receive its new 787-9s in 2021.
Hawaiian's debt structure primarily consists of secured, aircraft-backed debt. The company tapped the enhanced equipment trust certificate (EETC) market in 2013, using the proceeds to fund the purchase of six A330-200s that were delivered in 2013 and 2014. The EETC makes up just under half of the company's outstanding on balance sheet debt with the rest consisting of aircraft loan agreements secured by Boeing 717s, Japanese Yen denominated aircraft loans and capital leases on aircraft. Debt balances increased modestly over the past year as Hawaiian financed two new A321 NEOs with Yen denominated term loans. Roughly 15% of Hawaiian's revenue comes from Japan, most of which is Yen denominated, and the Yen term loans act as a natural hedge. The loans were also advantageous from a cost standpoint, as they feature fixed interest rates of just over 1%.
Off balance sheet debt primarily consists of aircraft rent. Fitch capitalizes aircraft rent at 7x; a change from our prior practice of using an 8x multiple. The change was made to more accurately capture the average useful life of the assets. In addition, new disclosure for operating leases allowed for a more granular approach to lease capitalization such that variable lease expenses for items like airport gates are not capitalized. These changes had a combined effect of reducing Fitch's calculated adjusted debt/EBITDAR metric by around 0.5x.
Hawaiian maintains a leverage target of 1.5x-2.5x, which they have committed to in public calls. Fitch views management's publicly stated commitment to this target to be a sign of conservative management and a credit positive.