Fitch Ratings-Chicago-08 March 2019: Fitch Ratings has affirmed JetBlue's (JBLU) Issuer Default Rating (IDR) at 'BB'. The Rating Outlook is Positive. The rating reflects JetBlue's strong credit metrics, consistent profitability, the expected reduction in unit cost growth rates and its solid financial flexibility. The rating is also supported by JBLU's meaningful debt reduction over the past few years and its continued commitment to a healthy balance sheet. Fitch has also upgraded JetBlue's 2013-1 class A certificates to 'A+' from 'A'.
Fitch's primary ratings concerns revolve around future margin headwinds including rising wages for pilots and general uncertainty around the macroeconomic environment. Additionally, JBLU's growth strategy and the replacement of its E190 fleet will require heavy spending on aircraft deliveries over the next few years. The increased aircraft related capex is a critical part of JBLU's capacity plans but it will put pressure on FCF over the next two to four years and will most likely lead to incremental borrowing. These risks are offset by the company's adequate liquidity balance, its growing pool of unencumbered aircraft and its successful track record of growth.
Fitch will also monitor JBLU's increased focus on returning cash to shareholders, but at this time considers it a minimal concern due to the strength of the company's balance sheet. Longer term concerns also include the strengthened competitive position coming from the major network carriers as their financial performance has improved and the rapid growth of ultra-low cost competitors. Other risks include cyclicality and the high degree of operating leverage that is typical for the airline industry.
The Positive Outlook encompasses an expectation that the credit profile will weaken somewhat due to the significant capacity and fleet plans but also acknowledges JetBlue's flexibility financially and operationally as well as its current position compared to similarly and higher rated peers.
KEY RATING DRIVERS
Modest Margin Expansion in 2019: Fitch forecasts that the company will generate EBIT margins moderately above long-term averages in the high single digits to the low teens throughout our Base Case. The pressure on margins from the pilot contract has increased the importance of the execution of the structural cost program. By YE 2018 the company had achieved a run-rate of $199 million of the $250 million-$300 million in cost savings that it aims to achieve through its cost program. The program focuses on integrating technology into a number of areas, driving down airport costs, improving productivity tools surrounding maintenance and customer facing operations. The remaining cost savings to be achieved involve optimizing third party contracts and relationships across airports, corporate functions, and operations.
The program should be completed by 2020, when the company expects CASM-ex fuel to fall by 0.5% to 2.5%. This would be the first decline in unit costs for the company as CASM-ex has increased by more than 23% since 2011; a potential ratings concern. After 2020, Fitch expects JetBlue's units cost to benefit from the delivery of highly efficient A321neos and A220s as the E190 fleet begins to be removed from operation.
Since peaking in 2016, margins have declined the past two years. However, Fitch expects this trend to abate in 2019 with operating margins increasing modestly y-o-y primarily due to stabilized and slightly lower fuel prices along with benefits from the structural cost savings program and a number of revenue initiatives. Fitch's current forecast for 2019 incorporates a jet fuel price of $2.20/gallon, representing a roughly 2% decrease from JetBlue's average price paid in 2018 of $2.24. However, Fitch expects non-fuel unit costs to slightly rise for 2019 due to higher labor expenses offset by the cost saving initiatives that will reduce maintenance and other operational costs. The company reached a new pilot contract that implemented higher wages at the beginning of August 2018.
JetBlue's operating margins in 2018 were slightly below Fitch's expectations as EBIT margins declined to 9.8% from EBIT margins of 14.6% in 2017 (operating margins per Fitch's calculations add back stock based compensation). The decline was due to higher fuel prices, and the pilot wage increase. Still, JetBlue's margin performance has been above many of its competitors over the last three to four years.
Projected Top Line Growth: Fitch projects top line revenue growth of 6.5% in 2019 based on the company's network reallocation plan, which is cutting unprofitable routes and centering growth around Boston, New York, Fort Lauderdale and ancillary revenue growth. With the company expecting to receive 14 or more high density A321s and adding an additional 12 seats to the remaining 116 A320s over the next two years, the ability to add healthy and margin accretive capacity in these markets and Fort Lauderdale- Hollywood is key to JetBlue's future network and revenue growth.
Some of the network reallocation plan started in 2018 when JetBlue's top line grew by 9.2%. The revenue increase was mainly driven by continued sizeable capacity growth and a modest improvement in the yield environment. The majority of capacity growth for 2018 was implemented in the company's large focus cities. The addition of 10 new A321ceos (seven of which were in JetBlue's high density layout) and nine restyled A320s in 2018 helped the company implement its network reallocation plan and to expand in its most profitable but constrained markets. Leading market share and strong brand loyalty in the congested markets of Boston and New York has enabled the company to successfully add capacity while not compromising unit revenue growth.
Another area of growth for JBLU is ancillary revenues. JetBlue has a history of executing on its revenue initiatives such as Mint, Fare Options, and other ancillary products. The company has experienced material growth in its ancillary revenues that now averages $30 per costumer (compared to $27 in 2017) through higher bag fees and increased credit card sales. Furthermore, while JetBlue Travel Products' revenue contribution is currently minimal, Fitch sees the segment as a potential benefit to margins if the company can attract its loyal customers to do more of their leisure planning through the airline.
Heavy Aircraft Deliveries Pressure Projected FCF: The company's growth strategy has driven the decision to take on significant aircraft deliveries over the next four to five years. In both 2018 and 2017, capex was over $1.1 billion as the company received 10 and 16 aircraft, respectively, while also buying out aircraft leases, acquiring spare engines, and restyling the A320s. Capex will be between $1.2 billion and $1.4 billion for 2019 with $150 million to $200 million on technology investments and up to $1.2 billion spent on aircraft related investments including six to 13 A321neo deliveries and the cabin restyling for 60 A320s.
In 2020, JetBlue will add 15 A321neos and one A220 and in 2021 22 aircraft will be delivered, representing a significant amount of capital spending those years. The company expects total capital spending to average $1.5 billion annually from 2019 to 2022 compared to an average of $1.1 billion annually from 2015 to 2018. Nevertheless, Fitch expects JetBlue to generate $70 million to $200 million of FCF in 2019 due to improved operating performance. FCF generation in 2020 and 2021 may be materially pressured and could swing negative. Projected negative FCF would not necessarily inhibit a potential future upgrade because capital spending in the airline industry tends to be lumpy and uneven due the timing of aircraft deliveries. Fitch notes JetBlue does have some ability to defer future aircraft deliveries if it so choses like the company did in early 2017.
Leverage to Rise; Remain Manageable: As of Dec. 31, 2018, Fitch calculates JetBlue's total adjusted debt/EBITDAR at 3.0x, up from 2.3x at YE 2017. The higher leverage was caused by both higher debt balances and jet fuel prices. Fitch expects JetBlue's leverage to incrementally rise over the next three to four years driven primarily by debt funded aircraft deliveries. We don't view this as a material ratings concern since JetBlue's current leverage is modest and we believe that management will continue to prioritize a healthy balance sheet overall. Nevertheless, the meaningful improvements seen in JetBlue's balance sheet in recent years are unlikely to continue in the near-to-intermediate term. Fitch estimates that adjusted debt/EBITDAR will remain between 2.8x and 3.6x over the intermediate term.
JetBlue's leverage is currently below several peers that Fitch rates in the 'BB' category. Leverage improvement over the past few years has largely been driven by relatively low fuel costs, increased capacity, and debt amortization.
Before the company increased debt by $456 million in 2018, it had used cash flows to decrease debt by more than $1.5 billion from 2012 to 2017. However, looking forward the company continues to purchase a significant number of aircraft with cash and debt. Technology investments and returning cash to shareholders will also be priorities for the company. JetBlue's unencumbered asset base as of 2018 stood at 107 aircraft, which equates to more than $2.5 billion in value. Fitch considers high quality unencumbered aircraft to be a good additional source of financial flexibility.
Solid Financial Flexibility: FCF generation remains a credit positive for the company but has declined over the last two years from peak levels at over $600 million in 2015 and 2016. JetBlue generated $103 million of FCF in 2018, which is about $93 million lower than FCF in 2017. While capex was only slightly down compared to 2017, FCF was pressured by higher fuel prices and higher wages.
JetBlue's liquidity is supportive of the ratings. As of Dec. 31, 2018, JetBlue had cash and cash equivalents balance of $474 million, short-term investment securities of $413 million and an undrawn balance of $425 million on its revolving credit facility. Fitch considers total liquidity to be more than adequate to address near-term needs. Upcoming debt maturities are manageable peaking at slightly over $300 million during the next three to four years. Despite cash flow from operations remaining relatively stable, Fitch forecasts that JetBlue will need to moderately increase debt funding over the next three to four years as the company funds aircraft capex. Assuming a stable operating environment, share buybacks are likely to remain around current levels. Management intends to continue to target 10% to 12% liquidity (cash and short-term investments) to LTM revenues over the next few years.
Financial flexibility is also supported by JetBlue's growing base of unencumbered assets. Fitch considers JetBlue's unencumbered Airbus A320s and A321s to be high quality assets which should support capital market access in the case of a liquidity crunch. Fitch expects JetBlue to further expand its base of unencumbered assets over the coming years as existing aircraft secured debt amortizes. Unencumbered aircraft also provide JetBlue with strategic flexibility to reduce capacity if needed.
Fitch has upgraded JetBlue's 2013-1 class A certificates to 'A+' from 'A'. The ratings upgrade is primarily based on an increasing level of overcollateralization due to the relatively rapid amortization profile of this transaction compared to other EETCs. Fitch calculates the current 'A' tranche loan to value (LTV) at 50.7% using appraisal values from independent appraisal firms. Fitch's maximum stress case LTV (the primary driver for the 'A' tranche rating) through the life of the transaction is 68.2% (when stresses are applied two years in the future). This level of OC provides a more sizeable amount of protection than many EETCs issued by other US airlines that Fitch rates at 'A'. The transaction is backed by 14 Airbus A320-200s delivered between 2002 and 2012. Fitch considers the A320-200 to be a Tier 1 aircraft, though we assume that the planes migrate to Tier 2 status as they reach 15 years of age (which leads to higher depreciation and values stresses in Fitch's modelling). The oldest aircraft are scheduled to fall out of the collateral pool prior to the transaction's maturity. Two aircraft drop out in March 2021 and four more drop out in March 2022, leaving eight aircraft in the pool for the final year prior to maturity.
JetBlue has shown significant improvement in its credit profile over the last three to four years. Despite the current rating of 'BB', the company's leverage metrics remain strong for the rating and are near those of Delta Airlines (DAL; BBB-) and Southwest Airlines (LUV; A-). Alaska Air (ALK; BBB-) currently has a weaker leverage profile than JetBlue with adjusted leverage at 4.1x compared to JetBlue's 3.0x at YE 2018. Fitch expects JetBlue's leverage to increase and ALK's to decrease modestly over next few years as ALK continues its of integration of Virgin and JetBlue finances its significant aircraft delivery schedule. Profitability continues to be a credit positive for JetBlue as the company has produced operating margins above the North American airline average for much of the past decade. However, profitability suffered compared to competitors in 2018 as operating costs rose. For the 2018, the carrier generated EBITDAR margins of 20.5% compared to margins of 22.0% for Alaska and 24.1% for Southwest.
Unlike ALK, LUV, and DAL, which have a history of containing cost inflation, JetBlue has struggled to keep its unit costs from increasing each year. Wage pressures from a recently ratified pilot contract will create headwinds in the near-term future. However, JetBlue is working through a structural cost control program aimed at keeping the cost per available seat mile, ex-fuel, to a 0%-1% CAGR between 2018 and 2020. As of 2018, JetBlue's liquidity as a percent of revenues is 17.2%, which is around the industry average and moderately better than similarly rated peers, such as United Continental Inc. (BB), at 14.4%. Financial flexibility will be driven by future free cash flow generation and the continued growth of the number of unencumbered aircraft.
JetBlue's network and route diversification still lags behind the big four U.S. carriers, but has strengthened over the past several years. The company has built a more defensible network with a leading market share in each of its three main focus cities (BOS, JFK and FLL).
The 'A+' rating on JetBlue's 2013-1 class A certificates is one notch above many peers rated at 'A', with the primary difference being a higher degree of overcollateralization on the JetBlue transaction.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Capacity growth in the mid- to high-single digits over the forecast period;
- North American Air traffic demand remains steady;
- Some incremental borrowing to fund aircraft deliveries throughout the Base Case;
- The company continues to return cash to shareholders;
- Jet Fuel ranges from $2.20 per gal to $2.30 per gal during the Base Case.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
Fitch has updated its sensitives to be more closely aligned with similarly rated peers. The updated rating sensitivities reflect Fitch's increased confidence in the sustainability of JetBlue's business model over time as well as its top-line growth and network diversification in recent years.
- FCF margins remaining in the low-to-mid-single-digits as a percentage of revenue.
- EBIT margins remaining in the low double digits.
- Sustained commitment to conservative financial policies.
- Adjusted debt/EBITDAR sustained around 3.0x.
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 4.0x
- FCF margins declining to neutral on a sustained basis or FFO fixed charge coverage falling below 4x on a sustained basis.
Healthy Liquidity: As of Dec. 31, 2018, JetBlue had a cash and cash equivalents balance of $474 million, short-term investment securities of $413 million and full availability under its $425 million revolving credit facility. Total liquidity, including the undrawn revolver, is equivalent to 17.2% of LTM revenue, which is near but slightly below the industry average.
As of Dec. 31 2018, the company had 253 aircraft: 130 A320s, 35 A321s with the Mint Configuration, 28 A321s with one core cabin, and 60 E190s. At the end of 2018, the company stated it had 107 unencumbered aircraft consisting of A320s and A321s. Fitch considers JetBlue's unencumbered Airbus A320s and A321s to be high-quality assets that should support capital market access in a stress case scenario. Fitch expects JetBlue to pay for some aircraft with cash and pay down existing aircraft secured debt as the company continues to grow its unencumbered aircraft base. Fitch forecasts that JetBlue's cash on hand and operating cash flow generation would cover its capital expenditures and debt maturities in 2018, however the company will likely use some debt funding to finance aircraft deliveries.
Revolver: The $425 million revolving credit facility, which had its borrowing availability increased from $400 million during 2017, is secured by take-off and landing slots at JFK, Newark Liberty, LaGuardia, and Washington Reagan, and is set to mature in April of 2021. The revolver capacity gives JetBlue additional cushion in the case of a future liquidity crunch. JetBlue's other facility, which was entered into during 2012, is a $200 million revolving line of credit. The credit facility is renewed annually and secured by investment securities held at Morgan Stanley. Fitch does not include this revolving credit facility in our total liquidity calculation to avoid "double counting" since the facility is secured by the investment securities on the balance sheet that we consider a part of readily available cash.
Other: JetBlue's debt primarily consists of secured fixed and floating rate notes backed by aircraft and related assets. Fitch also includes roughly $424 million related to JetBlue's construction obligation for terminal five at New York's JFK airport in its debt calculation. The obligation represents ground and facility rent payments made by JetBlue that are based on the number of passengers enplaned out of the terminal, and subject to annual minimums. The obligation is treated as a financing obligation for reporting purposes, and the constructed asset and corresponding liability are shown on the balance sheet.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
JetBlue Airways, Corp.
--IDR at 'BB';
--Senior secured credit facility at 'BB+'/'RR1'.;
The Rating Outlook is Positive.
Fitch upgrades the following rating:
JetBlue Airways Pass Through Trust Certificates, Series 2013-1
--Class A certificates to 'A+' from 'A'.