Fitch Ratings has downgraded American Airlines rating to 'B+' from 'BB-' and revised the Rating Outlook to Negative from Stable.
The rating action is based on the sharp drop in demand occurring in the market due the coronavirus pandemic. U.S. airlines are reporting steep and broad-based declines in passenger numbers since the virus began to appear widely outside of China. Additional debt raised to bolster liquidity, higher leverage and reduced financial flexibility along with the worsening drop in demand make returning to metrics consistent with Fitch's prior base case unlikely before 2022.
American has a significant amount of liquidity and the ability to raise more in the near term if needed. Therefore, Fitch believes the financial distress of the next few months is manageable, but cash burn will be significant and future downgrades are possible if the drop in demand goes on longer than expected.
American's 'B+' rating is supported by the company's market position as one of the largest airlines in the world and its dominant position in key hubs. However, credit metrics have been pressured over the past two years by a combination of one-time events including labor issues and the 737 MAX grounding, and by rising labor costs and by an intensely competitive environment. Fitch had expected metrics to improve over the next one to two years, as declining capital expenditures allowed for debt reduction, and as various revenue initiatives took hold; however, the current environment pushes that improvement further into the future. American's adjusted leverage at YE 2019 was 5.0x, which Fitch considered high for the 'BB-' rating.
KEY RATING DRIVERS
Coronavirus Assumptions: Fitch's main coronavirus scenario envisions a more than 25% drop in RPMs for the full year compared to the agency's prior forecast or roughly 18% below 2019 levels, along with a mid-single digit drop in yields. This would entail a steep drop-off in 2Q and 3Q traffic followed by a recovery in 4Q. This scenario will be revised further as more data becomes available. In this scenario, credit metrics would remain outside of Fitch's prior negative sensitivities through 2021. Liquidity could become strained in the near term, although Fitch expects that American has sufficient borrowing capacity to avoid running short of cash. Lower liquidity and higher debt balances will also leave American more exposed to future exogenous events should they occur. Fitch's stress scenario evaluated monthly cash burn assuming a revenue drop of at least 75% over the next few months.
Mitigating Actions: American has announced that it will cut international capacity by 75% in the near term, while domestic will be cut by 20% in April and 30% in May. Further domestic cuts are likely as public concerns and efforts to slow the virus increase. American is making efforts to cut back on non-essential costs such as hiring, consulting fees, non-essential training, etc. The sharpest impact to operating results will be in the next few months, as airline operating costs are largely fixed in the near term but become much more variable several months in the future. American is looking at fleet actions that should have longer-term benefits. The drop in demand has led to announcements that the company will retire its 767 and 757 fleets earlier than planned. These actions will simplify the fleet, driving ramifications on crew and maintenance costs, although the bulk of these benefits would be longer-term in nature.
The price of jet fuel is a key consideration. The recent drop in crude prices plus reductions in flying could cut American's fuel bill nearly in half from around $9.4 billion that it spent in 2019. Fitch's stress case incorporates jet fuel of around $1.50/gallon in 2020.
American has also taken steps to shore up liquidity, arranging for a $1 billion delayed draw term loan. The term loan will bring American's total liquidity to greater than $8 billion. More borrowing is likely to be necessary in the near term as cash burn in the next couple of months will be material due to the sharp drop in bookings. Other levers to be pulled include borrowing against the company's estimated $10 billion in unencumbered assets or potentially engaging in forward sales of miles to credit card partners.
Fitch's ratings do not reflect government assistance. However, if the proposed $50 billion airline assistance package is approved, it would provide American with significant additional liquidity to weather the downturn. Initial proposals call for proceeds to be distributed by percentage of ASMs flown by each carrier, meaning that American could benefit by more than $10 billion.
International Exposure: International travel has been harder hit by the coronavirus outbreak than domestic travel. American has relatively little exposure to Asia, but more than 11% of revenue comes from trans-Atlantic flying, which will be heavily impacted by the recently announced U.S. travel ban.
Cash Flow Aided by Moderate Capital Spending: American has passed the peak of what was an intense period of capital spending centered on the company's fleet renewal process. Fitch had expected lower capital spending to drive material FCF generation, allowing the company to pay down debt. Fitch now anticipates negative FCF generation and higher debt balances this year. Nonetheless, the fact that capital plans for the year were already much more modest than in prior years helps to stem cash burn during the coronavirus outbreak. Additionally, American has already arranged financing for the majority of its 2020 deliveries. Relatively low forecasted spending in upcoming years should also allow American to recover and to pay down incremental debt as demand returns.
American's EETC ratings were not a part of this rating review. Fitch intends to review all of American's EETC ratings within the next several business days.
American is rated lower than its major network competitors, Delta and United primarily due to the company's more aggressive financial policies. American's debt balance has increased substantially since its exit from bankruptcy and merger with US Airways in 2013 as it has spent heavily on fleet renewal and share repurchases. As such American's adjusted leverage metrics are at the high end of its peer group. The risk of maintaining a high debt balance is partially offset by American's substantial cash position.
--A sharp drop in near-term demand leading to revenues down 75% or more over the next several months.
--Fuel costs at $1.50/gallon through 2020.
--A gradual return to normal bookings in the back half of the year.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Adjusted debt/EBITDAR sustained above 5x;
--EBITDAR margins deteriorating into the single digit range;
--Shareholder-focused cash deployment at the expense of a healthy balance sheet;
--Evidence of strained liquidity caused by the current drop in demand.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Adjusted debt/EBITDAR sustained below 4.5x;
--FFO fixed-charge coverage sustained around 2.75x;
--FCF generation above Fitch's base case expectations;
--Moderating policies toward financial leverage and shareholder-friendly cash deployment.
LIQUIDITY AND DEBT STRUCTURE
American had total unrestricted cash and short-term investments of $3.8 billion, plus $3.2 billion in undrawn revolver capacity, equal to 15.5% of LTM revenue, as of Dec. 31, 2019. This is above the airline's long-term minimum liquidity target of $7 billion. This was bolstered by the company's recently announced $1 billion term loan.